[Federal Register Volume 65, Number 240 (Wednesday, December 13, 2000)]
[Rules and Regulations]
[Pages 77962-77993]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 00-30267]
[[Page 77961]]
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Part II
Commodity Futures Trading Commission
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17 CFR Part 1 et al.
A New Regulatory Framework for Multilateral Transaction Execution
Facilities, Intermediaries and Clearing Organizations; Rules Relating
to Intermediaries of Commodity Interest Transactions; A New Regulatory
Framework for Clearing Organizations; Exemption for Bilateral
Transactions; Final Rules
Federal Register / Vol. 65, No. 240 / Wednesday, December 13, 2000 /
Rules and Regulations
[[Page 77962]]
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COMMODITY FUTURES TRADING COMMISSION
17 CFR Parts 1, 5, 15, 36, 37, 38, 100, 170 and 180
RIN 3038-AB55
A New Regulatory Framework for Multilateral Transaction Execution
Facilities, Intermediaries and Clearing Organizations
AGENCY: Commodity Futures Trading Commission.
ACTION: Final rulemaking.
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SUMMARY: The Commodity Futures Trading Commission (Commission or CFTC)
is promulgating a new regulatory framework to apply to multilateral
transaction execution facilities, to market intermediaries and to
clearing organizations. This new framework constitutes a broad
exemption under the authority of section 4(c) of the Commodity Exchange
Act (Act or CEA) from many of the current rules applicable to
designated contract markets. In addition, the new framework relies more
heavily on disclosure rather than merit regulation. It establishes
three new market categories, including the category of exempt
multilateral transaction execution facility and two categories of
Commission-recognized and regulated multilateral transaction execution
facilities. In companion releases published in this edition of the
Federal Register, the Commission also is adopting new rules for
intermediaries and entities that clear derivative transactions. These
final rules make fundamental and far-reaching changes to Federal
regulation of commodity futures and option markets. However, nothing in
these rules alters or diminishes the Commission's responsibility for
overseeing and enforcing compliance by self-regulatory organizations,
Commission registrants and market participants with the provisions of
the Act.
The Commission in a companion release published in this edition of
the Federal Register also is expanding and clarifying the operation of
the current swaps exemption. Nothing in these releases, however, would
affect the continued vitality of the Commission's exemption for swaps
transactions under part 35 of its rules, or any of its other existing
exemptions, policy statements or interpretations. Moreover, nothing in
the final rules would affect the application of any statutory
exclusion, including in particular, the applicability of the exclusion
under section 2(a)(1)(A)(ii), known as ``the Treasury Amendment.''
EFFECTIVE DATE: February 12, 2001.
FOR FURTHER INFORMATION CONTACT: Paul M. Architzel, Chief Counsel,
Division of Economic Analysis, or Alan L. Seifert, Deputy Director or
Riva Spear Adriance, Special Counsel, Division of Trading and Markets,
Commodity Futures Trading Commission, Three Lafayette Centre, 1155 21st
Street, N.W., Washington, D.C. 20581. Telephone: (202) 418-5260. E-
mail: ([email protected]), ([email protected]) or
([email protected]).
SUPPLEMENTARY INFORMATION:
I. Background
A. Overview
The Commission, on June 22, 2000, proposed a new regulatory
framework to apply to multilateral transaction execution facilities
that trade contracts of sale of a commodity for future delivery or
commodity options. 65 FR 38986. The Commission proposed this new
framework to ``promote innovation, maintain U.S. competitiveness, and
at the same time reduce systemic risk and protect customers.'' Id. The
framework provides U.S. futures exchanges greater flexibility with
which to respond to the competitive challenges brought about by new
technologies.
Specifically, the framework proposed to replace the current ``one-
size-fits-all'' regulation for futures markets with broad, flexible
``core principles,'' and to establish three regulatory tiers for
markets: recognized futures exchanges (RFEs), derivatives transaction
facilities (DTFs) and exempt multilateral transaction execution
facilities (exempt MTEFs). The proposed core principles were tailored
to match the degree and manner of regulation to the varying nature of
the products and the participants permitted to trade on a facility.
In general, the framework proposed a lower level of regulatory
oversight where access to an exchange or facility is restricted to
eligible participants or commercial participants or where the nature of
the underlying commodity poses a relatively low susceptibility to
manipulation. This reflects the reduced need to monitor closely such
markets. The Commission also proposed, however, that markets serving a
price discovery function, irrespective of the product traded or market
participants, provide a degree of price transparency. The proposed
framework therefore balanced the public interests of market and price
integrity, protection against manipulation and customer protection with
the need to permit exchanges and other trading facilities to operate
more flexibly in today's competitive environment. As noted in the
Notice of Proposed Rulemaking, the President's Working Group on
Financial Markets and the chairmen of the Commission's Congressional
oversight committees encouraged the Commission to consider proposing
such major revisions to the regulatory framework.\1\ 65 FR at 38987.
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\1\ Recognizing the importance of the OTC derivatives markets,
the Chairmen of the Senate and House Agriculture Committees asked
the President's Working Group on Financial Markets (PWG) to conduct
a study of OTC derivatives markets. After studying the existing
regulatory framework for OTC derivatives, recent innovations, and
the potential for future developments, the PWG on November 9, 1999,
reported to Congress its recommendations. See, Over-the-Counter
Derivatives Markets and the Commodity Exchange Act, Report of the
President's Working Group. The PWG report focused on promoting
innovation, competition, efficiency, and transparency in OTC
derivatives markets and in reducing systemic risk. Although specific
recommendations about the regulatory structure applicable to
exchange-traded futures were beyond the scope of its report, the PWG
suggested that the Commission review existing regulatory structures
(particularly those applicable to markets for financial futures) to
determine whether they were appropriately tailored to serve valid
regulatory goals.
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B. The Proposed Rules
Under the proposed framework, current U.S. futures exchanges would
be included automatically in the RFE category.\2\ These exchanges would
be permitted greater business flexibility through compliance with core
principles rather than the prescriptive regulations now in place. In
addition to achieving greater flexibility in their current operations,
the exchanges, as a business choice, also could operate as a DTF or as
an exempt MTEF, as appropriate.
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\2\ Products subject to the special procedural provisions of
section 2(a)(1)(B)(ii) of the Act, however, must continue to be
designated and regulated by the Commission as contract markets.
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The proposed DTF market would be subject to an intermediate level
of regulation. DTFs, like RFEs, would be Commission-recognized markets.
As proposed, DTFs would be geared either to mainly institutional
traders or to only commercial traders. Specific requirements proposed
for DTFs differ somewhat depending upon whether a DTF is an
institutional or a commercial market.
The Commission proposed that institutional-participant DTFs may
provide a trading platform for transactions involving those commodities
listed in the rules that are eligible for such an intermediate level of
regulation.\3\ Additional commodities,
[[Page 77963]]
including agricultural commodities, would be eligible to trade on an
institutional-participant DTF on a case-by-case determination. The
Commission would make that determination based upon the depth and
liquidity of the cash market and on the surveillance history of the
commodity based on its actual trading history.
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\3\ The eligible commodities are those that are listed as
eligible for trading on an exempt MTEF. The rules relating to exempt
MTEFs are discussed below. A market that otherwise might be eligible
to be exempt from regulation as an exempt MTEF may voluntarily
become a DTF in order to be become a ``recognized'' market.
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Although institutional-participant DTFs would be intended primarily
for institutional traders, the proposed rules provide individual DTFs
with the flexibility to decide whether or not to permit access by non-
institutional traders. The Commission proposed, therefore, to permit
access to a DTF by non-institutional traders only through a registered
futures commission merchant (FCM) that is a member of a recognized
clearing organization and that has $20 million of adjusted net capital.
Those FCMs would be required to provide their non-institutional
customers trading on a DTF with additional disclosures and other
protections.
In addition, the rules proposed an intermediate level of oversight
for commercial-participant DTFs. Only commercial participants trading
for their own accounts would have access to these facilities.
Commercial-participant DTFs may trade any commodity other than the
agricultural commodities enumerated in section 1a(3) of the Act,
government securities and commodities subject to the provisions of
section 2(a)(1)(B)(ii) of the Act. Such commercial traders generally
would have both the financial ability and the physical means to deliver
tangible commodities or otherwise be involved in trading that commodity
in connection with their line of commerce. Accordingly, certain
requirements that were proposed to apply to institutional-participant
DTFs would not be applicable to commercial-participant DTFs.
The Commission also proposed a market tier exempt from all
Commission regulation, subject only to the Act's anti-fraud and anti-
manipulation provisions and a requirement that, if performing a price
discovery function, the market provide pricing information to the
public. This exemption was proposed for facilities on which
transactions would be entered into among institutional traders in
contracts based upon a specified list of commodities.\4\ The Commission
proposed to exempt counterparties to such transactions from a claim in
a private right of action that a violation of the terms of the
exemption renders the transactions void. These exempt markets could not
hold themselves out as being regulated by the Commission. As noted
above, existing futures markets, where appropriate, would have the
opportunity to operate under the terms of this exemption, if they so
choose.
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\4\ The proposed list of commodities included: a debt
obligation, a foreign currency, an interest rate, an exempt
security, a measure of credit risk or quality, or cash-settled based
upon an economic or commercial index or based upon an occurrence or
contingency.
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C. Overview of Comments
The Commission received a total of 71 comments from a wide range of
commenters on the proposed new regulatory framework for multilateral
transaction execution facilities.\5\ The commenters included 24 trade
associations, six commodity exchanges, two government agencies, four
financial institutions, three attorneys, two institutional study
organizations, one agri-business firm, a self-regulatory organization,
and several energy and communication firms or markets.
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\5\ A significant number of letters commenting on aspects of the
regulatory framework raised in companion notices were also submitted
to the Commission. In this and three companion Notices of Final
Rulemaking which are being published in this edition of the Federal
Register, comment letters (CL) are referenced by file number, letter
number and page. Comments filed in response to the notice of
proposed rulemaking on MTEFs, parts 36-38, are contained in file No.
21, on the notice of proposed rulemaking on intermediaries in file
No. 22, on the notice of proposed rulemaking on clearing in file No.
23 and on the notice of proposed rulemaking on the part 35 exemption
in file No. 24. These letters are available through the Commission
internet web site, www.cftc.gov.
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In addition to comment letters, the Commission received oral and
written statements during a public meeting held at the Commission's
headquarters on June 27 and 28, 2000. At that meeting, members of the
public had an opportunity to address the Commission and to respond to
questions.\6\ During the meeting, several panels of industry experts,
representing the U.S. futures exchanges, the over-the-counter
derivatives markets, emerging information and technology providers,
market intermediaries and clearing organizations discussed the
proposals in the context of current market structures and future
trends. The proposed rules were also discussed and public comments
received at a July 19, 2000, meeting of the Commission's Agricultural
Advisory Committee (AAC).\7\
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\6\ A transcript of the proceedings was included in the
Commission's comment file and is available through the Commission's
internet web site.
\7\ A transcript of the AAC meeting is also included in the
Commission's comment file and is available on the Commission's
website.
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The overwhelming majority of the comments expressed general support
for the Commission's proposed framework, and provided specific
suggestions for its improvement. Many commenters described the
Commission's initiative as a bold or important departure from the
status quo which recognizes the beginnings of a new financial market
landscape. In general, the commenters supported the framework's
innovative concepts of providing greater regulatory flexibility by
substituting core principles for prescriptive, one-size-fits-all
regulations, and of tiered regulations tailored to the particular
nature of the market. They also generally supported the Commission's
initiative as providing greater legal certainty to various types of
instruments.
Four commenters, however, strongly disagreed with the Commission's
approach, albeit for opposing reasons. One institutional study
organization argued that the proposal would take regulatory reform too
far. In contrast, a second institutional study organization, an
investment banking firm and an attorney expressed serious reservations,
contending that the framework provided neither significant regulatory
relief nor greater legal certainty. The substance of individual
comments is discussed in greater detail below.
II. Final Rules
A. Exempt Multilateral Transaction Execution Facilities (Exempt MTEFs)
As discussed above, the Commission, in revised part 36, proposed a
new, self-effectuating exemption for those multilateral transaction
facilities (MTEFs) to which only eligible participants have access,
either trading for their own account or through another eligible
participant, and only for contracts based upon: (1) A debt obligation;
(2) a foreign currency; (3) an interest rate; (4) an exempt security or
index thereof, as provided in section 2(a)(1)(B)(v) of the Act; (5) a
measure of credit risk or quality, including instruments known as
``total return swaps,'' ``credit swaps'' or ``spread swaps''; (6) an
occurrence or contingency beyond the control of the counterparties to
the transaction; or (7) cash-settled, based upon an economic or
commercial index or measure beyond the control of the counterparties to
the transaction and not based upon prices derived from trading in a
directly
[[Page 77964]]
corresponding underlying cash market.\8\ The Commission proposal was
based upon the ``view that these commodities, when traded between or
among eligible participants need not be subject to the regulatory
scheme of the Act. Accord PWG Report at 17.'' 65 FR at 38988.
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\8\ It should be noted that the instruments eligible for
exemption are limited by operation of section 2(a)(1)(B) of the Act,
which is reserved in proposed Sec. 36.3(a). As the Commission
observed, ``[t]he reservation, and application, of this provision is
consistent with the language of section 4(c) of the act which limits
the Commission's authority to exempt transactions from the
application of section 2(a)(1)(B) of the Act.'' 65 FR at 38988.
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Many commenters strongly supported this new exemption. For example,
the International Swaps and Derivatives Association, Inc. (ISDA)
observed that the ``clarifications contained in the Exempt MTEF
proposal are of critical importance to ISDA and its members.'' CL 21-37
at 4. Reuters Group PLC (Reuters), a provider and developer of
``electronic business-to-business transaction communities,'' stated
that in its view, ``[t]his new category of Exempt MTEF provides
significant legal certainty to new electronic marketplaces in the
enumerated derivatives.'' CL 21-62 at 3. A group of commercial and
investment banks (Coalition) \9\ commented that it ``strongly supports
the Commission's proposal, and believes that the proposal represents a
very important initiative both to promote legal certainty and to
facilitate the development by U.S. market participants of electronic
trading systems and technologies and the expanded use of clearing
facilities. In addition, proposed part 36 would * * * limit[] the
ability of an eligible participant to repudiate unprofitable contracts
based on the CEA. The Coalition strongly supports these provisions. * *
*'' CL 21-65 at 9. An attorney with the firm of Covington & Burling
commented that:
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\9\ They are: Chase Manhattan Bank; Citigroup, Inc.; Credit
Suisse First Boston, Inc.; Goldman Sachs & Co.; Merrill Lynch & Co.,
Inc.; and Morgan Stanley Dean Witter & Co.
Derivative transactions satisfying these three conditions would
be exempt from virtually all CEA regulation * * * and either (1)
were traded on a multilateral transaction execution facility (MTEF),
under newly-proposed part 36 of the Commission's regulations; or (2)
were not traded on an MTEF, under newly-revised part 35 of the
Commission's regulations. Thus, participants * * * would obtain
legal certainty about the limited scope of CEA regulation regardless
of whether the means for executing transactions did or did not
satisfy the technical definition of an MTEF.
It is our understanding that several comments have been filed
with the Commission that seek changes to the proposed regulations in
ways that conceivably could affect the legal certainty described
above, including the Commission's statement supporting such legal
certainty. We urge the Commission not to make any changes that would
affect the interrelationship between the MTEF exemption and the
bilateral transactions exemption in a manner that would diminish the
legal certainty provided to eligible participants trading exempt
commodities.
CL 21-63 at 2-3.
A number of the comments that generally supported proposed part 36
also suggested specific modifications, relating mainly to the
commodities which were proposed to be eligible for the part 36
exemption and the proposed definition of MTEF. These issues, along with
three comments opposing the proposed part 36 exemption on mainly
jurisdictional grounds, are discussed below.
1. Jurisdictional Issues
Three commenters objected to the part 36 exemption on
jurisdictional grounds. See, CLs 21-28, 55 and 57. One of the three, JP
Morgan Securities, Inc. (JP Morgan), objected generally to proposed
part 36, and particularly to the inclusion of instruments eligible for
the exemption that are ``a measure of credit risk or quality, including
instruments known as `total return swaps,' `credit swaps,' or `credit
spread swaps,''' reasoning that:
An Exempt MTEF is to be subject to the anti-fraud and anti-
manipulation provisions of the Act, as well as to whatever future
rule the Commission may enact governing information dissemination.
Therefore, a proposed ``exemption'' from the CEA has the effect of
extending the Commission's authority to facilities that may trade
products, such as swaps, which are not the Commission's to regulate
under the terms of the Act itself. A self-effectuating ``exemption''
in this instance unintentionally becomes the reverse, an assertion
of CFTC jurisdiction over non-futures products.
CL 21-55 at 4.
However, JP Morgan's conclusion is erroneous. As explained in its
Notice of Proposed Rulemaking (65 FR at 38989), and reiterated herein,
the Commission, by providing an exemption under part 36, is not thereby
making an initial determination that any particular instrument which
may be trading in reliance on the exemption is or is not within the
Commission's jurisdiction. The use of the Commission's section 4(c)
exemptive authority in this context to provide legal certainty to novel
instruments without a preliminary determination by the Commission of
complex jurisdictional issues is precisely as intended by the Congress.
When Congress adopted section 4(c) in 1992, the Conferees stated:
The conferees do not intend that the exercise of exemptive
authority by the Commission [under Section 4(c)] would require any
determination beforehand that the agreement, instrument, or
transaction for which an exemption is sought is subject to the Act.
Rather, this provision provides flexibility for the Commission to
provide legal certainty to novel instruments where the determination
as to jurisdiction is not straightforward.\10\
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\10\ H.R. Rep. No. 978, 102d Cong., 2d Sess. 82-83 (1992).
Moreover, the assertion that the Commission through this exemption
would extend provisions of the Act to instruments or persons not
subject to the Act misconstrues the nature and the scope of the
exemption. As proposed, rule 36.3(a) provides that the anti-fraud and
anti-manipulation sections of the Act ``continue to apply to
transactions and persons otherwise subject to those provisions.'' \11\
65 FR at 38999. Thus, it is clear that the proposed rules do not
attempt to extend application of the Act to any transactions not
already subject to the Act.\12\
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\11\ See also, CL 21-57 at 4, which makes the same fundamental
error.
\12\ In this regard, it must be noted that sections 6(c) and
9(a)(2) of the Act prohibit manipulation of ``the market price of
any commodity, in interstate commerce,'' and is not limited in
application to ``contracts of sale of a commodity for future
delivery.''
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Proposed rule 36.2(g) requires that an exempt MTEF disseminate
trading volume, price ranges and other trading data, but only pursuant
to a Commission determination, after notice and an opportunity for a
hearing, that the facility serves as a significant source for the
discovery of prices. That procedure provides the facility with an
opportunity to challenge the validity of the Commission's authority to
issue and enforce such an order on the grounds that the instruments
being traded are not subject to the Act.\13\ Nevertheless, the
Regulatory Studies Program of the Mercatus Center (Mercatus) opined
that, even though ``a party could contest the CFTC's assertion of
jurisdiction * * * it is the mere assertion of regulatory jurisdiction
by the CFTC that in the past has created the legal uncertainties that
these Proposals attempt to address.'' CL 21-57 at 4.
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\13\ For example, were the Chicago Mercantile Exchange (CME) to
offer trading of its Eurodollar contract through an exempt MTEF, the
rule provides for public notice and an opportunity for public
comment in determining that the market ``serves as a significant
source for the discovery of prices for an underlying commodity'' and
to require that, as a consequence, it disseminate certain
information to the public. See, PWG Report at 19.
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However, proposed rule 36.3(b), the contract non-repudiation
provision,
[[Page 77965]]
further removes any such potential negative, collateral effects on
other markets. To the extent that part 36 applies to transactions
traded on a facility, the contract non-repudiation provision also
applies, reinforcing the legal certainty and validity of the
transactions. On the other hand, to the extent that transactions and a
market are outside of the Commission's jurisdiction, the Act and
Commission rules (including the part 36 exemption) are inapplicable,
and hence there can be no legal uncertainty about the validity of the
contracts arising from the Act or Commission rules thereunder. As the
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Commission explained in the Notice of Proposed Rulemaking,
the Commission is not making a determination that any market that is
eligible to be an exempt MTEF under the proposed exemption is or is
not subject to the Commission's jurisdiction under the CEA.
Moreover, the fact that one market may operate as an exempt MTEF in
reliance upon the proposed exemption * * * does not imply that the
Commission has made a determination that any firm or entity that
operates in a similar manner is subject to the Commission's
jurisdiction under the CEA.
65 FR at 38989 (footnote omitted). Thus, the existence and application
to any particular market of the part 36 exemption carries no negative
legal inference or uncertainty for any other market.
Nevertheless, Mercatus further argues that the proposed exemption
``raises a whole new area for legal uncertainty in that the broad
definition of MTEF in Proposed Rule 36.1(b) would appear to cover
auction markets such as eBay and all other forms of B2B trading
facilities, whether electronic or not.'' CL 21-57 at 5. Similarly, an
attorney with the firm of Vinson & Elkins argues that, ``multilateral
transaction execution facilities--regardless of the nature of their
participants or the nature of the economic activity being undertaken on
those facilities--must agree to become regulated by the CFTC.'' CL 21-
28 at 1. This misconstrues the operation and structure of the part 36
exemption. As noted above, the exemption in part 36 is from application
of the Act. To the extent that the Act does not apply to a facility's
transactions, the regulatory framework is simply inapplicable. Thus, so
long as a facility auctions instruments outside of the Commission's
regulatory jurisdiction under the Act, these exemptions therefrom and
this framework would have no application to its business.
2. Eligible Commodities
Some commenters have suggested that the commodities eligible for
this exemption should differ somewhat from those proposed by the
Commission. Specifically, the United States Department of the Treasury
(Treasury) recommended that government securities should be ineligible
for trading on exempt MTEFs. Treasury noted that contracts eligible to
trade on an exempt MTEF would have included both single government
securities and baskets of government securities. It further noted that
``[s]ince the introduction of futures contracts on government
securities in the late 1970s, the trading of these instruments on
futures exchanges has always been subject to Commission regulation, and
all dealers and brokers in the cash market for government securities
have been subject to regulation since the enactment of the Government
Securities Act.'' CL 21-50 at 2.
As the Commission explained in its Notice of Proposed Rulemaking,
65 FR at 38988, its determination of which commodities to include as
eligible for exempt MTEF status was informed by the recommendations of
the PWG, including its recommendation to exclude from the Act
transactions by eligible participants on electronic trading systems in
commodities other than non-financial commodities with finite supplies.
Treasury, however, has concluded that, for futures and options on
government securities, a higher level of regulation than trading as an
exempt MTEF is necessary and appropriate in order not to ``undermine
the integrity of the government securities markets.'' Id. As Treasury
noted in its comment letter,
[p]rior to 1986, * * * problems with these entities [government
securities brokers and dealers] led to the passage of the Government
Securities Act of 1986, which was amended in 1993 to address issues
related to auction irregularities, short squeezes, and unfair sales
practices * * *. Allowing government securities futures to trade on
exempt MTEFs, where they would not be subject to the Government
Securities Act or any other regulatory framework designed to address
potential problems, could undermine the integrity of the government
securities markets.
[T]here have been a number of attempts to manipulate individual
securities within the broader market. Additionally, fraud and
mistreatment of customers has in the past also been a concern in the
government securities market.
Id.
In deference to Treasury's expressed concern that a higher level of
regulation is necessary than provided at the exempt MTEF level, the
final rules adopted by the Commission do not include government
securities as eligible for trading on exempt MTEFs. Specifically, the
Commission has removed the reference to exempt securities and indexes
thereof previously included in proposed rule 36.2(b)(4) and has amended
final rule 36.2(b)(1) to make clear that eligible debt instruments do
not include such exempt securities.
In contrast to Treasury's recommendation to delete government
securities from the list of eligible commodities, several commenters
with energy-related businesses suggested that energy-related products
be added to the list of commodities eligible to trade on exempt MTEFs.
See CLs 21-34, 37, 38, 43. Merrill Lynch Co., Inc. (Merrill Lynch), for
example, opined that ``over-the-counter bilateral trading in energy
products between commercial entities has been exempted * * * since 1993
* * * and that no pattern of abuses or irregularities has been
identified.'' CL 21-38 at 9. It further reasoned that, ``electricity
trading remains subject to oversight by the FERC and the states,
including licensing standards for market participants, reporting
requirements, and enforcement authority to remedy any problems that may
arise.'' Id. at 12. Merrill Lynch also noted that action has been taken
by the FERC,
to promote open access to transmission grids for natural gas. * * *
Similarly, many state legislatures and public utility commissions *
* * have adopt[ed] rules to facilitate or require the unbundling of
gas distribution from production and supply. [A] standardized form
of contract is in widespread use in the natural gas market. Given
this statutory background, it would be inconsistent with the intent
of Congress and actions taken by the FERC for the Commission to
impose additional regulation on natural gas trading.
Id. at 13.
However, the Commission does not require that cash markets, such as
those described above, come within the regulatory framework.\14\
Centralized markets to trade spot and forward agricultural commodities
have long existed outside of the regulatory scheme that applies to
futures and option markets. The Act, and the regulatory framework
thereunder, apply to markets that trade futures or option contracts on
such underlying commodities. Accordingly, there is no inconsistency
between the Commission's regulation of futures markets and regulation
of the underlying cash markets by other regulators, such as the FERC or
the states. To the contrary, the Commission in its oversight of the
futures and option
[[Page 77966]]
markets coordinates and cooperates with the regulators of related
underlying cash markets.
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\14\ See, CFTC Staff Letter No. 99-67, [Current Transfer Binder]
Comm. Fut. L. Rep. (CCH) para. 27,970 (Dec. 16, 1999), relating to a
market established by the legislature of California for the trading
of electricity.
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Moreover, although some commenters expressed the view that energy
products under the regulatory framework should be eligible to trade on
exempt MTEFs based on the sophistication of traders in the market,\15\
eligibility for exempt MTEF treatment must also be premised upon a
finding that the likelihood of manipulation is sufficiently low that
regulation is not required. That case has not yet been made. Existing
derivative contracts involving energy commodities typically are based
on physical delivery within a relatively narrow geographic area.
Delivery under these contracts can be subject to physical constraints,
e.g., pipeline congestion, transmission congestion in the case of
electricity, weather or natural disaster related events, concentration
of ownership of transmission, pipeline or storage and production
capacity. Although the total supplies of a broadly defined energy
commodity may be large if viewed on a global basis, only a small subset
of that total supply typically would be available for delivery on a
derivatives contract. As the New York Mercantile Exchange (NYMEX)
pointed out in its comment,
[t]he President's Working Group drew a distinction in its report
that limited exclusion from CFTC regulatory authority to financial
derivatives. The Working Group's reasoning, in part, was that
financial derivatives had ``virtually inexhaustible supplies'' and
that dealers in the swaps markets, * * * were subject to other forms
of regulatory oversight. That is not the case with many participants
in the OTC energy derivative marketplace. Because the President's
Working Group focused primarily upon financial derivatives in its
report, one may reasonably conclude at this time that the case has
yet to be made that such wholesale exemption from CFTC regulation
for energy derivatives would serve the public interest.
CL 21-47 at 3. In agreement, Williams Energy Marketing and Trading
Company, a company engaged in energy marketing and trading and risk
management activities, noted that it ``supports the Commission's
proposal to exempt from regulation those * * * MTEFs meeting the
conditions specified in the proposed rule,'' and it urged the
``Commission to stay the course of establishing the basic parameters
for its new regulatory framework.'' CL 21-25 at 3, 4.
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\15\ See, comment letter from the California Power Exchange, an
exchange offering physical delivery cash forward markets for the
purchase and sale of electricity between commercial parties. CL 21-
34 at 3.
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As proposed, the final rules do not make energy-related commodities
eligible for trading on exempt MTEF markets at this time.\16\ The
Commission is making this determination based upon its surveillance
experience of designated contract markets on energy-related products
and upon careful consideration of the comments. In making this
determination, the Commission is not foreclosing generally any
subsequent reconsideration of the issue. Moreover, the Commission
proposed to permit individual markets, including those offering energy-
related products, to petition the Commission for exemption under the
provisions of part 36. As proposed, rule 36.2(h) specifically provides
that ``any person or entity may apply to the Commission for exemption
for other arrangements or facilities, on such terms and conditions as
the Commission deems appropriate, including but not limited to, the
applicability of other regulatory regimes.'' 65 FR at 38999. The New
York Independent System Operator (NYISO) in its comment supported
inclusion of this provision, stating that,
[i]rrespective of whether the automatic exemption criteria are
modified, NYISO supports the inclusion of a provision permitting the
Commission authority to grant individual petitions for Exempt MTEF
status * * *. This type of flexibility is, we believe, necessary to
accommodate markets with which the Commission may not as yet be
familiar as well as changing markets.
CL 21-61 at 7.
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\16\ Of course, the framework does not preclude the trading of
such contracts altogether. Under the framework, contracts for these
commodities may trade on an institutional-participant DTF based on a
case-by-case determination by the Commission, on a commercial-
participant DTF or on an RFE.
The Commission agrees that flexibility to address new and changing
markets is both necessary and appropriate and is adopting proposed rule
36.2(h) as final.\17\ As with other such general exemptive provisions,
the rule does not limit the grounds on which such an exemption may be
granted. Compare, 17 CFR 32.4(b) and 35.2(d). However, those
petitioning for exemption should be guided by the overall principles
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underlying the framework, that
the level of oversight applied to exchanges or trading facilities *
* * be based on the nature of participants allowed to trade on the
facility and certain characteristics of the commodities being
traded. In general, where access to an exchange or facility is
restricted to more sophisticated traders or commercial participants,
or where the nature of the commodity being traded poses a relatively
low susceptibility to manipulation, regulatory oversight would be
set at a lower level, reflecting the reduced need to monitor closely
such markets.
65 FR at 38988. The commodities that are eligible for exempt MTEF
status enjoy nearly inexhaustible deliverable supplies or are otherwise
not subject to limitation. Petitions for inclusion of additional
commodities should be for commodities of a similar nature. In addition,
petitioners should consider addressing the sufficiency and
applicability of other regulatory schemes.
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\17\ ISDA suggests including a ``category of eligible
commodities * * * that over time become traded in sufficient volume
so as to be highly unlikely to be susceptible to manipulation.'' CL
21-37 at 4. The Commission is of the view that the petition
procedure provided in part 36 would in fact provide it with the type
of flexibility to respond to market developments that ISDA
advocates. The Coalition recommended that this authority be
delegated by the Commission to the Director of the Division of
Economic Analysis. CL 21-65 at 10. The Commission is of the view
that these determinations should not be delegated at this time.
Proposed rule 36.2(b)(5) would make eligible for exemption
contracts, agreements or transactions which are ``a measure of credit
risk or quality, including instruments known as `total return swaps,'
`credit swaps,' or `spread swaps.' '' JP Morgan objected to their
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proposed eligibility on the grounds that:
[t]he named swaps are commonly based upon the price of corporate
equities or, in the case of credit swaps, corporate debt, which is
represented by a non-exempt security. The Commission is given
authority under 4(c) to exempt futures contracts. But if these
particular swaps are futures, they cannot be exempted because they
would run afoul of the Shad-Johnson Accord, which bans futures on
non-exempt securities prices (except for indexes which have cleared
a lengthy regulatory approval process). The part 36 exemption will
be of no use because it specifically does not exempt such
transactions from the Shad-Johnson Accord. So if the Commission has
authority to exempt these transactions (which would only be the case
if they are futures), it cannot do so (because the Shad-Johnson
Accord prohibits such futures).
CL 21-55 at 4.
However, ``total return swaps,'' include a greater variety of
instruments than just swaps on corporate equities or debt, which as JP
Morgan correctly recognizes, are not exempt under part 36. Proposed
rule 36.2(b) also includes instruments that are not the subject of the
prohibitions of the Shad-Johnson Accord.\18\ Specifically, for example,
[[Page 77967]]
``total return swap'' also describes an agreement whereby one party
agrees to pay the total return on a loan portfolio to its counterparty
in exchange for semi-annual payments based on a floating interest rate.
It is this type of contract, transaction or agreement, traded among
eligible participants, that is exempt under rule 36.2(b)(5), which the
Commission is adopting as proposed.\19\
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\18\ Moreover, the specific named types of instruments such as
``total return swaps'' in the clause beginning with the word
``including'' modify the more general description ``a measure of
credit risk or quality.'' Thus ``total return swaps,'' a term which
may include many different types of instruments, are included under
this prong of the exemption only insofar as they are also ``a
measure of credit risk or quality.'' Of course, as noted in the
Notice of proposed Rulemaking and reiterated above, nothing in these
rules would affect the continued applicability of any existing
Commission exemptions, policy statements or interpretations to such
``total return swaps,'' or to any other instrument. Moreover, the
non-repudiation provision of rule 35.3(c) that the Commission is
adopting in a companion release would also apply to such
instruments.
\19\ The rule, as proposed, referenced ``spread swaps'' rather
than ``credit spread swaps,'' which were referenced correctly in the
preamble at page 38988. The final rule corrects this typographic
error.
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Proposed rule 36.2(b)(7) provides that cash-settled contracts on
any economic or commercial index or measure beyond the control of the
counterparties and not based upon prices derived from trading in a
directly corresponding underlying cash market are eligible to trade on
an exempt MTEF. The Board of Trade of the City of Chicago (CBT)
suggested that proposed rule 36.2(b)(7) be modified so that it is not
limited to economic or commercial indexes not based upon prices derived
from trading in a directly corresponding cash market. It argued that
the requirement that the index or measure be beyond the control of the
counterparties is alone sufficient to protect against manipulation. CL
21-36 at 3. However, the Commission believes that both requirements
must be met to qualify for the exemption. Basing the cash settlement
price of a futures contract on prices derived from trading on an
underlying cash market necessarily raises issues regarding the
potential ability and incentives of traders in one market to affect
pricing in the other market.\20\ The Commission, by adopting the rule
as proposed, intends to make eligible for this broad exemption only
those MTEFs on which the contract's settlement price is objectively
determined based upon prices that are ``an objective measurement of an
economic or commercial index.'' 65 FR at 38989. As the Commission made
clear, the exemption,
is not intended to include contracts based upon a cash-settlement
price determined through cash-market trading of any physical
commodity or financial instrument. * * * Finally, included in this
category are contracts based on an objectively determined index
value or measure of an economic or commercial index reflecting broad
characteristics of the economy as a whole, or portions thereof, or
material segments of commercial activity.
Id. The Notice of Proposed Rulemaking noted that the consumer price
index or the gross domestic product, insurance data, bankruptcy rates,
real estate rental indexes, measures of physical production or sales
amounts such as housing starts or auto sales or crop yields are
examples of contracts falling within this category.\21\
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\20\ This is in contrast to proposed 36.2(b)(6) which applies to
``an occurrence, extent of an occurrence or contingency beyond the
control of the counterparties to the transaction.'' As the
Commission explained, this category is intended to include
contracts:
based upon the outcome of a contingency, such as a recurring or
nonrecurring event, a specific incident, a natural phenomenon or the
unambiguous results of some other condition that gives rise to a
hedgeable risk.
65 FR at 38989. The Commission does not anticipate that the
settlement price of such contracts could be derived from trading in
a directly related cash market and has therefore not included that
as a criterion.
\21\ The Commission provided specific examples for each category
of commodities eligible to trade on an exempt MTEF under proposed
rule 36.2(b). 65 FR at 38988-89. Except for exempt securities, which
are being deleted from eligibility in the final rules, each of those
examples is incorporated herein by reference.
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3. Definition of MTEF
Several comments raised issues relating to the proposed definition
of MTEF. The Commission proposed in rule 36.1(b) to define ``MTEF'' as
``an electronic or non-electronic market or similar facility through
which persons, for their own accounts or for the accounts of others,
enter into, agree to enter into or execute binding transactions by
accepting bids or offers made by one person that are open to multiple
persons conducting business through such market or similar facility.''
65 FR at 38999. As explained in the Notice of Proposed Rulemaking,
[t]he definition as proposed does not, and is not intended to,
``preclude participants from engaging in privately negotiated
bilateral transactions, even where these participants use computer
or other electronic facilities, such as ``broker screens,'' to
communicate simultaneously with other participants so long as they
do not use such systems to enter orders to execute transactions.''
Accordingly, the definition makes clear that it does not include
facilities merely used as a means of communicating bids or offers
nor does it include markets in which a single market maker offers to
enter into bilateral transactions with multiple counterparties who
may not transact with each other.
Id. at 38989 (citation omitted).
Several commenters recommended that the definition of MTEF exclude
trading systems that include a credit screen. CL 21-21 at 6; CL 21-37
at 4. One commenter, DNI Holdings, reasoned that ``this credit emphasis
has always been a characteristic of swaps transactions, but has never
been a characteristic of the futures exchanges.'' CL 21-21 at 5-6.
However, in a companion notice of final rulemaking published in this
edition of the Federal Register, the Commission, consistent with the
amendment of part 35 to permit bilateral contracts, transactions or
agreements to be cleared, is deleting individualized creditworthiness
determinations as a condition for meeting its part 35 exemption for
bilateral transactions.
Moreover, as technology increases the availability of electronic
credit screens or filters, their use has become common in both
multilateral and bilateral environments. As NYMEX notes in commenting
on a different provision, which applies to multilateral trading
facilities,
this provision would appear to be premised upon the notion that the
credit checking and position limit functionality would reside only
within the FCM's internal systems * * *. However, * * * certain
trading systems, such as NYMEX's NYMEX ACCESS'' electronic trading
system maintains the credit checking functionality as a component of
the host computer. Clearing Members may enter inputs into the system
to set specific limits per customer.
CL 21-47 at 8.
Finally, the exemptions in part 35 and part 36, when taken
together, exempt derivative instruments from regulation under the Act
whether or not they are traded on an MTEF if: (1) They are traded among
or between eligible counterparties; (2) they are based on the
underlying commodities, instruments or measures listed in part 36; and
(3) they are, if cleared, cleared by an authorized clearing
organization. As correctly observed in a comment referenced above,
``participants in transactions that satisfy these three conditions
would obtain legal certainty about the limited scope of CEA regulation
regardless of whether the means for executing transactions did or did
not satisfy the technical definition of an MTEF.'' CL 21-63 at 2. In
light of the availability of the same degree of exemptive relief under
either part 35 or part 36 for the specified commodities, the deletion
of creditworthiness as a condition for exemption under part 35, and the
use of credit screens and filters in both bilateral and multilateral
environments, the final rule does not include such an exclusion.
The CBT suggested that the exclusion from the proposed MTEF
definition in rule 36.1(b)(3) for ``any facility on which only a single
firm may participate as market maker and participants other than the
market maker may not accept
[[Page 77968]]
bids or offers of other non-market maker participants'' should be
deleted. It reasons that ``the Commission's approach could be read to
allow a futures exchange * * * to decide to use a single market-maker
or specialist system, like many securities exchanges, and avoid being
considered to be an MTEF.'' CL 21-36 at 4. However, under the proposed
exclusion there can be but one counterparty to all market participants.
That is quite different from using one or more specialists in a
multilateral trading setting. In that structure, the bids and offers of
non-specialists are permitted to interact with each other. The
Commission believes that this is a valid and logical distinction
between bilateral and multilateral trading structures and is adopting
the proposed language as final.
The CBT also questioned whether the definition of MTEF in proposed
rule 36.1(b) would affect the Commission's view of the scope of the
Treasury Amendment exclusion in section 2(a)(1)(A)(ii) of the Act. CL
21-36-4. As the Commission stated in the Notice of Proposed Rulemaking,
the definition of MTEF in proposed Sec. 36.1(b) applies only to
those rules in which it is cited. It is not intended to modify,
alter, amend or interpret any other provision of the Act or the
Commission's rules. For example, the proposed Sec. 36.1(b)
definition of MTEF does not affect the meaning or application of the
statutory term, ``board of trade.'' 7 U.S.C. 1a(1). Thus, the scope
and application of the statutory exclusion in section 2(a)(1)(A)(ii)
of the Act, popularly known as the ``Treasury Amendment,'' which
depends in part on the meaning of ``board of trade,'' is in no way
affected by the Commission's proposed adoption of a definition of
MTEF under Sec. 36.1(b) for purposes of the exemptions in part 35
and part 36 of its rules.
65 FR at 38989.\22\
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\22\ The CBT raises the concern whether the Act's Treasury
Amendment exclusion would continue to apply to an exempt MTEF
without an explicit reservation in the rules of that provision of
the statute. CL 21-36 at 4. As the Commission explained in the
Notice of Proposed Rulemaking and reiterated herein, ``the scope and
application of the statutory exclusion in section 2(a)(1)(A)(ii) of
the Act * * * is in no way affected'' by this regulatory exemption.
Thus, the determination of whether or not a person or facility is a
``board of trade'' for purposes of the Act, generally, and the
Treasury Amendment, specifically, should be made without reference
to the definition of ``multilateral transaction execution facility''
under rule 36.1(b), which operates in the context of exemptions for
markets to which access is limited to eligible participants.
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Finally, commenters suggested a number of technical modifications
to the rules. The CBT suggested that the Commission modify the final
rules to clarify that it is the participant to whom notice is provided
under proposed rule 36.2(f)(1) and that the separate trading location
(or pit) required for trading on exempt MTEFs under proposed rule
36.2(f)(2) may nevertheless adjoin the location wherein Commission-
recognized markets are traded. CL 21-36 at 5. The Commission agrees
with these suggestions and is modifying the final rules accordingly. In
addition, the Minneapolis Grain Exchange (MGE), CL 21-24 at 4,
suggested that the Commission modify proposed rule 36.2(e)'s
requirement that an exempt MTEF be legally separate from Commission-
recognized markets. Upon further consideration of the issue, and based
upon the fact that many of the exchanges historically overseen by the
Commission have housed both designated contract markets and markets for
trading spot or forward contracts without adverse consequence, the
Commission is deleting that requirement from the final rules.
B. Derivatives Transaction Facilities.
The Commission also proposed a new exemptive category,
``Derivatives Transaction Facilities,'' which provides for an
intermediate level of regulation. This intermediate level of regulation
was proposed to be available for two separate types of markets.
Although many of the proposed rules are common to both types of
markets, some of the proposed rules were tailored to apply to one or
the other market.
The first type of DTF proposed by the Commission was for
(primarily) ``eligible-participants.''\23\ Under the provisions of
proposed part 37, these markets or similar facilities, including the
current boards of trades, would be eligible to become a DTF regardless
of the method of transmitting bids and offers or matching system used,
either on a case-by-case determination or if the contracts traded were
on the list of commodities eligible to trade as an exempt MTEF.\24\ The
Commission proposed that such ``eligible participant DTFs'' would have
the choice of whether or not to permit access to the market by non-
eligible traders. If they did permit access to non-eligible traders, a
number of additional requirements were proposed to apply, including
enhanced disclosure and higher net capital requirements for the
carrying FCM.\25\
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\23\ In a companion notice of final rulemaking published in this
edition of the Federal Register entitled ``Rules Relating to
Intermediaries of Commodity Interest Transactions,'' the term
``institutional customer'' is used rather than ``eligible
participant.'' These terms can be used interchangeably.
\24\ The Commission also expects, however, on a case-by-case
basis, that the surveillance history and the self-regulatory
undertakings of a particular exchange or facility could make it
possible to include a specific contract traded on that facility
within the DTF category even if the underlying commodity does not
meet the general eligibility criteria. An exchange or facility
seeking a case-by-case determination would be recognized as a DTF
for that contract or contracts only upon CFTC approval.
\25\ Amendments to the Commission's rules governing
intermediaries are published today in a separate release in this
edition of the Federal Register. Although those amendments apply to
all categories of intermediaries irrespective of where they choose
to transact business, certain proposals differentiate between
intermediation on various types of markets and for different types
of customers.
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The Commission proposed a second type of DTF under proposed part 37
for facilities that restricted participation to ``eligible commercial
participants.'' This type of ``commercial-participant DTF'' would be
eligible to trade contracts on all commodities other than those
domestic agricultural commodities enumerated in section 1a(3) of the
Act,\26\ any securities or indices thereof subject to section
2(a)(1)(B)(ii) of the Act or any exempt securities or indices thereof
included in section 2(a)(1)(B)(v) of the Act. This type of eligible
commercials-only market structure lessens many of the regulatory
concerns regarding manipulation ordinarily present with contracts for
tangible commodities and the regulations that are applicable to them
have been tailored to this specific type of market.\27\
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\26\ They are wheat, cotton, rice, corn, oats, barley, rye,
flaxseed, grain sorghums, mill feeds, butter, eggs, potatoes, wool,
wool tops, fats and oils, cottonseed meal, cottonseed, peanuts,
soybeans, soybean meal, livestock, livestock products, and frozen
concentrated orange juice.
\27\ Many of these trading facilities are expected to replicate
electronically various aspects of today's commercial markets,
including trading exclusively between principals, and direct
negotiation and documentation of trades. In addition, these
facilities often do not provide clearing arrangements for contracts.
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Although a few commenters objected to the DTF rules on
jurisdictional grounds, many more commenters supported the concept of
providing for an intermediate level of regulation. These commenters
included both those interested in the eligible-participant DTF as well
as those interested in the commercial-participant DTF. For example,
Cargill stated that the ``three-tier system seems to provide adequate
regulation for a wide range of financial products and market
participants depending on the relative sophistication of the
participants.'' CL 21-49 at 2. The Coalition stated that it supports
the Commission's efforts to create an intermediate category of
regulated trading facility subject to less regulation than an RFE and
more regulation than an exempt MTEF. The Coalition went on to say that
the tiered approach recognizes that there is a wide range of
[[Page 77969]]
types of markets, trading systems and market participants, and that it
will facilitate market innovation. CL 21-65 at 16. The Association for
Investment Management and Research (AIMR) opined that the tiered
approach to regulation recognizes different operational profiles and
risks inherent to individual participants. CL 21-64 at 3.
Commenters also suggested that the Commission reconsider various
specific aspects of the rules as proposed. These suggestions clustered
around how various commodities, including in particular, domestic
agricultural commodities, should fit within the framework, how eligible
participants should be defined, under what conditions non-eligible
participants should have access, how the core principles should be
enforced and what further tailoring might be appropriate for regulating
commercial-participant DTFs. Each of these issues is discussed in
greater detail below.
1. Jurisdictional Issues.
Although contracts, agreements or transactions traded on a DTF
would be exempt from many of the Act's provisions and Commission
regulations,\28\ the exemption is contingent upon compliance with the
conditions set forth in part 37. A market that applies to the
Commission for recognition, and is so recognized by the Commission, is
bound to comply with applicable provisions of the Act and Commission
rules as a condition of this exemption.
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\28\ Certain sections of the Act, including the fraud and
manipulation provisions of the Act and the Commission's regulations
are reserved in rule 37.8 and would continue to apply.
---------------------------------------------------------------------------
Notwithstanding the requirement that a market or facility must
apply to the Commission for recognition in order for the part 37
exemption to pertain, Mercatus questioned how commercial markets for
physical commodities would be treated in this regime, and suggested
that the Commission provide further guidance on the reach of the
proposed part 37 in this area. CL 21-57 at 6. As the Commission noted
in proposing part 37 (65 FR at 38989), and reiterates here, in
exercising its section 4(c) exemptive authority to date, the Commission
has not made a determination that the transactions being exempted were,
or were not, subject to the Commission's jurisdiction under the
CEA.\29\ Rather, the Commission has exercised its section 4(c)
authority to provide legal certainty for instruments that may be within
its jurisdiction. However, the Commission will not entertain
applications for recognition from markets or facilities offering
transactions that clearly are outside of its jurisdiction.
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\29\ As noted above, the legislative history states that the
Commission in exercising its section 4(c) exemptive authority is not
required to make an initial determination that the agreement,
instrument, or transaction for which an exemption is sought is
subject to the Act. Accordingly, in carrying out this mandate, when
the Commission exempted certain swap agreements in 1993, pursuant to
section 4(c) of the Act, it stated:
The issuance of this rule (Rule 35.2) should not be construed as
reflecting any determination that the swap agreements covered by the
terms hereof are subject to the Act, as the Commission has not made
and is not obligated to make any such determination.
58 FR 5587, 5588 (Jan. 22, 1993). See also Order Granting the
London Clearing House's Petition for an Exemption Pursuant to
Section 4(c) of the Commodity Exchange Act, 64 FR 53346 (Oct. 1,
1999); Exemption for Certain Contracts Involving Energy Products, 58
FR 21286, 21288 (Apr. 20, 1993); Regulation of Hybrid Instruments,
58 FR 5580, 55821 n. 2 (Jan. 22, 1993). The Commission is following
this same mandate with respect to this exemption for DTFs.
---------------------------------------------------------------------------
The Coalition directly addressed this issue and supports the
Commission's view. It reasoned that
the Commission would not be authorized to exercise jurisdiction over
activities that are clearly outside its jurisdiction under the CEA.
Examples of this would include trading in equity options and spot
transactions.
At the same time, the conferees to the Futures Trading Practices
Act of 1992 (the ``FTPA'') expressly authorized the Commission to
exercise its exemptive authority under Section 4(c)(1) of the CEA
without determining whether the exempted transactions are subject to
the CEA. And they authorized the Commission to do so on such terms
and conditions as the Commission deems appropriate. The conferees
specifically so provided to enable the Commission to act without
making consequential jurisdictional determinations that might create
legal uncertainty for, or imply the illegality of, other
transactions.
For precisely the reasons motivating the FTPA conferees, the
Coalition believes that the Commission is authorized to and should
accept requests by trading facilities who wish to be registered as
DTFs and who request that the Commission not make any determination
that the underlying transactions are futures contracts or commodity
options. The Coalition agrees with the Commission's implicit
judgment that this approach will minimize the adverse jurisdictional
implications, and therefore the legal uncertainty, that might
otherwise arise if one trading facility elects to pursue DTF
registration in circumstances where other, possibly analogous
trading facilities do not. However, as suggested by the immediately
preceding discussion, the Commission should only so proceed in cases
where a bona fide issue as to its jurisdiction exists and should not
so proceed in any case where it is clear that the Commission lacks
jurisdiction.
CL 21-65 at 17-18.
As the Commission noted above with regard to the application of the
part 36 exemption, this framework has no applicability to markets or
facilities that clearly are outside of the scope of the Act and the
Commission's jurisdiction. Thus, the availability of part 37
recognition to those markets that apply in no way carries a negative
legal inference or uncertainty for any other market. Accordingly, the
Commission is of the view that providing legal certainty through this
part 37 exemptive relief to markets or facilities that may be subject
to the Act is consistent with Congress' mandate to the Commission and
is in the public interest.
2. Commodities
A number of commenters recommended that the framework be modified
with regard to its application to the agricultural commodities
enumerated in section 1a(3) of the Act. The Commission proposed that
contracts on those commodities not be permitted to trade on a
commercial-participant DTF, and that they be permitted to trade on an
eligible-participant DTF only on a case-by-case determination by the
Commission.
The response of commenters representing various agricultural
interests was divided. National Grain and Feed Association (NGFA)
argued that agricultural markets should be regulated in precisely the
same manner as markets for financial commodities. The American Cotton
Shippers (Cotton Shippers) argued that any differences in regulation of
agricultural commodities penalizes these markets by denying them the
benefit of potential marketing innovations. CL 21-12 at 3-5. MGE and
the National Grain Trade Council (NGTC) also argued that there should
be no distinction in the regulatory framework for the enumerated
agricultural commodities. CL 21-24 at 1-2; CL 21-46. An FCM, F.C.
Stone, contended that agribusiness firms have substantial risk
management experience and can themselves weigh the risks of using a
particular trading facility. CL 21-59 at 3.
A significant number of commenters favored permitting enumerated
agricultural commodities to trade on an eligible-participant DTF on a
case-by-case determination, as provided in the proposed rules. In a
joint comment letter, eight agricultural producer groups \30\ supported
a case-by-case
[[Page 77970]]
Commission determination of eligibility for DTF trading of individual
agricultural commodities. They emphasized, however, that the Commission
should provide notice and accept public comment as part of its
deliberative process. They further cautioned that such a determination
should include appropriate conditions in addition to the seven DTF core
principles. CL 21-60 at 1. The NGTC concurred, suggesting that DTFs be
permitted to trade agricultural commodities conditioned upon enhanced
surveillance (RFE Core Principle 3), position limits (RFE Core
Principle 4), and such other requirements that the Commission concludes
are essential to market integrity. Cargill, while recognizing that
certain agricultural commodities may be subject to manipulation,
nevertheless recommended that the CFTC should retain flexibility to
address this issue by spelling out criteria that would have to be met
for such a commodity to achieve DTF status. CL 21-49 at 2-3.
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\30\ The eight groups are: the American Farm Bureau Federation,
American Soybean Association, National Association of Wheat Growers,
National Cattlemen's Beef Association, National Corn Growers
Association, National Farmers Union, National Grain Sorghum
Producers and National Pork Producers Council, and will be referred
to hereafter as ``agricultural producer groups.''
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The final rules, as proposed, provide that the Commission may
determine on a case-by-case basis to permit any commodity, including
the enumerated agricultural commodities, to trade on an eligible-
participant DTF. The Commission remains convinced, as do many
commenters, that this strikes the appropriate balance between caution
and flexibility to respond to future developments. Moreover, the
commenters' suggestions that any case-by-case determination include
particular, tailored conditions to the general core principles are
well-taken. In this regard, the Commission is of the view that, at a
minimum, any DTF trading a commodity on a case-by-case basis will be
required to retain the large trader reporting system that pertains to
RFEs. The Commission will determine additional requirements, if any,
during each individualized determination. In this regard, the
procedures to be used by the Commission in such case-by-case
determinations will indeed include public notice and an opportunity for
public comment.\31\
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\31\ Treasury similarly commented with respect to whether
government securities should be permitted to trade on a DTF. It
recommended that continued application of the segregation of
customer funds requirements, certain adjustments to capital
requirements for FCMs executing trades for retail customers and
large trader reporting be conditions of permitting government
securities to trade on a DTF. The Commission will certainly consider
these views if any such request to trade government securities on a
DTF is received. Moreover, consistent with current practice under
the Act, the Commission will continue to keep Treasury apprised of
new contracts involving government securities to be listed on both
DTFs and RFEs.
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Commission rule 37.2(a)(2)(i) provides that commodities eligible
through a case-by-case determination to trade on a DTF ``have a
sufficiently liquid and deep cash market and a surveillance history
based on actual trading experience to provide assurance that the
contract is highly unlikely to be manipulated.'' The Global
TeleExchange (GTX) commented that the Commission should articulate the
standards that it will use to judge whether there is a ``sufficiently
liquid and deep cash market'' to warrant approving a contract for DTF
trading. CL 21-40 at 4. The Commission is not establishing quantitative
thresholds or criteria for DTF inclusion a priori, because the
appropriate standards necessarily would differ across markets and time,
and the adoption of specific, detailed standards would deny the
Commission and applicants needed flexibility.\32\
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\32\ GTX also added that, in its view, telecommunication minutes
and other telecommunication products should qualify as such a
market. The Commission is not making such a determination in this
rulemaking. That decision is better made as an individualized
determination where a factual record can be developed and public
comment specifically sought on the issue.
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In making a determination whether a contract is highly unlikely to
be manipulated and thus eligible for DTF trading through an
individualized determination, the Commission will consider both the
liquidity and depth of the underlying cash market and the actual
trading experience of the contract, including, where relevant, the
facility's surveillance history in monitoring the market and in
addressing market problems. Sufficient liquidity and depth of the
underlying commodity can be demonstrated by looking at a number of
specific factors. These include: (1) A high level of liquidity; (2)
bid-ask spreads that are narrow relative to traded values; (3)
relatively frequent transactions involving participants that represent
major segments of the industry; (4) the absence of material impediments
to participation by commercial entities; (5) transfer of ownership that
is easily and readily accomplished at minimal cost; and (6) a pattern
of pricing that exhibits continuity and the absence of frequent, sharp
price changes such that a person cannot readily move materially the
price of the product in normal cash market channels. Facilities seeking
recognition as a DTF should provide to the Commission information on
these factors. Actual trading experience acceptable for DTF eligibility
can be based upon a history that the contract terms and conditions
provide for a deliverable supply that is adequate to minimize the
threat of market abuses such as price manipulation and distortions,
congestion, and defaults,\33\ and by having in place appropriate
procedures effectively to oversee the market, including a large trader
system, as well as a history of active surveillance to prevent or
mitigate market problems.\34\
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\33\ In this regard, deliverable supply represents the amount of
the commodity meeting the contract's specifications at the delivery
locations that is available for delivery at its economic value in
normal cash marketing channels.
\34\ This requirement is not intended to preclude a market
experienced in the trading of only cash or other instruments from
making the necessary demonstrations. Such facilities may rely on
that market experience in making the necessary demonstration.
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3. Access by Non-Eligible Participants
Only eligible participants (i.e., institutional traders) would have
unrestricted access to an eligible-participant DTF. Non-eligible
participants may access the market, but only through a registered FCM
with $20 million in net capital that is a clearing member of a contract
market or RFE. See, rule 37.2(a)(2)(ii). A number of commenters opposed
this requirement. The CBT contended that this requirement is overly
burdensome and does not further the Commission's stated goal that DTF
transactions ``be transacted through FCMs that are more capable of
properly maintaining such accounts and handling the associated risk.''
CL 21-36 at 7. It further reasoned that net capital is a poor proxy for
an FCM's trading capabilities or level of regulatory compliance and
that the rule favored large FCMs at the expense of smaller FCMs.
Accord, CL 21-24. The CME disagreed with the premise of the rule that
transactions on a DTF entail a higher degree of financial risk than do
transactions on an RFE, especially in the context of futures based on
liquid financial instruments carrying little risk of manipulation. CL
21-51 at 8. NGTC also questioned the relationship between an FCM's
capitalization and its fitness to handle retail accounts on a DTF and
argued that the $20 million threshold requirement was inconsistent with
other CFTC capital requirements. CL 21-46 at 4-6.
Although adjusted net capital may be an imprecise measure of an
FCM's capability to service accounts, the Commission nevertheless
believes that the capital requirement proposed to be required of FCMs
who trade on DTFs for non-institutional customers is appropriate at
this time. Because of the absence of restrictions on the type of
[[Page 77971]]
trading mechanisms that could be used by a DTF, and the possibility of
a greater number of such competing markets trading similar products,
filling non-institutional customer orders at the best price would
likely require the FCM to have a more extensive and sophisticated
infrastructure and greater trading resources than an FCM operating in a
traditional setting. Accordingly, the Commission, at this time, is
adopting the capital-related access restriction as proposed. The
Commission will consider further appropriate measures to permit
additional FCMs to handle non-institutional customers' access to DTFs
as experience is gained under the rules.
The Managed Funds Association (MFA) argued that customers trading
through registered CTAs should have trading access to DTFs without
regard to their individual financial qualifications. In particular, MFA
suggested that a CTA with at least $25 million under management should
be permitted to engage in transactions on behalf of their clients on
all eligible-participant DTFs. CL 21-31 at 5. Although the Commission
is not prepared at this time to treat a CTA's customers as eligible
participants without limitation on the basis of the CTA's management of
the account, the Commission does recognize that CTAs provide expertise
and professional management to their customers. In recognition of this
role, the Commission is revising proposed rule 37.2(a)(2)(ii) to permit
CTAs, with at least $25 million under management and having non-
institutional clients, to access DTFs that permit non-institutional
participants on behalf of both their institutional and non-
institutional customers through accounts carried by any registered FCM.
The Commission will reconsider this issue when it looks more broadly at
revising current rules applicable to CTAs and commodity pool operators.
NYMEX expressed concern that the proposed requirement that non-
eligible traders access a DTF through an FCM may not address adequately
electronic systems with direct customer order entry on which FCM credit
filters are resident. The Commission agrees, and is modifying
37.2(a)(2)(ii) to make it clear that while the accounts of non-eligible
traders must be carried by registered FCMs, they may have direct
trading access to the DTF if a credit filter is required to be used by
the FCM, regardless of where the filter is resident.
4. Commercial-Participant DTF
The Commission proposed that an intermediate level of regulation
also apply to commercial-participant DTFs. The proposed rules
applicable to commercial-participant DTFs, although having common
elements with eligible-participant DTFs, also have a number of special
features. For example, the proposed core principles for DTFs may
include two alternatives, with the proviso that they apply to the
market ``as applicable.'' See, e.g., Core Principle 2, rule 37.4(b).
Only one of the alternatives may be appropriate for a particular
facility, and should be understood to apply in that manner.
One commenter, a company beginning an electronic platform for
trading ``physical commodities and derivative products * * * among
commercial participants,'' opined that ``the overall approach * * *
will result in the imposition of excessive and unwarranted burdens on
Commercial DTFs.'' Intercontinental Exchange, LLC (Intercontinental) CL
21-22 at 2. A second letter from a group of oil and gas producers,
refiners, processors, and marketers and electric utilities and
marketers (Energy Group) raised many of the same issues as did
Intercontinental. CL 21-23. Specifically, these letters suggested that
the Commission provide for a streamlined review procedure for
recognition of a DTF within a fixed time period. The letters further
stated that the DTF may not have ``exchange-style memberships or rules.
Any substantive review of commercial DTFs, their owners or operators,
therefore, or any review of rules or principles applicable to trading
on or through such facilities would be inappropriate and unwarranted
and will render the DTF framework completely unworkable.'' CL 21-22 at
3. They also noted that electronic platforms may have ``trading
protocols, product descriptions, fee schedules, user guides and similar
trading or transaction related documents or information'' rather than
trading rules. Id.
The proposed rules, however, recognized this distinction and
provided that the facility have rules or terms and conditions governing
trading procedures. See, e.g., proposed rule 37.3(a)(2). The reference
to ``terms and conditions'' was intended to apply to trading platforms
that did not have exchange-style rules and instead incorporated their
trading procedures as terms of their operating agreements. However,
``terms and conditions'' is already a defined term under Commission
rule 1.41(a)(2). To provide greater clarity of the Commission's intent,
the final rules refer to ``rules, which may be trading protocols.''
Trading protocols include the methods and conditions for trading that
may be included in a user's guide or operator's manual, customer
agreements, screen trading prompts or other similar documents or
writings.\35\
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\35\ In addition, the Commission is amending the definition of
``rules'' under Commission rule 1.41(a)(1) specifically to include
the term ``trading protocols.''
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Intercontinental also opined that the reservation of various
sections of the Act in proposed rule 37.5(a) potentially would subject
a DTF to a number of additional obligations beyond those included in
the rules themselves. CL 21-22 at 4. The Commission's intent, however,
in reserving various sections of the Act in part 37 was not to import
additional regulatory obligations into the part 37 rules. Rather, its
reservation of various sections of the Act is to establish legal
authority for promulgating these regulatory requirements. By reserving
these sections of the Act, the Commission does not intend to
incorporate regulatory requirements for DTFs beyond those specified in
part 37. Moreover, the Commission intends that the reserved sections of
the Act be interpreted as applying to DTFs as the difference in the
contexts require. Some of the Act's provisions, such as section 4c(a)
of the Act are reserved ``as applicable,'' depending upon the
particular characteristics of a trading facility. The Commission will
confirm whether that section of the Act applies to a particular
facility in its Order granting recognition to the facility.
In contrast to the reservation of provisions of the Act
effectuating the regulatory conditions of the exemption, the Commission
has deleted from the final rules in parts 37, 38, and 39 specific
reservation of various enforcement provisions that it had proposed
specifically to retain. The Commission has determined that such
specific reservations are unnecessary. Rather, such specific
reservations do not affect the Commission's existing authority to
investigate violations and to bring enforcement actions. See, section
4(d) of the Act.
In order to conform the regulatory requirements of the commercial-
participant DTF more closely to cash market practices, the Commission
is deleting the proposed requirement that participants respond to
special calls for information about their trading activities. The
Commission will rely instead on its investigative authority, which also
applies to a person's cash market activities. Moreover, the Commission
is not requiring that a non-U.S. participant appoint an agent for
receipt of service of process within the United States or that the DTF
act in that
[[Page 77972]]
capacity. Instead, the Commission is requiring that the commercial-
participant DTF provide notice to its non-U.S. participants of
communications from the Commission. In the event that a non-U.S.
participant fails to comply with such a Commission communication, the
Commission may direct recognized DTFs to deny the participant further
trading access. Compare, 17 CFR 21.03. By modifying the final rules in
this way, the Commission is bringing the rules for commercial-
participant DTFs into closer alignment with the operation of related
cash markets, and the requirements on participants on commercial-
participant DTFs, by and large, will be no greater or no different than
is applicable to cash market trading.
Finally, both comment letters suggested that the rules applicable
to DTFs be located entirely within part 37 without cross-referencing
other rules. The Commission has modified the final rules to reduce the
number of cross-references within part 37. Accordingly, the final rules
have been reorganized to include a new rule 37.5 relating to
information requirements (formerly in proposed part 20) and has divided
the requirements for recognition into two sections. These modifications
to the final rules change the substance of the rules only as discussed
above. A number of voluntary provisions remain as cross-references to
other rules.
Several commenters raised issues regarding the proposed definition
of ``eligible commercial participant.'' Both NYMEX and the Commodity
Floor Brokers and Traders Association expressed concern that exchange
locals were not included within the category of eligible commercial
participants. They reasoned that locals provide the same market making
function as do dealers, a category included within the definition of
eligible commercial participant. NYMEX noted that professional floor
traders provide approximately 43-49% of the trading volume in NYMEX
energy contracts. CL 21-47 at 4. NYMEX further noted that unless floor
traders were included, the commercial-participant DTF model would ``be
used to exclude * * * another business model [exchanges] that is
generally comparable but for the sharing of market making
responsibilities among a group of professional market makers rather
than concentration of this function in a single dealer.'' Id. at 10.
The CBT concurred, stating that ``[c]ertainly floor brokers and floor
traders that trade regularly on exchange markets should be considered
to be as sophisticated as any market participants. For that reason, in
the Commission's current part 36 rules, floor brokers and traders are
defined to be eligible participants without regard to any total or net
asset test.'' CL 21-36 at 6. The Commission agrees that Commission
registrants, particularly floor brokers and floor traders should be
included as eligible to trade in a DTF with a guarantee of their
obligations by a futures commission merchant, as suggested by
NYMEX.\36\
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\36\ This determination is based on the important role that
floor brokers and floor traders, which are Commission registrants,
may fulfill in trading on a Commission-recognized market under the
part 37 exemption. For this reason, the Commission does not agree,
as NYMEX suggests, that floor trades or floor brokers should be
eligible participants for purposes of parts 35 and 36 under
conditions other than currently provided.
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These rules establish an intermediate level of regulation for DTFs
appropriate to the commodities traded and the participants trading
thereon. DTFs have great flexibility in determining the trading systems
and mechanisms that they will use. Accordingly, and in light of their
institutional nature, participants trading on DTFs are expected to
exercise the appropriate degree of understanding in making use of these
facilities. Notwithstanding part 37's greater degree of regulatory
flexibility, the Commission retains its enforcement responsibility to
ensure compliance with the fundamental regulatory goals of the Act, as
included within these rules. The Commission believes that it has
retained the tools necessary to accomplish this mandate and by adopting
a more flexible regulatory approach is not thereby indicating any
diminishment in its resolve effectively to enforce compliance.
5. Procedures for Recognition
A board of trade, facility, or entity seeking recognition as a
derivatives transaction facility would be deemed to be recognized
thirty days after the Commission received the application if the
application met the conditions for recognition pursuant to Secs. 37.3
and 37.4 and the applicant and/or its rules or procedures do not
violate the Act or the Commission's regulations.\37\ An entity seeking
recognition as a DTF may request that the Commission approve its
initial set of rules, which may be trading protocols, and any
subsequent rules or rule amendments under section 5a(a)(12)(A) of the
Act and Commission regulations thereunder. However, the DTF is only
required to notify the Commission of rules and rule amendments, which
include trading protocols, in the same manner that it notifies market
participants, but no later than close of business on the day preceding
implementation.
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\37\ The Commission has made clear in the rule 37.1(a) scope
provision that the part 37 rules apply to a ``a board of trade
operating as a derivatives transaction facility.'' Moreover, DTFs,
as a condition of the part 37 rules, generally would be considered
under proposed rule 37.1(a) to be subject to the Act's provisions as
though the DTF were a ``designated contract market'' under the Act.
As a board of trade within the meaning of that term under the Act
(and as a contract market by operation of part 37), a DTF on which
futures transactions are traded would be covered by the provisions
of Subchapter IV of Chapter 7, Title 11 of the Bankruptcy Code.
Similarly, DTFs should be considered ``contract markets'' for the
purpose of, for example, Sections 556 and 761 of the Bankruptcy
Code, and 12 U.S.C. 4402. The Commission has modified final rule
38.1(b) to make a similar clarification relating to RFEs.
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Several commenters raised issues regarding the procedures for
recognition. Kiodex, a risk management services firm, suggested that
the applicant have an opportunity to correct a deficiency before the
``Commission convert the review into a full-scale designation
proceeding.'' CL 21-29 at 4. However, proposed rule 37.4(c) merely
provided that upon termination of review under the thirty-day period,
the application would be subject to the ``procedures specified in
section 6 of the Act.'' That provision merely incorporates the time
periods and other procedures from section 6; it is not intended to
convert the application or its review into one for contract market
designation.
On a related point, the CBT suggested a technical modification to
clarify that a board of trade or other entity that files for
recognition as a DTF by certification is not required to demonstrate
that it satisfies conditions for recognition under part 37. CL 21-36 at
10. As both the proposed and final rules provide, however, the filing
by a facility which is already a designated contract market need only
include the DTF's rules and its certification that it meets the
conditions for recognition as a DTF under the part 37 rules.
Intercontinental suggested that the Commission specifically retain
the flexibility to grant recognition to new facilities at various
stages of readiness. CL 21-22 at 1-3. The Commission agrees, and has
modified rule 37.4 as proposed to provide that the Commission may
determine to recognize a DTF upon conditions. These might relate either
to additional regulatory undertakings by a particular facility, or to
recognition of a facility pending its subsequent fulfillment of a
regulatory requirement. This flexibility will enable new entrants to
apply for recognition before development of their trading system is
complete and to be recognized contingent upon their
[[Page 77973]]
meeting all of the recognition requirements.\38\
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\38\ The Commission has modified the final application guidances
to make clear that DTFs and RFEs must disclosure limitations of
liability, if any. Such limitations of liability, consistent with
longstanding Commission policy, may not limit liability for
violations of the Act or Commission rules, fraud, or wanton or
willful misconduct.
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6. Enforcement of Core Principles
Several letters raised concerns regarding the interpretation,
enforcement and oversight of core principles. NYMEX suggested that the
guidance with respect to Core Principle 6 which provides that rule 1.31
is the acceptable practice should be amended to read ``an acceptable
but non-exclusive means regarding the form and manner for keeping
records.'' CL 21-47 at 11. The Commission appreciates that the current
wording does not appear to offer a high degree of flexibility in
meeting this core principle. However, rule 1.31 was recently amended
(64 FR 28910) and in its amended form provides a degree of flexibility
in compliance. Moreover, rule 1.31's provisions are consistent with the
record-keeping requirements of the Securities and Exchange Commission
(SEC). In light of the importance of recordkeeping to the Commission's
ability to fulfill its oversight function and the high number of
Commission registrants that must also comply with similar SEC
requirements, the Commission is adopting the guidance as proposed and
will provide further guidance on acceptable record-keeping practices
after additional study of the issue.
The CBT opined that ``safeguards should be provided to ensure that
flexible standards do not become a license for the CFTC to dictate to
exchanges.'' CL 21-1 at 2-3. In contrast, Mercatus objected to the use
of core principles as too vague. See CL 21-57 at 7, 10. See also CL 21-
45 at 3. The Commission finds both of these arguments unpersuasive.
First, the core principles are specifically designed to afford
flexibility to trading facilities to design innovative trading
mechanisms in an expeditious manner. Second, this flexibility should
not be confused with vagueness. While not like typical prescriptive
regulations, the core principles nevertheless do set forth specific
standards to be satisfied by those seeking to gain and maintain
recognition. Finally, any interpretative advice, assistance or
direction provided by the Commission would constitute guidance only. It
does not preclude any facility from complying with the core principle
in some other manner.
Accordingly, the framework does not place the burden of proof upon
those covered by the framework to demonstrate why a particular practice
that differs from the specific guidance offered in a statement of
acceptable practices complies with a particular core principle. See, CL
21-57 at 7. If, as a practical matter, a disagreement on the
interpretation of any core principle could not be addressed through
informal mechanisms, the burden of proof to establish a violation of a
core principle would not differ from the Commission's current burden,
and would rest with the Commission in any formal regulatory or
enforcement proceeding.
Nevertheless, the CBT and CME called for a ``mechanism'' for
resolving disagreements over interpretation of core principles short of
the CFTC taking punitive action. CL 21-51 at 5. CBT suggested, for
example, that all adjectives, such as ``appropriate,''
``periodically,'' ``proper,'' and ``timely'' be removed from the core
principles and that the Commission ``structure an alternative dispute
resolution mechanism to resolve disagreements about the application of
core principles.'' CL 21-36 at 10. The Commission appreciates the
concerns of these commenters. By moving from prescriptive rules to more
general core principles, self-regulatory organizations will have not
only greater flexibility in how they meet the regulatory requirements,
but more responsibility, as well. Purging the core principles of
adjectives will not address the issue of whether the self-regulatory
organizations act in a manner consistent with these internationally
accepted norms for the conduct of trading facilities. The Commission
fully expects that as self-regulators, the entities covered by the
framework will strive to act at the highest ethical and professional
standards for the protection of customers and the integrity of the
market.
Finally, trading facilities must recognize that the requirements
contained in the core principles may involve many interested parties,
not just a facility's members or owners. Accordingly, as FIA suggested,
when issuing interpretative guidance having industry-wide application,
the Commission will follow the notice and public comments procedures of
the Administrative Procedure Act, as appropriate. CL 21-45 at 5.\39\
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\39\ The National Futures Association (NFA) advocated that its
member rules be the primary means of developing best practice or
other interpretative guidance for core principles applying the
framework. The Commission appreciates the NFA's willingness to
assist in interpreting Commission rules and in certain instances,
where the parts of the framework involve NFA's member rules, the
Commission may ask for NFA's interpretative assistance. However, it
would be inappropriate for NFA to assume that role for areas of the
framework that do not involve its membership, particularly for
example, where a trading facility does not permit intermediation.
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C. Recognized Futures Exchanges
The Commission further proposed to recognize all currently
designated contract markets, except for those designated as contract
markets in section 2(a)(1)(B) commodities, as ``Recognized Futures
Exchanges'' under proposed part 38. To provide recognized futures
exchanges with greater operational flexibility, part 38, as proposed,
would replace many prescriptive rules with performance-based rules, or
core principles. Moreover, Commission review would not be required for
new contracts or for rules and rule amendments prior to listing or
implementation, except for the terms and conditions of agricultural
commodities enumerated in section 1a(3) of the Act. Furthermore, the
exchanges would not be required to be responsible for auditing
intermediaries' sales practices. Instead, enforcement could be the
responsibility of a registered futures association.\40\
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\40\ As pointed out in the Federal Register release proposing
part 38, the NFA currently is the only such registered organization.
See 65 FR at 38991.
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The preamble to proposed part 38 noted that RFE markets can list
for trading contracts on any commodity, including those having
potentially a greater risk of price manipulation. In addition, because
they could permit unconditioned access to both institutional and non-
institutional traders, they raise greater concerns regarding customer
protection than do DTFs. 65 FR at 38991. Therefore, as the preamble
noted, the proposed rules in part 38 preserve a higher level of market
surveillance, position reporting obligations, customer protections and
financial safeguards than do the proposed rules for DTFs. Id. A number
of commenters questioned these requirements as incorporated in the core
principles that are applicable to RFEs.
1. RFEs as a Means of Regulatory Reform
As was the case with commenters on the proposed DTF category, many
commenters supported the general concept of changing from prescriptive
regulations to broad, flexible core principles for RFEs.\41\ Some
[[Page 77974]]
commenters expressed concern, however, that the RFE proposal would
permit greater deregulation than appropriate for these commodities and
market participants. For example, the Silver Users Association (SUA)
maintained that any change in the regulatory structure for silver
trading must provide clear assignment of responsibility for trading
facility operators, and procedures for market participants to obtain
redress for improper actions.\42\ The agricultural producer groups
urged that new agricultural contracts and amendments to such contracts
continue to be subject to Commission review prior to their trading. CL
21-60 at 1. Two commenters, Mercatus and CBT, questioned whether the
proposed framework for RFEs was sufficiently deregulatory in nature. CL
21-36 at 12.
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\41\ Specifically, for example, Cargill supported the basic
structure of the regulatory relief for organized futures exchanges.
CL 21-49 at 2. NYMEX strongly supported the overall design of the
proposal. CL 21-47 at 1. CME strongly supported the Commission's
approach in moving from prescriptive regulations to core principles.
CL 21-51 at 5. NYBOT stated that the proposed framework struck a
measured balance between self-regulation and federal oversight in
many respects. CL 21-27 at 1.
\42\ The SUA expressed the additional concern that if liquidity
in silver trading at RFEs using open-outcry diminishes due to
interest in electronic platforms, procedures should be in place for
making pricing data from electronic trading platforms available to
the public on a timely basis. CL 21-39 at 3.
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The Commission remains convinced, and most commenters agreed, that
the use of core principles supplemented by statements of acceptable
practices strikes the right balance between the need for appropriate
regulation and for flexibility. The proposed rules for RFEs are not
intended to remove internationally accepted standards for market or
financial integrity or for the protection of customers trading on
futures exchanges. Rather, they are intended to offer U.S. exchanges
greater flexibility in meeting those requirements. As the Commission
noted:
[t]hese proposed rules * * * [are] intended to provide greater
flexibility in meeting technological and competitive challenges. At
the same time, the Commission will retain its oversight authority to
ensure the integrity of markets and prices, to deter manipulation,
to protect the markets' financial integrity, and to protect
customers.
65 FR at 38987. This approach, although providing exchanges a high
degree of flexibility to meet these challenges, is not intended to
relieve U.S. exchanges from their obligations to comply with the
policies and requirements of the Act, nor to operate in a manner that
fails to meet ``internationally-accepted guidance regarding appropriate
regulatory measures for exchange-traded derivatives markets.'' \43\ 65
FR at 38987.
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\43\ Under Rule 38.3(f), as modified in the final rules, RFEs
are required to carry out international financial and surveillance
information sharing arrangements. The Commission points out that, at
this time, the International Information Sharing Agreement and
Memorandum of Understanding developed by the FIA Global Task Force
on Financial Integrity is one such arrangement.
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2. Comments Concerning the Core Principles
A number of commenters offered suggested changes to the core
principles. The Commission has considered these comments within the
overall goal that the core principles establish broad, flexible
requirements, that at the same time are specific enough to provide
notice of the required performance by the recognized entity. In this
regard, the final version of Appendix A to part 38 herein, clarifies
that the guidance offered on the means of complying with the core
principles is for illustrative purposes only and is not intended to be
a mandatory checklist for compliance.
Specifically, AIMR suggested that Core Principle 3 (Position
Monitoring and Reporting) should simply require exchanges to have the
process and rules necessary to deter market manipulation. CL 21-64 at
4. That formulation, however, fails to capture the breadth of an RFE's
responsibility under the Act. Both prevention of price manipulation and
assurance of market and price integrity are fundamental public policy
interests of the Act. Accordingly, the Commission believes that it is
vital that RFEs have more than just rules and a process to deter
manipulation, as suggested by AIMR. The Commission therefore is
retaining the language of Core Principle 3, which requires an RFE to
monitor ``on a routine and non-routine basis as necessary to prevent
manipulation, price distortion, and disruptions of the delivery or cash
settlement process.'' \44\
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\44\ AIMR also suggested that Core Principle 4 (Position Limits)
be modified only to require RFEs to hold members accountable for
their positions. However, position limits are a necessary tool for
preventing market manipulation or distortion in many markets and the
Commission therefore declines to modify the core principle as
proposed. However, the Commission in its proposed statement of
acceptable practices specifically determined that exchange position
accountability rules are an acceptable means of meeting the core
principle for various types of markets. 65 FR at 39005.
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NYBOT and CBT expressed concerns about Core Principle 7, which
relates to transparency. NYBOT raised the concern that the required
level of transparency under Core Principle 7 should be appropriate to
the method of order execution, explaining that some aspects of
transparency are affected by whether trading is electronic or open-
outcry (e.g., bids and offers are not automatically captured in open-
outcry trading). CL 21-7 at 3, CL 21-27 at 2. However, technology is
rapidly transforming futures markets and the core principles are
intended to be understood broadly and applied flexibly in each
particular market context. Accordingly, the Commission believes that
the transparency requirement, as proposed, provides the necessary
guidance for both open-outcry and electronic markets. The CBT suggested
that the Commission revise the DTF Transparency Core Principle to
mirror the proposed RFE Transparency Core Principle, commenting that
DTFs appear to have the more onerous transparency burden. CL 21-36 at
10. The material difference between the two core principles is that the
DTF Transparency Core Principle requires disclosure of information to
both market participants and the public. That requirement is
particularly necessary at the DTF level in light of the framework's
greater reliance on disclosure rather than merit-type regulation.
Upon further consideration, however, the Commission believes that
the Transparency Core Principle proposed to apply to DTFs should be
applied at the RFE level, as well. The RFE Transparency Core Principle
as proposed could result in permitting an inappropriate reduction in
the information currently available to market participants. Therefore,
under the final Transparency Core Principle, both RFEs and DTFs must
provide information to market participants, on a fair, equitable and
timely basis, regarding prices, bids and offers, as well as other
pertinent information as appropriate to the market. This additional
language is not intended to interfere with the current practice of
futures exchanges of selling price and other market information through
various information vendors.
FIA suggested in its comment that the guidance regarding price and
reporting time as it relates to block trading should be eliminated from
Appendix A, Core Principle 8.\45\ CL 21-45 at 6-7. The
[[Page 77975]]
Commission understands the difficulties in implementing both the ``fair
and reasonable price'' and ``transparency'' guidance. Nevertheless,
current block trading provisions meet both such criteria, and the
Commission believes it appropriate to retain them at this time. In this
regard, the Commission notes that the reporting time provision is not
the ``specific timing requirement'' referred to by FIA, but a provision
for transparency of the block trade, directing that the trade be
reported ``within a reasonable period of time.''(emphasis added). 65 FR
at 39006. Without such transparency, the market's price discovery role
would be harmed. The Commission may reconsider this guidance in the
future if, in practice, these criteria prove to be unworkable.\46\
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\45\ Core Principle 8 requires an RFE to ``provide a
competitive, open and efficient market.'' A primary goal of the
Commission's framework is to ensure that prices discovered in
futures and derivatives markets are accurate and reflective of
current supply and demand conditions in the markets. Core Principle
8 specifically includes the concept of ``efficient'' markets in
order to make clear that trading systems that discover prices
reflective of the forces of supply and demand and accurately reflect
publicly held information may include certain practices, such as
block trades, that permit large traders to enter the market with a
single trade as opposed to having to execute numerous small trades.
By including ``efficiency'' in addition to open and competitive
markets, the Commission is promoting a flexible standard that
protects the price discovery process of the markets while permitting
a variety of trading practices.
\46\ AIMR recommended that the Commission reword Core Principle
8 as an RFE should not only provide for, but should also facilitate
the appearance of, a competitive, open and efficient market (trading
system). CL 21-64 at 4. The final version of Core Principle 8 does
not include the additional language proposed by AIMR. The Commission
believes that provision of an open and competitive market would also
promote the appearance of such a market, without the need explicitly
to so require.
---------------------------------------------------------------------------
NYBOT suggested that requiring all RFEs on which intermediaries
trade to have relevant rules under Core Principle 10 (Financial
Standards) would impose a new, onerous burden, and might result in
conflicting rules being implemented at different RFEs. NYBOT states
that segregation of customer and proprietary funds and custody and
investment of customer funds are currently governed by Commission rules
implemented under the auspices of a designated self-regulatory
organization. CL 21-7 at 2. The adoption of Core Principle 10 is not
intended to impose a ``new, onerous burden'' on exchanges, to change
current systems in place for the oversight of intermediaries nor to
discourage the voluntary harmonization of rules by the exchanges
through the operation of organizations such as the Joint Audit
Committee.
The Commission has modified Core Principle 15 in response to
concerns that it inadvertently could impose a duty different in form or
degree from the antitrust statutes and court decisions construing them.
See, e.g., comment of the Board of Trade Clearing Corporation, CL 21-20
at 13. Final Core Principle 15 requires that RFEs operate in a manner
consistent with the public interest to be protected by the antitrust
laws. The Commission itself remains subject to the requirements of
section 15 of the Act, and will continue to take into consideration the
public interest to be protected by the antitrust laws and to endeavor
to take the least anticompetitive means of achieving the objectives of
the Act in requiring or approving any bylaw, rule or regulation of any
facility recognized under this framework.\47\
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\47\ Section 15 of the Act is also reserved under rule 38.6(a).
Section 15 of the Act requires the Commission to take into
consideration the public interest to be protected by the antitrust
laws and to endeavor to take the least anticompetitive means of
achieving the objectives of the Act in issuing any order, adopting
any regulation, or approving any rule.
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3. New Products and Rules and Amendments Thereof
The Commission proposed that alteration by RFEs of the terms and
conditions of futures contracts on the enumerated agricultural
contracts be subject to prior review and approval by the Commission.
The NYBOT, MGE, CBT, and CME opposed this provision, arguing that RFEs
should be permitted to alter the terms or conditions of agricultural
contract terms and conditions by self-certification, the same process
permitted for contracts on all other commodities.\48\ In contrast to
the exchange commenters, a number of commenters representing
agricultural interests specifically supported retention of the proposed
45-day prior approval requirement for changes to the terms and
conditions of existing agricultural contracts.\49\ Concern was also
raised by the National Cotton Council and the agricultural producers
groups regarding the certification process for new contracts. CL 21-54
at 1. They suggested that Commission prior approval under a 45-day
review period be required for new agricultural contracts, as well as
for alterations of existing contracts.\50\ CL 21-60 at 2.
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\48\ See CL 21-7 at 2, 4; CL 21-24 at 3-4; CL 21-36 at 11; CL
21-51 at 5.
\49\ See CL 21-52 at 1-2 (National Cattlemen's Beef
Association); CL 21-54 at 1 (The National Cotton Council of America,
``National Cotton Council''); CL 21-60 at 1-2 (agricultural
producers groups).
\50\ The comment letter stated that the agricultural
organizations were concerned that exchanges could use the ability to
offer a new contract with one day's notice to avoid prior review and
approval for amendments and changes to agricultural contracts. It
could also cause market fragmentation, since new trading facilities
might test new contracts on the market without a thorough prior
business analysis.
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The Commission concurs with the agricultural producers groups that,
as ``agricultural futures markets serve as the price discovery
mechanism for agricultural commodities, any changes to these markets
can have a significant impact on farmers and ranchers.'' CL 21-60 at 2.
In light of their reliance on the existing futures markets for price
discovery, the Commission concurs that agricultural producers,
processors and merchants have an interest in commenting on significant
alterations to the terms of contracts prior to their implementation.
Accordingly, the Commission is adopting the prior approval provision
for amendments to contract terms and conditions, as proposed. However,
the Commission does not agree that the same opportunity for comment is
necessary for new contracts, upon which producers have not previously
relied. The success of a new contract will rest on its attractiveness
to market participants and the marketplace will determine whether the
terms and conditions of a new contract offer a reliable price discovery
mechanism. Accordingly, the Commission has decided to permit an RFE to
list new agricultural contracts by self-certification, as proposed.
Several commenters opposed Commission authority to stay the
effectiveness of rules implemented by exchange certification during a
Commission action to disapprove those rules. See, rule 1.41(c)(4) as
amended.\51\ They argued that such stays could disrupt the
marketplace.\52\ However, under the rule, the Commission would only be
able to stay a proposed rule incident to disapproval proceedings and
the stay determination would not be delegable to Commission staff. The
Commission anticipates that it will stay implementation of an RFE rule
only in limited and egregious situations, where, for example, one or
more core principles
[[Page 77976]]
were being violated, but that the Commission's emergency authority
would not apply.\53\ In such serious situations, the Commission
believes that the unavailability of a stay could cause significantly
more disruptive effects than imposition of a stay in appropriate
situations. In those rare instances, the absence of a stay could cause
significantly greater harm to the market than its use. The Commission
has determined that this authority is central to its ability to oversee
the operation of RFEs consistent with its responsibilities under the
Act.
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\51\ Amendments to Commission rule 1.41 were proposed as part of
the new regulatory framework. These amendments, appearing in the
final version in this Federal Register release, allow an RFE to make
modifications to its rules (other than terms or conditions of
contracts on the commodities enumerated in section 1a(3) of the Act)
by certification to the Commission that the new or amended rule does
not violate the Act or the Commission's regulations. Upon the
adoption of the attached amendments to Commission rule 1.41, the
Commission's earlier certification proposal, published as a proposed
rule on November 26, 1999 (64 FR 55428), will be unnecessary.
Therefore, the Commission is withdrawing proposed rule 1.41(z) at
this time.
\52\ See, e.g., CL 21-24 at 4 (assertions by MGE that rules
should not be stayed absent sufficient evidence that market
participants will suffer material harm). See also CL 21-27 at 3
(conclusions by NYBOT that staying a rule pending a proceeding to
disapprove or amend it could take months, and the uncertainty thus
created would deter traders); CL 21-36 at 11-12 (statement by CBT
that it could be detrimental for the Commission to retain authority
to impose a stay during a proceeding to disapprove, alter, or amend
an RFE rule as stays could disrupt the marketplace); CL 21-51 at 5
(observation by CME that the Commission should not retain authority
to stay operation of an exchange rule as, in an emergency situation,
the Commission could act under section 8a(9) of the Act, without
advance notice or a hearing).
\53\ For example, a rule that altered a trade matching algorithm
to give one class of participants a significant and improper ongoing
advantage over another or that had a continuing significant adverse
affect on customers could be the subject of a stay. In contrast,
such a rule might not be a proper basis for a market emergency, as
it might not result in a situation where action was necessary to
ensure that the market accurately reflected the forces of supply and
demand. The term ``emergency'' as defined in the Act means, in
addition to threatened or actual market manipulations and corners,
any act of the United States or a foreign government affecting a
commodity or any other major market disturbance which prevents the
market from accurately reflecting the forces of supply and demand
for such commodity. See section 8a(9) of the Act.
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4. Bankruptcy Status
Several commenters requested that the Commission clarify that
transactions on both DTFs and RFEs continue to enjoy the same
Bankruptcy Code status as transactions on a designated contract
market.\54\ As noted above, recognized RFEs and DTFs are both ``boards
of trade'' within the meaning of the Act, and pursuant to these
regulations, are deemed to be subject to all provisions of the Act and
Commission rules applicable to a ``designated contract market.'' See,
e.g., rule 38.1(b). Moreover, final part 38 explicitly reserves the
applicability of part 190 to part 38 transactions. Accordingly, as
explained in footnote 37 above, as a board of trade within the meaning
of that term under the Act (and as a contract market by operation of
part 38), transactions on RFEs (and DTFs) would be covered by the
provisions of Subchapter IV of Chapter 7, Title 11 of the Bankruptcy
Code, which apply to futures contracts (or options) traded on or
subject to the rules of a board of trade or contract market.\55\
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\54\ See, e.g., CL 21-65 at 22.
\55\ Similarly, the Commission believes that transactions on
recognized DTFs and RFEs should be subject to the same tax treatment
as transactions on formally designated contract markets.
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III. Section 4(c) Findings
These rule amendments are being promulgated under section 4(c) of
the Act, which grants the Commission broad exemptive authority. Section
4(c) of the Act provides that, in order to promote responsible economic
or financial innovation and fair competition, the Commission may by
rule, regulation or order exempt any class of agreements, contracts or
transactions, either unconditionally or on stated terms or conditions
from any of the requirements of any provision of the Act. For any
exemption granted pursuant to 4(c), the Commission must find that the
exemption would be consistent with the public interest. For any
exemption granted pursuant to 4(c) from the requirements of section
4(a), the Commission must further find that the section 4(a)
requirement(s) should not be applied to the agreement, contract or
transaction to be exempted, that the exemption would be consistent with
the public interest and the purposes of the Act, that the agreement,
contract, or transaction to be exempted would be entered into solely
between appropriate persons and that the exemption will not have a
material adverse effect on the ability of the Commission or any
contract market to discharge its regulatory or self-regulatory duties
under the Act.\56\
---------------------------------------------------------------------------
\56\ See 7 U.S.C. 6(c).
---------------------------------------------------------------------------
The Commission specifically requested the public to comment on
these issues. The Commission finds and the commenters overwhelmingly
concurred that the proposed regulatory framework would be in the public
interest. As explained above, these proposed rules establish a new
regulatory framework. The proposed framework is intended to promote
innovation and competition in futures trading and to permit the markets
the flexibility to respond to technological and structural changes.
Consequently, the Commission finds that section 4(a) requirements
should not be applied to agreements, contracts or transactions executed
pursuant to parts 36, 37 or 38 except as provided for in each part,
respectively. Moreover, the proposed framework establishes three
regulatory tiers with regulations tailored to the nature of the
commodities traded and the nature of the market participant. As the
Commission explained above, access to each of the tiers is dependent
upon the appropriateness of the participant.
Accordingly, and for the reasons detailed above, the Commission
finds that each class of participant eligible to participate in a
specific tier is appropriate for that exemptive relief. Finally, the
exemptions for parts 37 and 38 are upon stated terms. As detailed
above, these terms include application of regulatory and self-
regulatory requirements tailored to the nature of the market. In light
of these conditions, this exemptive relief would have no adverse effect
on any of the regulatory or self-regulatory responsibilities imposed by
the Act and the exemptions are consistent with the purposes of the Act.
IV. Related Matters
A. Regulatory Flexibility Act
The Regulatory Flexibility Act (RFA), 5 U.S.C. 601, et seq. (1994 &
Supp. II 1996), requires federal agencies, in promulgating rules, to
consider the impact of those rules on small entities. The rules adopted
herein would affect contract markets, FCMs, CTAs, Floor Brokers and
Floor Traders. The Commission has previously established certain
definitions of ``small entities'' to be used by the Commission in
evaluating the impact of its rules on small entities in accordance with
the RFA.\57\ In its previous determinations, the Commission has
concluded that contract markets and registered FCMs are not small
entities for the purpose of the RFA.\58\ With respect to CTAs, Floor
Brokers and Floor Traders, the Commission has stated that it is
appropriate to evaluate within the context of a particular rule
proposal whether some or all of the affected entities should be
considered small entities and, if so, to analyze the economic impact on
them of any rule. In this regard, the rules being adopted herein would
allow qualifying CTAs, floor brokers and floor traders to access
trading in less regulated futures markets than is currently the case;
consequently, these rules should not have any, or result in only a de
minimus, increase in the regulatory requirements that apply to CTAs,
Floor Brokers and Floor Traders. Accordingly, the Commission does not
expect the rules, as adopted herein, to have a significant economic
impact on a substantial number of small entities. Furthermore, no
comments were received from the public on the RFA and its relation to
the proposed rules. Therefore, the Chairman, on behalf of the
Commission, hereby certifies, pursuant to 5 U.S.C. 605(b), that the
action taken herein will not have a significant economic impact on a
substantial number of small entities.
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\57\ 47 FR 18618-21 (Apr. 30, 1982).
\58\ 47 FR 18618, 18619 (discussing contract markets); 47 FR
18619-20 (discussing FCMs and CPOs).
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B. Paperwork Reduction Act of 1995
These parts 15, 37, 38 contain information collection requirements.
As required by the Paperwork Reduction Act of 1995 (Pub. L. 104-13 (May
13,
[[Page 77977]]
1996)), the Commission has submitted a copy of these proposed parts to
the Office of Management and Budget (OMB) for its review (44 U.S.C.
3504(h)). No comments were received in response to the Commission's
invitation in the NPRM to comment on any potential paperwork burden
associated with these regulations.
List of Subjects
17 CFR Part 1
Commodity futures, Consumer protection, Contract markets,
Designation application, Reporting and recordkeeping requirements.
17 CFR Part 5
Authority delegations (Government agencies), Commodity futures,
Contract markets, Designation application, Reporting and recordkeeping
requirements.
17 CFR Part 15
Commodity futures, Contract markets, Reporting and recordkeeping
requirements.
17 CFR Part 36
Commodity futures, Commodity Futures Trading Commission.
17 CFR Part 37
Authority delegations (Government agencies), Commodity futures,
Commodity Futures Trading Commission.
17 CFR Part 38
Commodity futures, Commodity Futures Trading Commission.
17 CFR Part 100
Commodity futures, Commodity Futures Trading Commission.
17 CFR Part 170
Authority delegations (Government agencies), Commodity futures,
Reporting and recordkeeping requirements.
17 CFR Part 180
Claims, Commodity futures, Consumer protection, Reporting and
recordkeeping requirements.
In consideration of the foregoing, and pursuant to the authority
contained in the Act and, in particular, sections 4, 4c, 4i, 5, 5a, 6
and 8a thereof, 7 U.S.C. 6, 6c, 6i, 7, 7a, 8, and 12a, the Commission
hereby amends Chapter I of Title 17 of the Code of Federal Regulations
as follows:
PART 1--GENERAL REGULATIONS UNDER THE COMMODITY EXCHANGE ACT
1. The authority citation for Part 1 continues to read as follows:
Authority: 7 U.S.C. 1a, 2, 2a, 4, 4a, 6, 6a, 6b, 6c, 6d, 6e, 6f,
6g, 6h, 6i, 6j, 6k, 6l, 6m, 6n, 6o, 6p, 7, 7a, 7b, 8, 9, 12, 12a,
12c, 13a, 13a-1, 16, 16a, 19, 21, 23, and 24.
2. Section 1.37 is amended by adding paragraphs (c) and (d) to read
as follows:
Sec. 1.37 Customer's or option customer's name, address, and
occupation recorded; record of guarantor or controller of account.
* * * * *
(c) Each recognized futures exchange shall keep a record in
permanent form which shall show the true name; address; and principal
occupation or business of any foreign trader executing transactions on
the facility or exchange, as well as the name of any person
guaranteeing such transactions or exercising any control over the
trading of such foreign trader.
(d) Paragraph (c) of this section shall not apply to a recognized
futures exchange on which transactions in futures or option contracts
of foreign traders are executed through and the resulting transactions
are maintained in accounts carried by a registered futures commission
merchant or introducing broker subject to the provisions of paragraph
(a) of this section.
* * * * *
3. Section 1.41 is amended as follows:
a. By revising paragraph (a)(1),
b. By removing and reserving paragraph (b), and removing paragarphs
(i) through (t),
c. By redesignating paragraph (e) as paragraph (i) and revising it,
d. By revising paragraphs (c) and (d) and adding (e), and
e. By amending paragraphs (f) and (g) by adding the words ``or
recognized futures exchange'' after the words ``contract market'' each
time they appear, to read as follows:
Sec. 1.41 Contract market rules; submission of rules to the
Commission; exemption of certain rules.
(a) * * *
(1) The term rule of a contract market means any constitutional
provision, article of incorporation, bylaw, rule, regulation,
resolution, interpretation, stated policy, term and condition, trading
protocol, agreement or instrument corresponding thereto, in whatever
form adopted, and any amendment or addition thereto or repeal thereof,
made or issued by a contract market, or by the governing board thereof
or any committee thereof.
* * * * *
(b) [Reserved]
(c) Exemption from the rule review procedure requirements of
section 5a(a)(12)(A) of the Act and related regulations.
Notwithstanding the rule approval and filing requirements of section
5a(a)(12) of the Act, designated contract markets, recognized futures
exchanges and recognized clearing organizations may place a rule into
effect without prior Commission review or approval if:
(1) The rule is not a term or condition of a contract for future
delivery of an agricultural commodity listed in section 1a(3) of the
Act;
(2) The entity has filed a submission for the rule, and the
Commission has received the submission at its Washington, D.C.
headquarters and at the regional office having jurisdiction over the
entity by close of business on the business day preceding
implementation of the rule; and
(3) The rule submission includes:
(i) The label, ``Submission of rule by self-certification;'
(ii) The text of the rule (in the case of a rule amendment,
brackets must indicate words deleted and underscoring must indicate
words added);
(iii) A brief explanation of the rule including any substantive
opposing views not incorporated into the rule; and
(iv) A certification by the eligible entity that the rule does not
violate any provision of the Act and regulations thereunder.
(4) The Commission retains the authority to stay the effectiveness
of a rule implemented pursuant to paragraph (c)(1) of this section
during the pendency of Commission proceedings to disapprove, alter or
amend the rule. The decision to stay the effectiveness of a rule in
such circumstances may not be delegable to any employee of the
Commission.
(d)(1) Voluntary submission of rules for fast-track approval. A
designated contract market, recognized futures exchange, derivatives
transaction facility or recognized clearing organization may submit any
rule or proposed rule (which may be terms or conditions of trading or
trading protocols), except those submitted to the Commission under
paragraph (f) of this section, for approval by the Commission pursuant
to section 5a(a)(12)(A) of the Act, whether or not so required by
section 5a(a)(12) of the Act under the following procedures:
[[Page 77978]]
(i) One copy of each rule submitted under this section shall be
furnished in hard copy or electronically in a format specified by the
Secretary of the Commission to the Commission at its Washington, DC
headquarters. If a hard copy is furnished for submissions under
appendix A to part 5 of this chapter, two additional hard copies shall
be furnished to the Commodity Futures Trading Commission, Three
Lafayette Centre, 1155 21st Street NW., Washington, DC 20581. Each
submission under this paragraph (d)(1) shall be in the following order:
(A) Label the submission as ``Submission for Commission rule
approval'';
(B) Set forth the text of the rule or proposed rule (in the case of
a rule amendment, brackets must indicate words deleted and underscoring
must indicate words added);
(C) Describe the proposed effective date of a proposed rule and any
action taken or anticipated to be taken to adopt the proposed rule by
the contract market, recognized futures exchange, derivatives
transaction facility or recognized clearing organization or by its
governing board or by any committee thereof, and cite the rules of the
entity that authorize the adoption of the proposed rule;
(D) Explain the operation, purpose, and effect of the proposed
rule, including, as applicable, a description of the anticipated
benefits to market participants or others, any potential
anticompetitive effects on market participants or others, how the rule
fits into the contract market, recognized futures exchange, derivatives
transaction facility or recognized clearing organization's framework of
self-regulation, and any other information which may be beneficial to
the Commission in analyzing the proposed rule. If a proposed rule
affects, directly or indirectly, the application of any other rule of
the submitting entity, set forth the pertinent text of any such rule
and describe the anticipated effect;
(E) Note and briefly describe any substantive opposing views
expressed with respect to the proposed rule which were not incorporated
into the proposed rule prior to its submission to the Commission; and
(F) Identify any Commission regulation that the Commission may need
to amend, or sections of the Act or Commission regulations that the
Commission may need to interpret in order to approve or allow into
effect the proposed rule. To the extent that such an amendment or
interpretation is necessary to accommodate a proposed rule, the
submission should include a reasoned analysis supporting the change.
(ii) All rules submitted for Commission approval under paragraph
(d)(1)(i) of this section shall be deemed approved by the Commission
under section 5a(a)(12)(A) of the Act, forty-five days after receipt by
the Commission, unless notified otherwise within that period, if:
(A) The submission complies with the requirements of paragraphs
(d)(1)(i) (A) through (F) of this section or, for dormant contracts,
the requirements of Sec. 5.3 of this chapter;
(B) The submitting entity does not amend the proposed rule or
supplement the submission, except as requested by the Commission,
during the pendency of the review period; and
(C) The submitting entity has not instructed the Commission in
writing during the review period to review the proposed rule under the
180 day review period under section 5a(a)(12)(A) of the Act.
(iii) The Commission, within forty-five days after receipt of a
submission filed pursuant to paragraph (d)(1)(i) of this section, may
notify the entity making the submission that the review period has been
extended for a period of thirty days where the proposed rule raises
novel or complex issues which require additional time for review or is
of major economic significance. This notification shall briefly
describe the nature of the specific issues for which additional time
for review is required. Upon such notification, the period for review
shall be extended for a period of thirty days, and, unless the entity
is notified otherwise during that period, the rule shall be deemed
approved at the end of the enlarged review time.
(iv) During the forty-five day period for fast-track review, or the
thirty-day extension when the period has been enlarged under paragraph
(d)(1)(iii) of this section, the Commission shall notify the submitting
entity that the Commission is terminating fast-track review procedures
and will review the proposed rule under the 180 day review period of
section 5a(a)(12)(A) of the Act, if it appears that the proposed rule
may violate a specific provision of the Act, regulations, or form or
content requirements of this section. This termination notification
will briefly specify the nature of the issues raised and the specific
provision of the Act, regulations, or form or content requirements of
this section that the proposed rule appears to violate. Within fifteen
days of receipt of this termination notification, the designated
contract market, recognized futures exchange, derivatives transaction
facility or recognized clearing organization may:
(A) Withdraw the rule;
(B) Request the Commission to review the rule pursuant to the one
hundred and eighty day review procedures set forth in section
5a(a)(12)(A) of the Act; or
(C) Request the Commission to render a decision whether to approve
the proposed rule or to institute a proceeding to disapprove the
proposed rule under the procedures specified in section 5a(a)(12)(A) of
the Act by notifying the Commission that the submitting entity views
its submission as complete and final as submitted.
(2) Voluntary submission of rules for expedited approval.
Notwithstanding the provisions of paragraph (d)(1) of this section,
changes to terms and conditions of a contract that are consistent with
the Act and Commission regulations and with standards approved or
established by the Commission in a written notification to the market
or clearing organization of the applicability of this paragraph (d)(2)
shall be deemed approved by the Commission at such time and under such
conditions as the Commission shall specify, provided, however, that the
Commission may at any time alter or revoke the applicability of such a
notice to any particular contract.
(e)(1) Notification of rule amendments. Notwithstanding the rule
approval and filing requirements of section 5a(a)(12) of the Act and of
paragraphs (c) and (d) of this section, designated contract markets,
recognized futures exchanges and recognized clearing organizations may
place the following rules into effect without prior notice to the
Commission if the following conditions are met:
(i) The designated contract market, recognized futures exchange, or
recognized clearing organization provides to the Commission at least
weekly a summary notice of all rule changes made effective pursuant to
this paragraph during the preceding week. Such notice must be labeled
``Weekly Notification of Rule Changes'' and need not be filed for weeks
during which no such actions have been taken. One copy of each such
submission shall be furnished in hard copy or electronically in a
format specified by the Secretary of the Commission to the Commodity
Futures Trading Commission, Three Lafayette Centre, 1155 21st Street
NW., Washington, DC 20581; and
(ii) The rule change governs:
(A) Nonmaterial revisions. Corrections of typographical errors,
renumbering, periodic routine updates to identifying information about
[[Page 77979]]
approved entities and other such nonsubstantive revisions of contract
terms and conditions that have no effect on the economic
characteristics of the contract;
(B) Delivery standards set by third parties. Changes to grades or
standards of commodities deliverable on futures contracts that are
established by an independent third party and that are incorporated by
reference as terms of the contract, provided that the grade or standard
is not established, selected or calculated solely for use in connection
with futures or option trading;
(C) Index contracts. Routine changes in the composition,
computation, or method of selection of component entities of an index
other than a stock index referenced and defined in the contract's
terms, made by an independent third party whose business relates to the
collection or dissemination of price information and that was not
formed solely for the purpose of compiling an index for use in
connection with a futures or option contract;
(D) Transfer of membership or ownership. Procedures and forms for
the purchase, sale or transfer of membership or ownership, but not
including qualifications for membership or ownership, any right or
obligation of membership or ownership or dues or assessments; or
(E) Administrative procedures. The organization and administrative
procedures of a contract market's governing bodies such as a Board of
Directors, Officers and Committees, but not voting requirements and
procedures or requirements or procedures relating to conflicts of
interest.
(2) Notification of rule amendments not required. Notwithstanding
the rule approval and filing requirements of section 5a(a)(12) of the
Act and of paragraphs (c) and (d) of this section, designated contract
markets, recognized futures exchanges and recognized clearing
organizations may place into effect without notice to the Commission,
rules governing:
(i) Administration. The routine, daily administration, direction
and control of employees, requirements relating to gratuity and similar
funds, but not guaranty, reserves, or similar funds; declaration of
holidays, and changes to facilities housing the market, trading floor
or trading area; or
(ii) Standards of decorum. Standards of decorum or attire or
similar provisions relating to admission to the floor, badges,
visitors, but not the establishment of penalties for violations of such
rules.
* * * * *
(i) Membership lists. Upon request of the Commission each
designated contract market, recognized futures exchange or recognized
clearing organization shall promptly furnish to the Commission a
current list of the facility's or entity's members or owners subject to
fitness requirements.
Secs. 1.43, 1.45 and 1.50 [Removed]
4. In part 1, Secs. 1.43, 1.45, and 1.50 are proposed to be removed
and reserved.
5. Part 5 is amended as follows:
PART 5--PROCEDURES FOR LISTING NEW PRODUCTS
a. The authority citation for part 5 continues to read as follows:
Authority: 7 U.S.C. 6(c), 6c, 7, 7a, 8 and 12a.
b. The heading of part 5 is revised as set forth above and
Secs. 5.1 through 5.3 are revised to read as follows:
Sec. 5.1 Listing contracts for trading by exchange certification.
(a) Notwithstanding the provisions of section 4(a)(1) of the Act or
Sec. 33.2 of this chapter, a board of trade that has been recognized by
the Commission as a recognized futures exchange under part 38 of this
chapter may list for trading contracts of sale of a commodity for
future delivery or commodity option contracts, if the recognized
futures exchange:
(1) Lists for trading at least one contract which is not dormant
within the meaning of Sec. 5.3;
(2) In connection with the trading of the contract complies with
all requirements of the Act and Commission regulations thereunder
applicable to the recognized futures exchange under part 38 of this
chapter;
(3) Files with the Commission at its Washington, D.C., headquarters
either in electronic or hard-copy form a copy of the contract's initial
terms and conditions and a certification by the recognized futures
exchange that the contract's initial terms and conditions do not
violate any requirement of part 38 of this chapter, any applicable
provision of the Act or of the rules thereunder, and the filing is
received no later than the close of business of the business day
preceding the contract's initial listing; and
(4) Identifies the contract in its rules as listed for trading
pursuant to exchange certification.
(b) The provisions of this section shall not apply to:
(1) A contract subject to the provisions of section 2(a)(1)(B) of
the Act;
(2) A contract to be listed initially for trading that is the same
or substantially the same as one for which an application for
Commission review and approval pursuant to Sec. 5.2 was filed by
another board of trade while the application is pending before the
Commission; or
(3) A contract to be listed initially for trading that is the same
or substantially the same as one which is the subject of a pending
Commission disapproval proceeding under section 6 of the Act, to
disapprove a term or condition under section 5a(a)(12) of the Act, to
alter or supplement a term or condition under section 8a(7) of the Act,
to amend terms or conditions under section 5a(a)(10) of the Act, to
declare an emergency under section 8a(9) of the Act, or to any other
proceeding the effect of which is to disapprove, alter, supplement, or
require a contract market or a recognized futures exchange to adopt a
specific term or condition, trading rule or procedure, or to take or
refrain from taking a specific action.
Sec. 5.2 Voluntary submission of new products for Commission review
and approval.
(a) Cash-settled contracts. A new contract to be listed for trading
by a recognized futures exchange under part 38 of this chapter or a
recognized derivatives transaction facility under part 37 of this
chapter shall be deemed approved by the Commission ten business days
after receipt by the Commission of the application for contract
approval, unless notified otherwise within that period, if:
(1) The submitting entity labels the submission as being submitted
pursuant to Commission rule 5.2--Fast Track Ten-Day Review;
(2)(i) The application for approval is for a futures contract
providing for cash settlement or for delivery of a foreign currency for
which there is no legal impediment to delivery and for which there
exists a liquid cash market; or
(ii) For an option contract that is itself cash-settled, is for
delivery of a foreign currency that meets the requirements of paragraph
(a)(2)(i) of this section or is to be exercised into a futures contract
which has already been designated as a contract market or approved
under this section;
(3) The application for approval is for a commodity other than
those enumerated in section 1a(3) of the Act or one that is subject to
the procedures of section 2(a)(1)(B) of the Act;
(4) The submitting entity trades at least one contract which is not
dormant within the meaning of this part;
[[Page 77980]]
(5) The submission complies with the requirements of Appendix A of
this part--Guideline No. 1;
(6) The submitting entity does not amend the terms or conditions of
the proposed contract or supplement the application for designation,
except as requested by the Commission or for correction of
typographical errors, renumbering or other such nonsubstantive
revisions, during that period; and
(7) The submitting entity has not instructed the Commission in
writing during the review period to review the application for
designation under the usual procedures under section 6 of the Act.
(b) Contracts for physical delivery. A new contract to be listed
for trading by a recognized futures exchange under part 38 of this
chapter or by a derivatives transaction facility under part 37 of this
chapter shall be deemed approved by the Commission forty-five days
after receipt by the Commission of the application for contract
approval, unless notified otherwise within that period, if:
(1) The submitting entity labels the submission as being submitted
pursuant to Commission rule 5.2--Fast Track Forty-Five Day Review;
(2) The application for contract approval is for a commodity other
than those subject to the procedures of section 2(a)(1)(B) of the Act;
(3) The submitting entity lists for trading at least one contract
which is not dormant within the meaning of this part;
(4) The submission complies with the requirements of Appendix A to
this part--Guideline No. 1;
(5) The submitting entity does not amend the terms or conditions of
the proposed contract or supplement the application for designation,
except as requested by the Commission or for correction of
typographical errors, renumbering or other such nonsubstantive
revisions, during that period; and
(6) The submitting entity has not instructed the Commission in
writing during the forty-five day review period to review the
application for designation under the usual procedures under section 6
of the Act.
(c) Notification of extension of time. The Commission, within ten
days after receipt of a submission filed under paragraph (a) of this
section, or forty-five days after receipt of a submission filed under
paragraph (b) of this section, may notify the submitting entity that
the review period has been extended for a period of thirty days where
the application for approval raises novel or complex issues which
require additional time for review. This notification will briefly
specify the nature of the specific issues for which additional time for
review is required. Upon such notification, the period for fast-track
review of paragraphs (a) and (b) of this section shall be extended for
a period of thirty days.
(d) Notification of termination of fast-track procedures. During
the fast-track review period provided under paragraphs (a) or (b) of
this section, or of the thirty-day extension when the period has been
enlarged under paragraph (c) of this section, the Commission shall
notify the submitting entity that the Commission is terminating fast-
track review procedures and will review the proposed contract under the
usual procedures of section 6 of the Act, if it appears that the
proposed contract may violate a specific provision of the Act,
regulations, or form or content requirements of Appendix A to this
part. This termination notification will briefly specify the nature of
the issues raised and the specific provision of the Act, regulation, or
form or content requirement of Appendix A to this part that the
proposed contract appears to violate. Within ten days of receipt of
this termination notification, the submitting entity may request that
the Commission render a decision whether to approve the designation or
to institute a proceeding to disapprove the proposed application for
designation under the procedures specified in section 6 of the Act by
notifying the Commission that the exchange views its application as
complete and final as submitted.
(e) Delegation of authority. (1) The Commission hereby delegates,
until it orders otherwise, to the Director of the Division of Economic
Analysis or to the Director's delegatee, with the concurrence of the
General Counsel or the General Counsel's delegatee, authority to
request under paragraphs (a)(6) and (b)(5) of this section that the
recognized futures exchange or derivatives transaction facility amend
the proposed contract or supplement the application, to notify a
submitting entity under paragraph (c) of this section that the time for
review of a proposed contract term submitted for review under
paragraphs (a) or (b) of this section has been extended, and to notify
the submitting entity under paragraph (d) of this section that the
fast-track procedures of this section are being terminated.
(2) The Director of the Division of Economic Analysis may submit to
the Commission for its consideration any matter which has been
delegated in paragraph (e)(1) of this section.
(3) Nothing in the paragraph prohibits the Commission, at its
election, from exercising the authority delegated in paragraph (e)(1)
of this section.
Sec. 5.3 Dormant contracts.
(a) Definitions. For purposes of this section:
(1) The term dormant contract means any commodity futures or option
contract:
(i) In which no trading has occurred in any future or option
expiration for a period of six complete calendar months; or
(ii) Which has been certified by a recognized futures exchange or a
recognized derivatives transaction facility to the Commission to be a
dormant contract market.
(2) [Reserved]
(b) Listing of additional futures trading months or option
expiration by certification. A contract that has been listed for
trading initially under the procedures of either Secs. 5.1 or 5.2 that
has become dormant may be relisted for trading additional months
pursuant to the procedures of Sec. 1.41(c) of this chapter by filing
the bylaw, rule, regulation or resolution to list additional trading
months or expirations with the Commission as specified in that section.
Upon relisting, the contract must be identified by the recognized
futures exchange as listed for trading by exchange certification.
(c) Approval for listing of additional futures trading months or
option expirations. A contract that has been initially approved by the
Commission under Sec. 5.2 and that has become dormant may be relisted
for trading additional months pursuant to the procedures of
Sec. 1.41(d) of this chapter by filing the bylaw, rule, regulation or
resolution to list additional trading months or expirations with the
Commission as specified in that section.
(1) Each such submission shall clearly designate the submission as
filed pursuant to Commission Rule 5.3; and
(2) Include the information required to be submitted pursuant to
Sec. 5.3 or an economic justification for the listing of additional
months or expirations in the dormant contract market, which shall
include an explanation of those economic conditions which have changed
subsequent to the time the contract became dormant and an explanation
of how any new terms and conditions which are now being proposed, or
which have been proposed for an option market's underlying futures
contract market, would make it reasonable to expect that the futures or
[[Page 77981]]
option contract will be used on more than an occasional basis for
hedging or price basing.
(d) Exemptions. No contract shall be considered dormant until the
end of sixty (60) complete calendar months:
(1) Following initial listing; or
(2) Following Commission approval of the contract market bylaw,
rule, regulation, or resolution to relist trading months submitted
pursuant to paragraph (c) of this section.
Appendices C and D [Removed and Reserved]
c. Appendices C and D are removed and reserved.
PART 15--REPORTS--GENERAL PROVISIONS
6. The authority citation for Part 15 is revised to read as
follows:
Authority: 7 U.S.C. 2, 4, 5, 6(c), 6a, 6c(a)-(d), 6f, 6g, 6i,
6k, 6m, 6n, 7, 9, 12a, 19 and 21.
7. Section 15.05 is amended by revising the heading and by adding
paragraphs (e) through (h) to read as follows:
Sec. 15.05 Designation of agent for foreign brokers, customers of a
foreign broker and foreign traders.
* * * * *
(e) Any derivatives transaction facility eligible under
Sec. 37.2(a)(2) of this chapter or recognized futures exchange that
permits a foreign broker to intermediate transactions in futures or
option contracts on the facility or exchange, or permits a foreign
trader to effect transactions in futures or option contracts on the
facility or exchange shall be deemed to be the agent of the foreign
broker and any of its customers for whom the transactions were
executed, or the foreign trader for purposes of accepting delivery and
service of any communication issued by or on behalf of the Commission
to the foreign broker, any of its customers or the foreign trader with
respect to any futures or option contracts executed by the foreign
broker or the foreign trader on the derivatives transaction facility
eligible under Sec. 37.2(a)(2) of this chapter or recognized futures
exchange. Service or delivery of any communication issued by or on
behalf of the Commission to a derivatives transaction facility eligible
under Sec. 37.2(a)(2) of this chapter or recognized futures exchange
pursuant to such agency shall constitute valid and effective service
upon the foreign broker, any of its customers, or the foreign trader. A
derivatives transaction facility eligible under Sec. 37.2(a)(2) of this
chapter or recognized futures exchange which has been served with, or
to which there has been delivered, a communication issued by or on
behalf of the Commission to a foreign broker, any of its customers, or
a foreign trader shall transmit the communication promptly and in a
manner which is reasonable under the circumstances, or in a manner
specified by the Commission in the communication, to the foreign
broker, any of its customers or the foreign trader.
(f) It shall be unlawful for any derivatives transaction facility
eligible under Sec. 37.2(a)(2) of this chapter or recognized futures
exchange to permit a foreign broker, any of its customers or a foreign
trader to effect transactions in futures or option contracts unless the
derivatives transaction facility eligible under Sec. 37.2(a)(2) of this
chapter or recognized futures exchange prior thereto informs the
foreign broker, any of its customers or the foreign trader in any
reasonable manner the derivatives transaction facility eligible under
Sec. 37.2(a)(2) of this chapter or recognized futures exchange deems to
be appropriate, of the requirements of this section.
(g) The requirements of paragraphs (e) and (f) of this section
shall not apply to any transactions in futures or option contracts if
the foreign broker, any of its customers or the foreign trader has duly
executed and maintains in effect a written agency agreement in
compliance with this paragraph with a person domiciled in the United
States and has provided a copy of the agreement to the derivatives
transaction facility eligible under Sec. 37.2(a)(2) of this chapter or
recognized futures exchange prior to effecting any transactions in
futures or option contracts on the derivatives transaction facility
eligible under Sec. 37.2(a)(2) of this chapter or recognized futures
exchange. This agreement must authorize the person domiciled in the
United States to serve as the agent of the foreign broker, any of its
customers or the foreign trader for purposes of accepting delivery and
service of all communications issued by or on behalf of the Commission
to the foreign broker, any of its customers or the foreign trader and
must provide an address in the United States where the agent will
accept delivery and service of communications from the Commission. This
agreement must be filed with the Commission by the derivatives
transaction facility eligible under Sec. 37.2(a)(2) of this chapter or
recognized futures exchange prior to permitting the foreign broker, any
of its customers or the foreign trader to effect any transactions in
futures or option contracts. Unless otherwise specified by the
Commission, the agreements required to be filed with the Commission
shall be filed with the Secretary of the Commission at Three Lafayette
Centre, 1155 21st Street, N.W., Washington, D.C. 20581. A foreign
broker, any of its customers or a foreign trader shall notify the
Commission immediately if the written agency agreement is terminated,
revoked, or is otherwise no longer in effect. If the derivatives
transaction facility eligible under Sec. 37.2(a)(2) of this chapter or
recognized futures exchange knows or should know that the agreement has
expired, been terminated, or is no longer in effect, the derivatives
transaction facility eligible under Sec. 37.2(a)(2) of this chapter or
recognized futures exchange shall notify the Secretary of the
Commission immediately. If the written agency agreement expires,
terminates, or is not in effect, the derivatives transaction facility
eligible under Sec. 37.2(a)(2) of this chapter or recognized futures
exchange and the foreign broker, any of its customers or the foreign
trader are subject to the provisions of paragraphs (e) and (f) of this
section.
(h) The provisions of paragraphs (e), (f) and (g) of this section
shall not apply to a derivatives transaction facility or recognized
futures exchange on which all transactions in futures or option
contracts of foreign brokers, their customers or foreign traders are
executed through and the resulting transactions are maintained in
accounts carried by a registered futures commission merchant or
introducing broker subject to the provisions of Rules 15.05(a), (b),
(c) and (d).
* * * * *
8. Part 36 is revised to read as follows:
PART 36--EXEMPTION OF TRANSACTIONS ON MULTILATERAL TRANSACTION
EXECUTION FACILITIES
Sec.
36.1 Definitions. As used in this part:
36.2 Exemption.
36.3 Enforceability.
Authority: 7 U.S.C. 2, 6, 6c, and 12a.
Sec. 36.1 Definitions.
As used in this part:
(a) Eligible participant means and shall be limited to the parties
or entities listed in Sec. 35.1(b)(1) through (11) of this chapter; and
(b) Multilateral transaction execution facility means an electronic
or non-electronic market or similar facility through which persons, for
their own accounts or for the accounts of others,
[[Page 77982]]
enter into, agree to enter into or execute binding contracts,
agreements or transactions by accepting bids or offers made by one
person that are open to multiple persons who conduct business through
such market or similar facility, but does not include:
(1) A facility whose participants individually negotiate (or have
individually negotiated) with counterparties the material terms
applicable to contracts, agreements, or transactions between them,
including contracts, agreements, or transactions conducted on the
facility, and which are subject to subsequent acceptance by the
counterparties;
(2) Any electronic communications system on which the execution of
a contract, agreement or transaction results from the content of
bilateral communications exchanged between the parties and not by the
interaction of multiple orders within a predetermined, non-
discretionary automated trade matching algorithm; or
(3) Any facility on which only a single firm may participate as
market maker and participants other than the market maker may not
accept bids or offers of other non-market maker participants.
Sec. 36.2 Exemption.
A contract, agreement or transaction traded on a multilateral
transaction execution facility as defined in Sec. 36.1(b) is exempt
from all provisions of the Act and any person or class of persons
offering, entering into, rendering advice, or rendering other services
with respect to such contract, agreement or transaction is exempt for
such activity from all provisions of the Act (except in each case the
provisions enumerated in Sec. 36.3(a)) provided the following terms and
conditions are met:
(a) Only eligible participants, either trading for their own
account or through another eligible participant, have trading access to
the multilateral transaction execution facility;
(b) The contract, agreement or transaction listed on or traded
through the multilateral transaction execution facility is based upon:
(1) A debt obligation other than an exempt security under section 3
of the Securities Act of 1933 or section 3a(12) of the Securities
Exchange Act of 1934;
(2) A foreign currency;
(3) An interest rate;
(4) A measure of credit risk or quality, including instruments
known as ``total return swaps,'' ``credit swaps'' or ``credit spread
swaps'';
(5) An occurrence, extent of an occurrence or contingency beyond
the control of the counterparties to the transaction; or
(6) An economic or commercial index or measure which is beyond the
control of the counterparties to the transaction, and is not based upon
prices derived from trading in a directly corresponding underlying cash
market and for which the related contract, agreement or transaction is
cash settled;
(c) If cleared, the submission of such contracts, agreements or
transactions for clearance and/or settlement must be to a clearing
organization that is authorized under Sec. 39.2 of this chapter:
Provided, however, that nothing in this paragraph precludes:
(1) Arrangements or facilities between parties to such contracts,
agreements or transactions that provide for netting of payment or
delivery obligations resulting from such contracts, agreements, or
transactions; or
(2) Arrangements or facilities among parties to such contracts,
agreements or transactions, that provide for netting of payments or
deliveries resulting from such contracts, agreements or transactions;
(d) The multilateral transaction execution facility on or through
which such contracts, agreements or transactions are traded and the
parties to, participants in, or intermediaries in such a facility that
is exempt under this section are prohibited from claiming that the
facility is regulated, recognized or approved by the Commission; and
(e) The facility:
(1) If an electronic system that also lists for trading products
pursuant to parts 37 or 38 of this chapter, must provide notice to
participants of the agreements, contracts or transactions traded on the
facility pursuant to this part 36 and that such transactions are not
subject to regulation under the Act; or
(2) If providing a physical trading environment, must provide that
products trading pursuant to parts 37 or 38 of this chapter be traded
in a location separate from, but which may adjoin, the location for
products traded pursuant to this part 36.
(f) If the Commission determines by order, after notice and an
opportunity for a hearing through submission of written data, views and
arguments, that the facility serves as a significant source for the
discovery of prices for an underlying commodity, the facility must on a
daily basis disseminate publicly trading volume and price ranges and
other trading data appropriate to that market as specified in the
order.
(g) Any person or entity may apply to the Commission for exemption
from any of the provisions of the Act (except section 2(a)(1)(B)) for
other arrangements or facilities, on such terms and conditions as the
Commission deems appropriate, including, but not limited to, the
applicability of other regulatory regimes.
Sec. 36.3 Enforceability.
(a) Notwithstanding the exemption in Sec. 36.2, sections
2(a)(1)(B), 4b, and 4o of the Act and Sec. 32.9 of this chapter as
adopted under section 4c(b) of the Act, and sections 6(c) and 9(a)(2)
of the Act to the extent they prohibit manipulation of the market price
of any commodity in interstate commerce or for future delivery on or
subject to the rules of any contract market, continue to apply to
transactions and persons otherwise subject to those provisions.
(b) A party to a contract, agreement or transaction that is with a
counterparty that is an eligible participant (or counterparty
reasonably believed by such party at the time the contract, agreement
or transaction was entered into to be an eligible participant) shall be
exempt from any claim, counterclaim or affirmative defense by such
counterparty under section 22(a)(1) of the Act or any other provision
of the Act:
(1) That such contract, agreement or transaction is void, voidable
or unenforceable, or
(2) To rescind, or recover any payment made in respect of, such
contract, agreement or transaction, based solely on the failure of such
party or such contract, agreement or transaction to comply with the
terms or conditions of the exemption under this part.
9. Chapter I of 17 CFR is amended by adding new Part 37 as follows:
PART 37--EXEMPTION OF TRANSACTIONS ON A DERIVATIVES TRANSACTION
FACILITY
Sec.
37.1 Scope and definitions.
37.2 Exemption.
37.3 General conditions for recognition as a derivatives
transaction facilities.
37.4 Conditions for recognition as a derivatives transaction
facility, compliance with core principles.
37.5 Additional conditions for recognition as a derivative
transaction facility.
37.6 Information relating to transactions on derivative
transaction facilities.
37.7 Procedures for recognition.
37.8 Enforceability.
37.9 Fraud in connection with part 37 transactions.
Appendix A to Part 37--Application Guidance.
Authority: 7 U.S.C. 2, 6, 6c, 6(c), 6(i) and 12a.
[[Page 77983]]
Sec. 37.1 Scope and definitions.
(a) Scope. (1) A board of trade operating as a recognized
derivatives transaction facility and the products listed for trading
thereon under this exemption shall be deemed to be subject to all of
the provisions of the Act and Commission regulations thereunder which
are applicable to a ``board of trade,'' ``board of trade licensed by
the Commission,'' ``exchange,'' ``contract market,'' ``designated
contract market,'' or ``contract market designated by the Commission''
as though those provisions were set forth in this section and included
specific reference to contracts listed for trading by recognized
derivatives transaction facilities pursuant to this section.
(2) The provisions of this section shall not apply to a commodity
or a contract subject to the provisions of section 2(a)(1)(B) of the
Act.
(b) Definitions. As used in this part:
(1) Eligible participant means, and shall be limited to, the
parties or entities listed in Sec. 35.1(b)(1) through (11) of this
chapter, Provided, however, that notwithstanding the proviso of
Sec. 35.1(b)(10), a floor broker or floor trader that is a natural
person or proprietorship shall be considered to be an eligible
participant for transactions on a derivatives transaction facility
recognized under Sec. 37.7 if the floor broker or floor trader is
registered in such a capacity under the Act and its trading obligations
on the derivatives trading facility are guaranteed by a futures
commission merchant.
(2) ``Eligible commercial participant'' means, and shall be limited
to, a party or entity listed in Secs. 35.1(b)(1), (b)(2), (b)(3),
(b)(6) and (b)(8) of this chapter that in connection with its business,
makes and takes delivery of the underlying commodity and regularly
incurs risks in addition to price risk related to such commodity, is a
dealer that regularly provides hedging, risk management or market-
making services to the foregoing entities, or is a registered floor
trader or floor broker trading for its own account, whose trading
obligations are guaranteed by a futures commission merchant.
Sec. 37.2 Exemption.
Notwithstanding Sec. 37.1(a)(1), a contract, agreement or
transaction traded on a multilateral transaction execution facility as
defined in Sec. 36.1(b) of this chapter, the facility and the
facility's operator are exempt from all provisions of the Act and from
all Commission regulations thereunder for such activity, except for
those provisions of the Act and Commission regulations which, as a
condition of this exemption, are reserved in Sec. 37.8(a), provided the
following terms and conditions are met:
(a)(1) Commercial-participant derivatives transaction facility.
Only eligible commercial participants trading for their own account
have trading access to the derivatives transaction facility for
contracts, agreements or transactions in any commodity except for those
listed in section 1a(3) of the Act or an exempted security under
section 3 of the Securities Act of 1933 or section 3(a)(12) of the
Securities Exchange Act of 1934; or
(2)(i) Eligible-participant derivatives transaction facility. The
contract, agreement or transaction listed on or traded through the
multilateral transaction execution facility meets the requirements set
forth in Sec. 36.2(b) of this chapter or has been found by the
Commission on a case-by-case determination to have a sufficiently
liquid and deep cash market and a surveillance history based on actual
trading experience to provide assurance that the contract is highly
unlikely to be manipulated; and
(ii) Non-eligible participants. Participants that are not eligible
participants as defined in Sec. 37.1(b)(1) may have trading access only
through:
(A) A registered futures commission merchant that operates in
accordance with the provisions of Sec. 1.17(a)(1)(ii) of this chapter
and that carries such participant's account, including access directly
through any credit filter on which the futures commission merchant
affirmatively imposes credit standards; or
(B) A commodity trading advisor that operates in accordance with
Sec. 4.32 of this chapter, where the participant's account is carried
by any registered futures commission merchant;
(b) The multilateral transaction execution facility through which
the contract, agreement or transaction is entered into has been
recognized by the Commission as a derivatives transaction facility
pursuant to Sec. 37.7;
(c) A multilateral transaction execution facility that applies to
be, and is, a recognized derivatives transaction facility must comply
with all of the conditions of this part 37 exemption and must disclose
to participants transacting on or through its facility that
transactions conducted on or through the facility are subject to the
provisions of this part 37;
(d)(1) If intermediated, the transactions of eligible participants
must be carried in accounts at a registered futures commission
merchant;
(2) If cleared, the submission of such contracts, agreements or
transactions for clearance and/or settlement must be to a clearinghouse
that is recognized by the Commission under Sec. 39.4 of this chapter.
Provided, however, that nothing in this paragraph (d)(2) precludes:
(i) Arrangements or facilities between parties to such contracts,
agreements or transactions that provide for netting of payment or
delivery obligations resulting from such contracts, agreements, or
transactions; or
(ii) Arrangements or facilities among parties to such contracts,
agreements or transactions, that provide for netting of payments or
deliveries resulting from such contracts, agreements or transactions;
and
(e) The products if traded on an electronic system must be clearly
identified as traded on a recognized derivatives transaction facility
or if traded in a physical trading environment must be traded in a
location separate from, but which may adjoin the location for, the
trading of products pursuant to contract market designation, or to
parts 36 and 38 of this chapter.
Sec. 37.3 General conditions for recognition as a derivatives
transaction facility.
To be recognized as a derivatives transaction facility, the
facility initially must have:
(a) Rules, which may be trading protocols, relating to trading on
its facility, including, depending on the nature of the trading
mechanism:
(1) Rules, which may be trading protocols, to deter trading abuses,
and adequate power and capacity to detect, investigate and take action
against violation of its trade rules or trading protocols including
arrangements to obtain necessary information to perform the functions
in this paragraph (a)(1), or
(2) Use of technology that provides participants with impartial
access to transactions and captures information that is available for
use in determining whether violations of its rules or trading protocols
have occurred;
(b) Rules, which may be trading protocols, defining, or
specifications detailing, the operation of the trading mechanism or
electronic matching platform; and
(c) Rules, which may be trading protocols, detailing the financial
framework applying to the transactions or ensuring the financial
integrity of transactions entered into by, or through, its facilities.
[[Page 77984]]
Sec. 37.4 Conditions for recognition as a derivatives transaction
facility, compliance with core principles.
To be recognized as a derivatives transaction facility, the
facility, initially and on a continuing basis, must meet and adhere to
the following core principles:
(a) Enforcement. Effectively monitor and enforce its rules, which
may be trading protocols, including, if applicable, limitations on
access.
(b) Market oversight. As appropriate to the market and the
contracts traded:
(1) Monitor markets on a routine and nonroutine basis as necessary
to ensure fair and orderly trading, and have, and where appropriate
exercise, authority to maintain a fair and orderly market; or
(2) Provide information to the Commission as requested by the
Commission to satisfy its obligations under the Act.
(c) Operational information. Disclose to regulators and to market
participants, as appropriate, information concerning trading terms,
trading protocols, contract terms and conditions, trading mechanisms,
financial integrity arrangements or mechanisms, as well as other
relevant information.
(d) Transparency. Provide to market participants on a fair,
equitable and timely basis information regarding prices, bids and
offers, and other information appropriate to the market and, as
appropriate to the market, make available to the public with respect to
actively traded products, to the extent applicable, information
regarding daily opening and closing prices, price range, trading volume
and other related market information.
(e) Fitness. Have appropriate fitness standards for members,
operators or owners with greater than 10 percent interest or an
affiliate of such an owner, members of the governing board, and those
who make disciplinary determinations.
(f) Recordkeeping. Keep full books and records of all activities
related to its business as a recognized derivatives transaction
facility, including full information relating to data entry and trade
details sufficient to reconstruct trading, in a form and manner
acceptable to the Commission for a period of five years, during the
first two of which the books and records are readily available, and
which shall be open to inspection by any representative of the
Commission or the U.S. Department of Justice.
(g) Competition. Operate in a manner consistent with the public
interest to be protected by the antitrust laws.
Sec. 37.5 Additional conditions for recognition as a derivative
transaction facility.
To be recognized as a derivatives transaction facility, initially
and on a continuing basis, the facility must:
(a) Products. Notwithstanding the provisions of section 4(a)(1) of
the Act or Sec. 33.2 of this chapter, notify the Commission of the
listing of new contracts for trading, posting of new product
descriptions, terms and conditions or trading protocols or providing
for a new system product functionality, by filing with the Commission
at its Washington, D.C. headquarters, a submission labeled ``DTF Notice
of Product Listing'' that includes the text of the contract's terms or
conditions, product description, trading protocol or description of the
system functionality or by electronic notification of the foregoing at
the time traders or participants in the market are notified, but in no
event later than the close of business on the business day preceding
initial listing, posting or implementation of the trading protocol or
system functionality;
(b) Material modifications. Notwithstanding the rule approval and
filing requirements of section 5a(a)(12)(A) of the Act, notify the
Commission prior to placing a material rule, term or condition or
trading protocol into effect or amending a material rule, term or
condition or trading protocol, by filing with the Commission at its
Washington, D.C. headquarters a submission labeled, ``DTF Rule Notice''
which includes the text of the rule or rule amendment, term and
condition or trading protocol (brackets must indicate words deleted and
underscoring must indicate words added) or by electronic notification
of the rule, term and condition or trading protocol to be placed into
effect or to be changed, at the time and in the manner traders or
participants in the market are notified, but in no event later than the
close of business on the business day preceding implementation of the
rule, term and condition or trading protocol. The derivatives
transaction facility must maintain documentation regarding all changes
to rules, terms and conditions or trading protocols;
(c) Identify participants. Keep a record in permanent form which
shall show the true name; address; and principal occupation or business
of any foreign trader executing transactions on the facility or
exchange, as well as the name of any person guaranteeing such
transactions or exercising any control over the trading of such foreign
trader. Provided, however, this paragraph shall not apply to a
derivatives transactions facility insofar as transactions in futures or
option contracts of foreign traders are executed through and the
resulting transactions are maintained in accounts carried by a
registered futures commission merchant or introducing broker subject to
Sec. 1.37 of this chapter; and
(d) Identify persons subject to fitness. Upon request by the
Commission, furnish to the Commission a current list of persons subject
to the fitness requirements in accordance with Sec. 37.4(e).
Sec. 37.6 Information relating to transactions on derivative
transaction facilities.
(a) Special calls for information from derivatives transaction
facilities. Upon special call by the Commission, a derivatives
transaction facility shall provide to the Commission such information
related to its business as a derivatives transaction facility,
including information relating to data entry and trade details, in the
form and manner and within the time as specified by the Commission in
the special call.
(b) Notification of communications. (1) Upon receipt of any
communications issued by or on behalf of the Commission to any person
who resides or is domiciled outside of the United States, its
territories, or possessions, relating to contracts, agreements, or
transactions effected on or through a derivatives transaction facility,
the derivatives transaction facility shall promptly notify such foreign
person of, and transmit the communication to such foreign person, in a
manner reasonable under the circumstances, or as specified by the
Commission.
(2) If the Commission has reason to believe that a person has not
complied with a communication issued by or on behalf of the Commission
pursuant to paragraph (b)(1) of this section, the Commission in writing
may direct the derivatives transaction facility on or through which the
person is or has traded to deny that person further trading access
either directly or, if applicable, through an intermediary or, as
applicable, to permit that person access to trade for liquidation only.
(3) Any person that believes he or she is or may be adversely
affected or aggrieved by action taken by the Commission under paragraph
(b)(2) of this section, shall have the opportunity for a prompt hearing
after the Commission acts pursuant to paragraph (b)(2) of this section
under the procedures provided in Sec. 21.03(g) of this chapter.
(c) Special calls for information from futures commission
merchants. Upon special call by the Commission, each
[[Page 77985]]
person registered as a futures commission merchant that carries or has
carried an account for a customer on a derivatives transaction facility
shall provide information to the Commission concerning such accounts or
related positions carried for the customer on that or other facilities
or markets, in the form and manner and within the time specified by the
Commission in the special call.
(d) Special calls for information from participants. Upon special
call by the Commission, any person who enters into or has entered into
a contract, agreement or transaction on a derivatives transaction
facility eligible under Sec. 37.2(a)(2) shall provide information to
the Commission concerning such contracts, agreements, or transactions
or related positions on other facilities or markets, in the form and
manner and within the time specified by the Commission in the special
call.
(e) Delegation of authority. The Commission hereby delegates, until
the Commission orders otherwise, the authority set forth in paragraphs
(a) through (d) of this section to the Directors of the Division of
Economic Analysis and the Division of Trading and Markets to be
exercised separately by each Director or by such other employee or
employees as the Director may designate from time to time. The Director
of the Divisions of Economic Analysis and Trading and Markets may
submit to the Commission for its consideration any matter that has been
delegated in this paragraph. Nothing in this paragraph prohibits the
Commission, at its election, from exercising the authority delegated in
this paragraph.
Sec. 37.7 Procedures for recognition.
(a) Recognition by certification. A board of trade, facility or
entity that is designated under sections 4c, 5, 5a(a) or 6 of the Act
as a contract market in at least one commodity which is not dormant
within the meaning of Sec. 5.2 of this chapter will be recognized by
the Commission as a derivatives transaction facility upon receipt by
the Commission at its Washington, D.C. headquarters of a copy of the
derivatives transaction facility's rules, which may be trading
protocols, and a certification by the board of trade, facility or
entity that it meets the conditions for recognition under this part.
(b) Recognition by application. A board of trade, facility or
entity shall be recognized or, as determined by the Commission,
recognized upon conditions as a derivatives transaction facility thirty
days after receipt by the Commission of an application for recognition
as a derivatives transaction facility unless notified otherwise during
that period, if:
(1) The application demonstrates that the applicant satisfies the
conditions for recognition under this part;
(2) The submission is labeled as being submitted pursuant to this
part 37;
(3) The submission includes a copy of:
(i) The derivatives transaction facility's rules, which may be
trading protocols;
(ii) Any agreements entered into or to be entered into between or
among the facility, its operator or its participants, technical manuals
and other guides or instructions for users of such facility,
descriptions of any system test procedures, tests conducted or test
results, and descriptions of the trading mechanism or algorithm used or
to be used by such facility, to the extent such documentation was
otherwise prepared; and
(iii) To the extent that compliance with the conditions of
recognition is not self-evident, a brief explanation of how the rules
or trading protocols satisfy each of the conditions for recognition
under Secs. 37.3 and 37.4;
(4) The applicant does not amend or supplement the application for
recognition, except as requested by the Commission or for correction of
typographical errors, renumbering or other nonsubstantive revisions,
during that period; and
(5) The applicant has not instructed the Commission in writing
during the review period to review the application pursuant to
procedures under section 6 of the Act.
(6) Appendix A to this part provides guidance to applicants on how
the conditions for recognition enumerated in Secs. 37.3 and 37.4 could
be satisfied.
(c) Termination of part 37 review. During the thirty-day period for
review pursuant to paragraph (b) of this section, the Commission shall
notify the applicant seeking recognition that the Commission is
terminating review under this section and will review the proposal
under the procedures of section 6 of the Act, if it appears that the
application fails to meet the conditions for recognition under this
part. This termination notification will state the nature of the issues
raised and the specific condition of recognition that the application
appears to violate, is contrary to or fails to meet. Within ten days of
receipt of this termination notification, the applicant seeking
recognition may request that the Commission render a decision whether
to recognize the derivatives transaction facility or to institute a
proceeding to disapprove the proposed submission under procedures
specified in section 6 of the Act by notifying the Commission that the
applicant seeking recognition views its submission as complete and
final as submitted.
(d) Delegation of authority. (1) The Commission hereby delegates,
until it orders otherwise, to the Directors of the Division of Trading
and Markets and the Division of Economic Analysis or their delegatees,
with the concurrence of the General Counsel or the General Counsel's
delegatee, authority to notify the entity seeking recognition under
paragraph (b) of this section that review under those procedures is
being terminated or to recognize the entity as a derivatives
transaction facility upon conditions.
(2) The Directors of the Division of Trading and Markets or the
Division of Economic Analysis may submit to the Commission for its
consideration any matter which has been delegated in this paragraph.
(3) Nothing in the paragraph prohibits the Commission, at its
election, from exercising the authority delegated in paragraph (d)(1)
of this section.
(e) Request for Commission approval of rules and products. (1) An
entity seeking recognition as a derivatives transaction facility may
request that the Commission approve any or all of its rules and
subsequent amendments thereto, including both operational rules and the
terms or conditions of products listed for trading on the facility, at
the time of recognition or thereafter, under section 5a(a)(12) of the
Act and Secs. 1.41(d) and 5.2 of this chapter, as applicable. A
derivatives transaction facility may label a product in its rules as,
``Listed for trading pursuant to Commission approval,'' if the
product's terms or conditions have been approved by the Commission.
(2) An entity seeking recognition as a derivatives transaction
facility may request that the Commission consider under the provisions
of section 15 of the Act any of the entity's rules or policies,
including both operational rules and the terms or conditions of
products listed for trading, at the time of recognition or thereafter.
(f) Request for withdrawal of application for recognition or
withdrawal of recognition. A recognized derivatives transaction
facility may withdraw an application to be a recognized derivatives
transaction facility or, once recognized, may withdraw from Commission
recognition by filing with the Commission at its Washington, D.C.,
headquarters such a request. Withdrawal from recognition
[[Page 77986]]
shall not affect any action taken or to be taken by the Commission
based upon actions, activities or events occurring during the time that
the facility was recognized by the Commission.
Sec. 37.8 Enforceability.
(a) Notwithstanding the exemption in Sec. 37.2, the following
provisions of the Act and Commission regulations thereunder are
reserved, and shall continue to apply: sections 1a, 2(a)(1), 4, 4b,
4c(a) as applicable to the market, 4c(b), 4g, 4i, 4o, 5(6), 5(7),
5a(a)(1), 5a(a)(2), 5a(a)(8), 5a(a)(16), 5a(a)(17), 5a(b), 6(a), 6(c)
to the extent it prohibits manipulation of the market price of any
commodity in interstate commerce or for future delivery on or subject
to the rules of any contract market, 8a(9), 8c(a) as applicable to the
market, 9(a)(2), 9(a)(3), 9(f), 14, 15, 20 and 22 of the Act and
Secs. 1.3, 1.31, 1.41, 5.2, 15.05 as applicable to the market,
Sec. 33.10, this part 37 and part 190 of this chapter; and for
derivatives transaction facilities eligible under Sec. 37.2(a)(2), in
addition to the foregoing, the rule disapproval procedures of section
5a(a)(12) of the Act, section 9(a)(1) of the Act, and sections 8c(b),
8c(c) and 8c(d) of the Act and parts 15 through 21 of this chapter as
applicable to the market.
(b) For purposes of section 22(a) of the Act, a party to a
contract, agreement or transaction is exempt from a claim that the
contract, agreement or transaction is void, voidable, subject to
rescission or otherwise invalidated or rendered unenforceable solely
for failure of the parties to a contract, agreement or transaction, or
the contract, agreement or transaction itself, to comply with the terms
and conditions for the exemption under this part or as a result of:
(1) A violation by the recognized derivatives transaction facility
of the provisions of this part 37; or
(2) Any Commission proceeding to disapprove a rule, term or
condition under section 5a(a)(12) of the Act, to alter or supplement a
rule, term or condition under section 8a(7) of the Act, to declare an
emergency under section 8a(9) of the Act, or any other proceeding the
effect of which is to disapprove, alter, supplement, or require a
recognized derivatives transaction facility to adopt a specific term or
condition, trading rule or procedure, or to take or refrain from taking
a specific action.
Sec. 37.9 Fraud in connection with part 37 transactions.
It shall be unlawful for any person, directly or indirectly, in or
in connection with an offer to enter into, the entry into, the
confirmation of the execution of, or the maintenance of any transaction
entered into pursuant to this part--
(1) To cheat or defraud or attempt to cheat or defraud any person;
(2) Willfully to make or cause to be made to any person any false
report or statement thereof or cause to be entered for any person any
false record thereof; or
(3) Willfully to deceive or attempt to deceive any person by any
means whatsoever.
Appendix A to Part 37--Application Guidance
This appendix provides guidance to applicants for recognition as
derivatives transaction facilities under Secs. 37.3 and 37.4.
Addressing the issues and questions set forth in this appendix would
help the Commission in its consideration of whether the application
has met the conditions for recognition. To the extent that
compliance with, or satisfaction of, a core principle is not self-
explanatory from the face of the derivatives transaction facilities
rules or terms, the application should include an explanation or
other form of documentation demonstrating that the applicant meets
the conditions for recognition.
Core Principle 1: Enforcement: Effectively monitor and enforce
its rules, which may be trading protocols, including, if applicable,
limitations on access.
(a) A derivatives transaction facility should have arrangements
and resources and authority for effectively and affirmatively
enforcing its rules, including the authority and ability to collect
or capture information and documents on both a routine and non-
routine basis and to investigate effectively possible rule
violations.
(b) This should include the authority and ability to discipline,
and limit or suspend a member's or participant's activities and/or
the authority and ability to terminate a member's or participant's
activities or access pursuant to clear and fair standards.
Core Principle 2: Market Oversight. As appropriate to the market
and the contracts traded: (1) Monitor markets on a routine and
nonroutine basis as necessary to ensure fair and orderly trading,
and have, and where appropriate exercise, authority to maintain a
fair and orderly market; or (2) Provide information to the
Commission as requested by the Commission to satisfy its obligations
under the Act.
(a) Arrangements and resources for effective market surveillance
programs should facilitate, on both a routine and nonroutine basis,
direct supervision of the market. Appropriate objective testing and
review of any automated systems should occur initially and
periodically to ensure proper system functioning, adequate capacity
and security. The analysis of data collected should be suitable for
the type of information collected and should occur in a timely
fashion. A derivatives transaction facility should have the
authority to collect the information and documents necessary to
reconstruct trading for appropriate market analysis as it carries
out its market surveillance programs. The derivatives transaction
facility also should have the authority to intervene as necessary to
maintain an open and competitive market. In carrying out this
responsibility, the facility should address access to, and use of,
material non-public information by members, owners or operators,
participants or facility employees.
(b) Alternatively, and as appropriate to the market, a
derivatives transaction facility may choose to satisfy Core
Principle 2 by providing information to the Commission as requested
by the Commission to satisfy its obligations under the Act. The
derivatives transaction facility should have the authority to
collect or capture and retrieve all necessary information.
(c) The Commission will collect reporting data from eligible
participants trading in a derivatives transaction facility eligible
under Sec. 37.2(a)(2) only upon Special Call as provided in
Sec. 37.6(d).
Core Principle 3: Operational Information: Disclose to
regulators and to market participants, as appropriate, information
concerning trading terms, trading protocols, contract terms and
conditions, trading mechanisms, financial integrity arrangements or
mechanisms, as well as other relevant information.
A derivatives transaction facility should have arrangements and
resources for the disclosure and explanation of trading terms,
trading protocols, contract terms and conditions, trading
mechanisms, system functioning, system capacity, system security,
system testing and review, financial integrity arrangements or
mechanisms. The facility must also disclose any limitations of
liability (which may not include limitations of liability for
violations of the Act or Commission rules, fraud, or wanton or
willful misconduct. Such information may be made publicly available
through the operation of a website by the derivatives transaction
facility.
Core Principle 4: Transparency: Provide to market participants
on a fair, equitable and timely basis information regarding prices,
bids and offers, and other information appropriate to the market
and, as appropriate to the market, make available to the public with
respect to actively traded products, to the extent applicable,
information regarding daily opening and closing prices, price range,
trading volume and other related market information.
All market participants should have information regarding
prices, bids and offers, or other information appropriate to the
market readily available on a fair and equitable basis. The
derivatives transaction facility should provide to the public
information regarding daily opening and closing prices, price range,
trading volume, open interest and other related market information
for actively traded products. Provision of information could be
through such means as provision of the information to a financial
information service or by placement of the information on a
facility's web site.
Core Principle 5: Fitness: Have appropriate fitness standards
for members, operators or
[[Page 77987]]
owners with greater than 10 percent interest or an affiliate of such
an owner, members of the governing board, and those who make
disciplinary determinations.
A derivatives transaction facility should have appropriate
eligibility criteria for the categories of persons set forth in the
Core Principle which would include standards for fitness and for the
collection and verification of information supporting compliance
with such standards. Minimum standards of fitness are those bases
for refusal to register a person under section 8a(2) of the Act. or
a history of serious disciplinary offenses, such as those which
would be disqualifying under Sec. 1.63 of this chapter. A
demonstration of the fitness of the applicant's members, operators
or owners may include providing the Commission with registration
information for such persons, certification to the fitness of such
persons, an affidavit of such persons' fitness by the facility's
Counsel or other information substantiating the fitness of such
persons.
Core Principle 6: Recordkeeping: Keep full books and records of
all activities related to its business as a recognized derivatives
transaction facility, including full information relating to data
entry and trade details sufficient to reconstruct trading, in a form
and manner acceptable to the Commission for a period of five years,
during the first two of which the books and records are readily
available, and which shall be open to inspection by any
representative of the Commission or the U.S. Department of Justice.
Commission rule 1.31 constitutes the acceptable practice
regarding the form and manner for keeping records.
Core Principle 7: Competition: Operate in a manner consistent
with the public interest to be protected by the antitrust laws.
An entity seeking recognition as a derivatives transaction
facility may request that the Commission consider under the
provisions of section 15 of the Act any of the entity's rules, which
may be trading protocols or policies, and including both operational
rules and the terms or conditions of products listed for trading, at
the time of recognition or thereafter. The Commission intends to
apply Section 15 of the Act to its consideration of issues under the
Competition Core Principle in a manner consistent with that
previously applied to contract markets.
10. Chapter I of 17 CFR is amended by adding new Part 38 as
follows:
PART 38--EXEMPTION OF TRANSACTIONS ON A RECOGNIZED FUTURES EXCHANGE
Sec.
38.1 Scope.
38.2 Exemption.
38.3 General conditions for recognition as a recognized futures
exchange.
38.4 Conditions for recognition as a recognized futures exchange,
compliance with core principles.
38.5 Procedures for recognition.
38.6 Enforceability
38.7 Fraud in connection with part 38 transactions.
Appendix A to Part 38--Guidance for Applicants and Acceptable
Practices
Authority: 7 U.S.C. 2, 6, 6c, and 12a.
Sec. 38.1 Scope.
(a) Except for commodities subject to paragraph (c) of this
section, the provisions of the exemption in Sec. 38.2 shall apply to
every board of trade that has been designated as a contract market in a
commodity under section 6 of the Act. Provided, however, nothing in
this provision affects the eligibility of designated contract markets
for exemption under parts 36 or 37 of this chapter.
(b) A board of trade operating as a recognized futures exchange and
the products listed for trading thereon under this exemption shall be
deemed to be subject to all of the provisions of the Act and Commission
regulations thereunder which are applicable to a ``board of trade,''
``board of trade licensed by the Commission,'' ``exchange,'' ``contract
market,'' ``designated contract market,'' or ``contract market
designated by the Commission'' as though those provisions were set
forth in this section and included specific reference to contracts
listed for trading by recognized futures exchanges pursuant to this
section.
(c) The provisions of this section shall not apply to a commodity
or a contract subject to the provisions of section 2(a)(1)(B) of the
Act.
Sec. 38.2 Exemption.
Notwithstanding Sec. 38.1(b), a contract, agreement or transaction
traded on a multilateral transaction execution facility as defined in
Sec. 36.1(b) of this chapter, the facility and the facility's operator
is exempt from all provisions of the Act and from all Commission
regulations thereunder for such activity, except for those provisions
of the Act and Commission regulations which, as a condition of this
exemption, are reserved in Sec. 38.6(a), provided the following terms
and conditions are met:
(a) The multilateral transaction execution facility on which the
contract, agreement or transaction is entered into has been recognized
by the Commission as a recognized futures exchange pursuant to
Sec. 38.5;
(b) A multilateral transaction execution facility that applies to
be, and is, a recognized futures exchange must comply with all of the
conditions of this part 38 exemption and must disclose to participants
transacting on or through its facilities that transactions conducted on
or through the facility are subject to the provisions of part 38;
(c)(1) If intermediated, the transactions of participants must be
carried in accounts at a registered futures commission merchant;
(2) If cleared, the submission of such contracts, agreements or
transactions for clearance and/or settlement must be to a clearinghouse
which is recognized by the Commission under part 39 of this chapter.
Provided, however, that nothing in this paragraph precludes:
(i) Arrangements or facilities between parties to such contracts,
agreements or transactions that provide for netting of payment or
delivery obligations resulting from such agreements; or
(ii) Arrangements or facilities among parties to such contracts,
agreements or transactions, that provide for netting of payments or
deliveries resulting from such agreements; and
(d) The products if traded on an electronic system must be clearly
identified as traded on a recognized futures exchange or if traded in a
physical trading environment must be traded in a location separate
from, but which may adjoin the location for, the trading of products
pursuant to parts 36 and 37 of this chapter;
Sec. 38.3 General conditions for recognition as a recognized futures
exchange.
To be recognized as a recognized futures exchange, the exchange
must demonstrate initially that it has:
(a) A clear framework for conducting programs of market
surveillance, compliance, and enforcement, including having procedures
in place to make use of collected data for real-time monitoring and for
post-event audit and compliance purposes to prevent market
manipulation;
(b) Rules relating to trading on the exchange, including rules to
deter trading abuses, and adequate power and capacity to detect,
investigate and take action against violations of its trading rules,
and a dedicated regulatory department or delegation of that function to
an appropriate entity;
(c) Rules defining, or specifications detailing, the manner of
operation of the trading mechanism or electronic matching platform and
a trading mechanism or electronic matching platform that performs as
articulated in the operational rules or specifications;
(d) A clear framework for ensuring the financial integrity of
transactions entered into by or through the exchange;
(e) Established procedures for impartial disciplinary committee(s)
or other similar mechanisms empowered to discipline, suspend, and expel
members, or to deny access to participants or, if provided for,
discipline participants; and
[[Page 77988]]
(f) Arrangements to obtain necessary information to perform the
functions in this section, including the capacity and arrangements to
share financial and surveillance information with other derivative
exchanges, both domestic and international, and a mechanism to provide
to the public ready access to its rules and regulations.
Sec. 38.4 Conditions for recognition as a recognized futures exchange,
compliance with core principles.
To be recognized as a futures exchange, the exchange initially, and
on a continuing basis, must meet and adhere to the following core
principles:
(a) Rule enforcement. Effectively monitor and enforce its rules.
(b) Products. List contracts for trading that are not readily
susceptible to manipulation.
(c) Position monitoring and reporting. Monitor markets on a routine
and nonroutine basis as necessary to prevent manipulation, price
distortion, and disruptions of the delivery or cash settlement process.
(d) Position limits. Adopt position limits on trading where
necessary and appropriate to lessen the threat of market manipulation
or congestion during delivery months.
(e) Emergency authority. Exercise authority to intervene to
maintain fair and orderly trading, including, where applicable,
authority to liquidate or transfer open positions, to require the
suspension or curtailment of trading, and to require the posting of
additional margin.
(f) Public information. Make information concerning the contract
terms and conditions and the trading mechanism, as well as other
relevant information, readily available to market authorities, users
and the public.
(g) Transparency. Provide market participants on a fair, equitable
and timely basis information regarding, as appropriate to the market,
prices, bids and offers, and other appropriate information, and make
available to the public information regarding daily opening and closing
prices, price ranges, trading volume, open interest and other related
market information.
(h) Trading system. Provide a competitive, open and efficient
market.
(i) Audit trail. Have procedures to ensure the recording of full
data entry and trade details sufficient to reconstruct trading, the
quality of the data captured, and the safe storage of such information,
and have systems to enable information to be used in assisting in
detecting and deterring customer and market abuse.
(j) Financial standards. Have, monitor, and enforce rules regarding
the financial integrity of the transactions that have been executed on
the exchange and, where intermediaries are permitted, rules addressing
the financial integrity of the intermediary and the protection of
customer funds, as appropriate, and a program to enforce those
requirements.
(k) Customer protection. Have, monitor and enforce rules for
customer protection.
(l) Dispute resolution. Provide for alternative dispute resolution
mechanisms appropriate to the nature of the market.
(m) Governance. Have fitness standards for members, owners or
operators with greater than ten percent interest or an affiliate of
such an owner, members of the governing board, and those who make
disciplinary determinations. The recognized futures exchange must have
a means to address conflicts of interest in making decisions and access
to, and use of, material non-public information by the foregoing
persons and by exchange employees. For mutually owned futures
exchanges, the composition of the governing board must reflect market
participants.
(n) Recordkeeping. Keep full books and records of all activities
related to its business as a recognized futures exchange in a form and
manner acceptable to the Commission for a period of five years, during
the first two of which the books and records are readily available, and
which shall be open to inspection by any representative of the
Commission or the U.S. Department of Justice.
(o) Competition. Operate in a manner consistent with the public
interest to be protected by the antitrust laws.
Sec. 38. 5 Procedures for recognition.
(a) Recognition by prior designation. A board of trade, facility or
entity that is designated under sections 4c, 5, 5a(a) or 6 of the Act
as a contract market on February 12, 2001 in at least one commodity
which is not dormant within the meaning of Sec. 5.3 of this chapter is
recognized by the Commission as a recognized futures exchange and each
of the contracts traded thereon that has been designated by the
Commission as a designated contract market in a commodity may be
labeled in the recognized futures exchange's rules as listed for
trading pursuant to Commission approval.
(b) Recognition by application. A board of trade, facility or
entity shall be recognized or, as determined by the Commission,
recognized upon conditions as a recognized futures exchange sixty days
after receipt by the Commission of an application for recognition
unless notified otherwise during that period, if:
(1) The application demonstrates that the applicant satisfies the
conditions for recognition under this part;
(2) The submission is labeled as being submitted pursuant to this
part 38;
(3) The submission includes a copy of the applicant's rules and, to
the extent that compliance with the conditions for recognition is not
self-evident, a brief explanation of how the rules satisfy each of the
conditions for registration under Secs. 38.3 and 38.4;
(4) The applicant does not amend or supplement the application for
recognition, except as requested by the Commission or for correction of
typographical errors, renumbering or other nonsubstantive revisions,
during that period; and
(5) The applicant has not instructed the Commission in writing
during the review period to review the application pursuant to
procedures under section 6 of the Act.
(6) Appendix A to this part provides guidance to applicants on how
the conditions for recognition enumerated in Secs. 38.3 and 38.4 could
be satisfied.
(c) Termination of part 38 review. During the sixty-day period for
review pursuant to paragraph (b) of this section, the Commission shall
notify the applicant seeking recognition that the Commission is
terminating review under this section and will review the proposal
under the procedures of section 6 of the Act, if it appears that the
application fails to meet the conditions for recognition under this
part. This termination notification will state the nature of the issues
raised and the specific condition of recognition that the application
appears to violate, is contrary to or fails to meet. Within ten days of
receipt of this termination notification, the applicant seeking
recognition may request that the Commission render a decision whether
to recognize the futures exchange or to institute a proceeding to
disapprove the proposed submission under procedures specified in
section 6 of the Act by notifying the Commission that the applicant
seeking recognition views its submission as complete and final as
submitted.
(d) Delegation of authority. (1) The Commission hereby delegates,
until it orders otherwise, to the Directors of the Division of Trading
and Markets and the Division of Economic Analysis or their delegatees,
with the concurrence of the General Counsel or the General Counsel's
delegatee, authority to notify the entity seeking recognition under
paragraph (b) of this section that review under those procedures is
being
[[Page 77989]]
terminated or to recognize the entity as a recognized futures exchange
upon conditions.
(2) The Directors of the Division of Trading and Markets or the
Division of Economic Analysis may submit to the Commission for its
consideration any matter which has been delegated in this paragraph.
(3) Nothing in the paragraph prohibits the Commission, at its
election, from exercising the authority delegated in paragraph (d)(1)
of this section.
(e) Request for Commission approval of rules and products. (1) An
entity seeking recognition as a recognized futures exchange may request
that the Commission approve any or all of its rules and subsequent
amendments thereto, including both operational rules and the terms or
conditions of products listed for trading on the exchange, at the time
of recognition or thereafter, under section 5a(a)(12) of the Act and
Secs. 1.41 and 5.2 of this chapter, as applicable. A product the terms
or conditions of which have been approved by the Commission may be
labeled in its rules as listed for trading pursuant to Commission
approval. In addition, rules of the recognized futures exchange not
submitted pursuant to Sec. 38.5(b)(3) shall be submitted to the
Commission pursuant to Sec. 1.41.
(2) An entity seeking recognition as a recognized futures exchange
may request that the Commission consider under the provisions of
section 15 of the Act any of the entity's rules or policies, including
both operational rules and the terms or conditions of products listed
for trading, at the time of recognition or thereafter.
(f) Request for withdrawal of application for recognition or
withdrawal of recognition. An entity may withdraw an application to be
a recognized futures exchange or once recognized, may withdraw from
Commission recognition by filing with the Commission at its Washington,
D.C. headquarters such a request. Withdrawal from recognition shall not
affect any action taken or to be taken by the Commission based upon
actions, activities or events occurring during the time that the
exchange was recognized by the Commission.
Sec. 38.6 Enforceability.
(a) Notwithstanding the exemption in Sec. 38.2, the following
provisions of the Act and the Commission's regulations thereunder are
reserved and shall continue to apply, as applicable: sections 1a,
2(a)(1), 4, 4a, 4b, 4c, 4g, 4i, 4o, 5(6), 5(7), 5a(a)(1), 5a(a)(2),
5a(a)(8), the rule disapproval procedures of 5a(a)(12), 5a(a)(16),
5a(a)(17), 5a(b), 6(a), 6(c) to the extent it prohibits manipulation of
the market price of any commodity in interstate commerce or for future
delivery on or subject to the rules of any contract market, 8a(7),
8a(9), 8c(a), 8c(b), 8c(c), 8c(d), 9(a), 9(f), 14, 15, 20 and 22 of the
Act and Secs. 1.3, 1.31, 1.38, 1.41, 33.10, part 5, part 9, parts 15
through 21, part 38 and part 190 of this chapter.
(b) For purposes of section 22(a) of the Act, a party to a
contract, agreement or transaction is exempt from a claim that the
contract, agreement or transaction is void, voidable, subject to
rescission or otherwise invalidated or rendered unenforceable as a
result of:
(1) A violation by the recognized futures exchange of the
provisions of this part 38; or
(2) Any Commission proceeding to disapprove a rule, term or
condition under section 5a(a)(12) of the Act, to alter or supplement a
rule, term or condition under section 8a(7) of the Act, to declare an
emergency under section 8a(9) of the Act, or any other proceeding the
effect of which is to disapprove, alter, supplement, or require a
recognized futures exchange to adopt a specific term or condition,
trading rule or procedure, or to take or refrain from taking a specific
action.
Sec. 38.7 Fraud in connection with part 38 transactions.
It shall be unlawful for any person, directly or indirectly, in or
in connection with an offer to enter into, the entry into, the
confirmation of the execution of, or the maintenance of any transaction
entered pursuant to this part:
(a) To cheat or defraud or attempt to cheat or defraud any person;
(b) Willfully to make or cause to be made to any person any false
report or statement thereof or cause to be entered for any person any
false record thereof; or
(c) Willfully to deceive or attempt to deceive any person by any
means whatsoever.
Appendix A to Part 38--Guidance for Applicants and Acceptable
Practices
1. This appendix provides guidance and acceptable practices for
the core principles found in Part 38. Guidance to applicants for
recognition as recognized futures exchanges under Secs. 38.3 and
38.4 is offered under subsection (a) following a core principle.
This appendix is only illustrative of the types of matters an
applicant may address, as applicable, and is not intended to be a
mandatory checklist. Addressing the issues and questions set forth
in this appendix would help the Commission in its consideration of
whether the application has met the conditions for recognition. To
the extent that compliance with, or satisfaction of, a core
principle is not self-explanatory from the face of the recognized
futures exchange's rules or terms, the application should include an
explanation or other form of documentation demonstrating that the
applicant meets the conditions for recognition.
2. Acceptable practices meeting the requirements of the core
principles are set forth in subsection (b). Recognized futures
exchanges that follow specific practices outlined under subsection
(b) for any core principle in this appendix will meet the applicable
core principle. Except where otherwise provided, subsection (b) is
for illustrative purposes only, and does not state the exclusive
means for satisfying a core principle.
Core Principle 1: Rule Enforcement: Effectively monitor and
enforce its rules.
(a) Application Guidance.
(1) A recognized futures exchange should have arrangements and
resources for effective trade practice surveillance programs, with
the authority to collect information and documents on both a routine
and non-routine basis including the examination of books and records
kept by members/participants of the exchange. The arrangements and
resources should facilitate the direct supervision of the market and
the analysis of data collected.
(2) A recognized futures exchange should have arrangements,
resources and authority for effective rule enforcement. The
Commission believes that this should include the authority and
ability to discipline and limit or suspend a member's or
participant's activities as well as the authority and ability to
terminate a member's or participant's activities pursuant to clear
and fair standards.
(b) Acceptable Practices. An effective trade practice
surveillance program should include:
(1) Maintenance of data reflecting the details of each
transaction executed on an RFE;
(2) Electronic analysis of this data routinely to detect
potential trading violations;
(3) Appropriate and thorough investigative analysis of these and
other potential trading violations brought to its attention; and
(4) Prompt and effective disciplinary action for any violation
that is found to have been committed. The Commission believes that
the latter element should include the authority and ability to
discipline and limit or suspend a member's or participant's
activities pursuant to clear and fair standards. See, e.g., 17 CFR
part 8.
Core Principle 2: Products: List contracts for trading that are
not readily susceptible to manipulation.
(a) Application Guidance. Applicants should submit their initial
product for listing for Commission approval under Sec. 5.2 and Part
5, Appendix A, of this chapter. Subsequent products may be listed
for trading by self-certification under Sec. 5.1 of this chapter.
(b) Acceptable Practices.
Guideline No. 1, 17 CFR Part 5, Appendix A may be used as
guidance in meeting this core principle.
[[Page 77990]]
Core Principle 3: Position monitoring and reporting: Monitor
markets on a routine and nonroutine basis as necessary to prevent
manipulation, price distortion, and disruptions of the delivery or
cash settlement process.
(a) Application Guidance. [Reserved]
(b) Acceptable Practices.
(1) An acceptable program for monitoring markets will generally
involve the collection of various market data, including information
on traders' market activity. Those data should be evaluated on an
ongoing basis in order to make an appropriate regulatory response to
potential market disruptions or abusive practices.
(2) The recognized futures exchange should collect data in order
to assess whether the market price is responding to the forces of
supply and demand. Appropriate data usually include various
fundamental data about the underlying commodity, its supply, its
demand, and its movement through marketing channels. Especially
important are data related to the size and ownership of deliverable
supplies--the existing supply and the future or potential supply,
and to the pricing of the deliverable commodity relative to the
futures price and relative to similar, but nondeliverable, kinds of
the commodity. For cash-settled markets, it is more appropriate to
pay attention to the availability and pricing of the commodity
making up the index to which the market will be settled, as well as
monitoring the continued suitability of the methodology for deriving
the index.
(3) To assess traders' activity and potential power in a market,
at a minimum, every exchange should have routine access to the
positions and trading done by the members of its clearing facility.
Although clearing member data may be sufficient for some exchanges,
an effective surveillance program for exchanges with substantial
numbers of customers trading through intermediaries should employ a
much more comprehensive large-trader reporting system (LTRS). The
Commission operates an industry-wide LTRS. As an alternative to
having its own LTRS or contracting out for such a system, exchanges
may find it more efficient to use information available from the
Commission's LTRS data for position monitoring.
Core Principle 4: Position Limits. Adopt position limits on
trading where necessary and appropriate to lessen the threat of
market manipulation or congestion during delivery months.
(a) Application Guidance. [Reserved]
(b) Acceptable Practices.
(1) In order to diminish potential problems arising from
excessively large speculative positions, the Commission sets limits
on traders' positions for certain commodities. These position limits
specifically exempt bona fide hedging, permit other exemptions, and
set limits differently by markets, by futures or delivery months, or
by time periods. For purposes of evaluating an exchange speculative-
limit program, the Commission considers the specified limit levels,
aggregation policies, types of exemptions allowed, methods for
monitoring compliance with the specified levels, and procedures for
enforcement to deal with violations.
(2) In general, position limits are not necessary for markets
where the threat of excessive speculation or manipulation is very
low. Thus, exchanges do not need to set position-limit levels for
futures markets in major foreign currencies and in certain financial
futures having very liquid and deep underlying cash markets. Where
speculative limits are appropriate, acceptable speculative-limit
levels typically are set in terms of a trader's combined position in
the futures contract plus its position in the option contract (on a
delta-adjusted basis).
(3) Spot-month levels for physical-delivery markets should be
based upon an analysis of deliverable supplies and the history of
spot-month liquidations. Spot-month limits for physical-delivery
markets are appropriately set at no more than 25 percent of the
estimated deliverable supply. For cash-settled markets, spot-month
position limits may be necessary if the underlying cash market is
small or illiquid such that traders can disrupt the cash market or
otherwise influence the cash-settlement price to profit on a futures
position. In these cases, the limit should be set at a level that
minimizes the potential for manipulation or distortion of the
futures contract's or the underlying commodity's price. Markets may
elect not to provide all-months-combined and non-spot month limits.
(4) An exchange may provide for position accountability
provisions in lieu of position limits for contracts on financial
instruments, intangible commodities, or certain tangible
commodities. Markets appropriate for position accountability rules
include those with large open-interest, high daily trading volumes
and liquid cash markets.
(5) Exchanges must have aggregation rules that apply to those
accounts under common control, those with common ownership, i.e.,
where there is a 10 percent or greater financial interest, and those
traded according to an expressed or implied agreement. Exchanges
will be permitted to set more stringent aggregation policies. For
example, one major exchange adopted a policy of automatically
aggregating members of the same household, unless they were granted
a specific waiver. Exchanges may grant exemptions to their position
limits for bona fide hedging (as defined in Commission Rule 1.3(z))
and may grant exemptions for reduced risk positions, such as
spreads, straddles and arbitrage positions.
(6) Exchanges must establish a program for effective monitoring
and enforcement of these limits. One acceptable enforcement
mechanism is a program whereby traders apply for these exemptions by
the exchange and are granted a position level higher than the
applicable speculative limit. The position levels granted under
hedge exemptions are based upon the trader's commercial activity in
related markets. Exchanges may allow a brief grace period where a
qualifying trader may exceed speculative limits or an existing
exemption level pending the submission and approval of appropriate
justification. An exchange should consider whether it wants to
restrict exemptions during the last several days of trading in a
delivery month. Acceptable procedures for obtaining and granting
exemptions include a requirement that the exchange approve a
specific maximum higher level.
(7) Exchanges with many markets with large numbers of traders
should have an automated means of detecting traders' violations of
speculative limits or exemptions. Exchanges should monitor the
continuing appropriateness of approved exemptions by periodically
reviewing each trader's basis for exemption or requiring a
reapplication.
(8) Finally, an acceptable speculative limit program must have
specific policies for taking regulatory action once a violation of a
position limit or exemption is detected. The exchange policy will
need to consider appropriate actions where the violation is by a
non-member and should address traders carrying accounts through more
than one intermediary.
(9) A violation of exchange position limits that have been
approved by the Commission is also a violation of section 4a(e) of
the Act.
Core Principle 5: Emergency Authority: Exercise authority to
intervene to maintain fair and orderly trading, including, where
applicable, authority to liquidate or transfer open positions, to
require the suspension or curtailment of trading, and to require the
posting of additional margin.
(a) Application Guidance.
A recognized futures exchange should have clear procedures and
guidelines for exchange decision-making regarding emergency
intervention in the market, including procedures and guidelines to
carry out such decision-making without a conflict of interests. An
exchange should also have the authority to intervene as necessary to
maintain markets with fair and orderly trading as well as procedures
for carrying out the intervention. The Commission believes that a
recognized futures exchange should also have procedures and
guidelines for the notification of the Commission of the exercise of
regulatory emergency authority, as well as procedures and guidelines
to prevent conflicts of interest, for the documentation of the
exchange's decision-making process and for the reasons for use of
its emergency action authority.
(b) Acceptable Practices.
As is necessary to address perceived market threats, the
exchange, among other things, should be able to impose position
limits in particular in the delivery month, impose or modify price
limits, modify circuit breakers, call for additional margin either
from customers or clearing members, order the liquidation or
transfer of open positions, order the fixing of a settlement price,
order the reduction in positions, extend or shorten the expiration
date or the trading hours, suspend or curtail trading on the market,
order the transfer of customer contracts and the margin for such
contracts from one member of the exchange to another or alter the
delivery terms or conditions.
Core Principle 6: Public Information: Make information
concerning the contract terms and conditions and the trading
mechanism, as well as other relevant information, readily available
to market authorities, users and the public.
(a) Application Guidance.
A recognized futures exchange should have arrangements and
resources for the
[[Page 77991]]
disclosure of contract terms and conditions and trading mechanisms
to the Commission, users and the public. Procedures should also
include the provision of information on listing new products, rule
amendments or other changes to previously disclosed information to
the Commission, users and the public.
(b) Acceptable Practices. [Reserved]
Core Principle 7: Transparency: Provide market participants on a
fair, equitable and timely basis information regarding, as
appropriate to the market, prices, bids and offers, and other
appropriate information, and make available to the public
information regarding daily opening and closing prices, price
ranges, trading volume, open interest and other related market
information.
(a) Application Guidance. [Reserved].
(b) Acceptable Practices. [Reserved]
Core Principle 8: Trading System: Provide a competitive, open
and efficient market.
(a) Application Guidance.
(1) Appropriate objective testing and review of any automated
systems should occur initially and periodically to ensure proper
system functioning, adequate capacity and security. A recognized
futures exchange's analysis of its automated system should address
appropriate principles for the oversight of automated systems,
ensuring proper system function, adequate capacity and security. The
Commission believes that the guidelines issued by the International
Organization of Securities Commissions (IOSCO) in 1990 (which have
been referred to as the ``Principles for Screen-Based Trading
Systems''), subsequently adopted by the Commission on November 21,
1990 (55 FR 48670), are appropriate guidelines for a recognized
futures exchange to apply to electronic trading systems. Any program
of objective testing and review of the system should be performed by
a qualified independent professional. The Commission believes that
information gathered by analysis, oversight or any program of
objective testing and review of any automated systems regarding
system functioning, capacity and security should be made available
to the Commission and the public.
(2) A recognized futures exchange that determines to allow block
trading should have rules which:
(i) Define the block based upon the customary size of large
positions in the cash and derivatives market,
(ii) Restrict access to block trading to eligible participants,
(iii) Provide a mechanism for ensuring that the block's price
will be fair and reasonable, and
(iv) provide for transparency of the trade by requiring that it
be reported for clearing within a reasonable period of time and that
it be identified separately in the price reporting system.
(b) Acceptable Practices.
A professional that is a certified member of the Informational
Systems Audit and Control Association experienced in the industry
would be an example of an acceptable party to carry out such testing
and review.
Core Principle 9: Audit Trail: Have procedures to ensure the
recording of full data entry and trade details sufficient to
reconstruct trading, the quality of the data captured, and the safe
storage of such information, and have systems to enable information
to be used in assisting in detecting and deterring customer and
market abuse.
(a) Application Guidance.
A recognized futures exchange should have arrangements and
resources for recording of full data entry and trade details
sufficient to reconstruct trading and the safe storage of audit
trail data systems enabling information to be used in combating
customer and market abuse.
(b) Acceptable Practices.
(1) The goal of an audit trail is to detect and deter customer
and market abuse. An effective exchange audit trail should capture
and retain sufficient trade-related information to permit exchange
staff to detect trading abuses and to reconstruct all transactions.
An audit trail should include specialized electronic surveillance
programs that would identify potentially abusive trades and trade
patterns, including for instance, withholding or disclosing customer
orders, trading ahead, and preferential allocation. An acceptable
audit trail must be able to track a customer order from time of
receipt through fill allocation. The exchange must create and
maintain an electronic transaction history database that contains
information with respect to transactions affected on the recognized
futures exchange.
(2) An acceptable audit trail, therefore, should include the
following: original source documents, transaction history,
electronic analysis capability, and safe storage capability. A
registered futures exchange whose audit trail satisfies the
following acceptable practices would satisfy Core Principle 9.
(i) Original Source Documents. Original source documents include
unalterable, sequentially identified records on which trade
execution information is originally recorded, whether recorded
manually or electronically. For each customer order, such records
reflect the terms of the order, an account identifier that relates
back to the account(s) owner(s), and the time of order entry. For
floor-based exchanges, the time of report of execution of the order
should also be captured.
(ii) Transaction History. A transaction history which consists
of an electronic history of each transaction, including:
(A) All data that are input into the trade entry or matching
system for the transaction to match and clear;
(B) Whether the trade was for a customer or proprietary account;
(C) Timing and sequencing data adequate to reconstruct trading;
and
(D) The identification of each account to which fills are
allocated.
(iii) Eectronic Analysis Capability. An electronic analysis
capability that permits sorting and presenting data included in the
transaction history so as to reconstruct trading and to identify
possible trading violations with respect to both customer and market
abuse.
(iv) Safe Storage Capability. Safe storage capability provides
for a method of storing the data included in the transaction history
in a manner that protects the data from unauthorized alteration, as
well as from accidental erasure or other loss. Data should be
retained in accordance with the recordkeeping standards of Core
Principle 14.
Core Principle 10: Financial Standards: Have, monitor, and
enforce rules regarding the financial integrity of the transactions
that have been executed on the exchange and, where intermediaries
are permitted, rules addressing the financial integrity of the
intermediary and the protection of customer funds, as appropriate,
and a program to enforce those requirements.
(a) Application Guidance.
Clearing of transactions executed on a recognized futures
exchange should be provided through a Commission-recognized clearing
facility. In addition, a recognized futures exchange should maintain
the financial integrity of its transactions by maintaining minimum
financial standards for its members and having default rules and
procedures. The minimum financial standards should be monitored for
compliance purposes. The Commission believes that in order to
monitor for minimum financial requirements, a recognized futures
exchange should routinely receive and promptly review financial and
related information. Rules concerning the protection of customer
funds should address the segregation of customer and proprietary
funds, the custody of customer funds, the investment standards for
customer funds, and related recordkeeping.
(b) Acceptable Practices. [Reserved]
Core Principle 11: Customer Protection: Have, monitor and
enforce rules for customer protection.
(a) Application Guidance.
A recognized futures exchange should have rules prohibiting
conduct by intermediaries that is fraudulent, noncompetitive,
unfair, or an abusive practice in connection with the execution of
trades and a program to detect and discipline such behavior.
Intermediated markets are not required to have, monitor or enforce
rules requiring intermediaries to provide risk disclosure or to
comply with other sales practices.
(b) Acceptable Practices. [Reserved]
Core Principle 12: Dispute Resolution: Provide for alternative
dispute resolution mechanisms appropriate to the nature of the
market.
(a) Application Guidance.
A recognized futures exchange should provide customer dispute
resolution procedures that are fair and equitable and that are made
available to the customer on a voluntary basis, either directly or
through another self-regulatory organization.
(b) Acceptable Practices.
(1) Core Principle 12 requires a recognized futures exchange to
provide for dispute resolution mechanisms that are appropriate to
the nature of the market.
(2) In order to satisfy acceptable standards, a recognized
futures exchange should provide a customer dispute resolution
mechanism that is fundamentally fair and is equitable. The procedure
should provide:
(i) The customer with an opportunity to have his or her claim
decided by a decision-maker that is objective and impartial,
[[Page 77992]]
(ii) Each party with the right to be represented by counsel, at
the party's own expense,
(iii) Each party with adequate notice of claims presented
against him or her, an opportunity to be heard on all claims,
defenses and permitted counterclaims, and an opportunity for a
prompt hearing,
(iv) For prompt written final settlement awards that are not
subject to appeal within the exchange, and
(v) Notice to the parties of the fees and costs which may be
assessed.
(3) The procedure employed also must be voluntary and may permit
counter claims, as provided in Sec. 166.5 of this chapter.
(4) If the recognized futures exchange also provides a procedure
for the resolution of disputes which do not involve customers (i.e.,
member-to-member disputes), the procedure for the resolution of such
disputes must be independent of and shall not interfere with or
delay the resolution of customers' claims or grievances.
(5) A recognized futures exchange may delegate to another self-
regulatory organization or to a registered futures association its
responsibility to provide for customer dispute resolution
mechanisms, Provided, however, that, if the recognized futures
exchange does so delegate that responsibility, the exchange shall in
all respects treat any decision issued by such other organization or
association as if the decision were its own including providing for
the appropriate enforcement of any award issued against a delinquent
member.
Core Principle 13: Governance: Have fitness standards for
members, owners or operators with greater than 10 percent interest
or an affiliate of such an owner, members of the governing board,
and those who make disciplinary determinations. The recognized
futures exchange must have a means to address conflicts of interest
in making decisions and access to, and use of, material non-public
information by the foregoing persons and by exchange employees. For
mutually owned futures exchanges, the composition of the governing
board must reflect market participants.
(a) Application Guidance.
(1) A recognized futures exchange should have appropriate
eligibility criteria for the categories of persons set forth in the
Core Principle which should include standards for fitness and for
the collection and verification of information supporting compliance
with such standards. Minimum standards of fitness are those bases
for refusal to register a person under section 8a(2) of the Act or a
history of serious disciplinary offenses, such as those which would
be disqualifying under Sec. 1.63 of this chapter. The Commission
believes that such standards should include the provision to the
Commission of registration information for such persons, whether
registration information, certification to the fitness of such
persons, an affidavit of such persons' fitness by the facility's
counsel or other information substantiating the fitness of such
persons. If an exchange provided certification of the fitness of
such a person, the Commission believes that such certification
should be based on verified information that the person is fit to be
in their position. The means to address conflicts of interest in
decision-making should include methods to ascertain the presence of
conflicts of interest and to make decisions in the event of such a
conflict. In addressing the access to, and use of, material non-
public information, the Commission believes that the recognized
futures exchange should provide for limitations on exchange employee
trading.
(2) A recognized futures exchange may not limit its liability or
the liability of any of its officers, directors, employees,
licensors, contractors and/or affiliates where such liability arises
from such person's violation of the Act or Commission rules, fraud,
or wanton or willful misconduct.
(b) Acceptable Practices. [Reserved]
Core Principle 14: Recordkeeping: Keep full books and records of
all activities related to its business as a recognized futures
exchange in a form and manner acceptable to the Commission for a
period of five years, during the first two of which the books and
records are readily available, and which shall be open to inspection
by any representative of the Commission or the U.S. Department of
Justice.
(a) Application Guidance. [Reserved]
(b) Acceptable Practices.
Commission rule 1.31 constitutes the acceptable practice
regarding the form and manner for keeping records.
Core Principle 15: Competition: Operate in a manner consistent
with the public interest to be protected by the antitrust laws.
(a) Application Guidance.
An entity seeking recognition as a recognized futures exchange
may request that the Commission consider under the provisions of
section 15 of the Act any of the entity's rules, including trading
protocols or policies, and including both operational rules and the
terms or conditions of products listed for trading, at the time of
recognition or thereafter. The Commission intends to apply section
15 of the Act to its consideration of issues under the Competition
Core Principle in a manner consistent with that previously applied
to contract markets.
(b) Acceptable Practices. [Reserved]
PART 170--REGISTERED FUTURES ASSOCIATIONS
11. The authority citation for Part 170 continues to read as
follows:
Authority: 7 U.S.C. 6p, 12a, and 21.
12. Section 170.8 is revised to read as follows:
Sec. 170.8 Settlement of customer disputes (section 17(b)(10) of the
Act).
A futures association must be able to demonstrate its capacity to
promulgate rules and to conduct proceedings which provide a fair,
equitable and expeditious procedure, through arbitration or otherwise,
for the voluntary settlement of a customer's claim or grievance brought
against any member of the association or any employee of a member of
the association. Such rules shall conform to and be consistent with
section 17(b)(10) of the Act and be consistent with the guidelines and
acceptable practices for dispute resolution found within Appendix A and
Appendix B to part 38 of this chapter.
PART 180--ARBITRATION OR OTHER DISPUTE SETTLEMENT PROCEDURES
13. Part 180 is removed.
Issued in Washington, DC, this 21st day of November, 2000, by
the Commission.
Jean A. Webb,
Secretary of the Commission.
[This statement will not appear in the Code of Federal Regulations]
Dissent of Commissioner Thomas J. Erickson Regarding Final Rules for a
New Regulatory Framework for Multilateral Transaction Execution
Facilities, Intermediaries and Clearing Organizations
I dissent from the Commission's final rules regarding
multilateral transaction execution facilities, or ``MTEFs.'' While I
believe this is the most dynamic element of the proposed framework,
I also fear that it will only expand the legal uncertainty that the
industry has decried for so long in reference to the existing swaps
exemption in Part 35. I am thus simultaneously interested in the
potential this proposal represents and disappointed in the lost
opportunity for clarification.
At its core, my concern is this: The framework will, for the
first time, inject legal uncertainty into regulated exchange markets
by conferring ``recognition'' upon derivatives transaction
facilities, or DTFs, without any determination that the transactions
are within the CFTC's jurisdiction. I believe that if an agency of
the United States Government tells market participants, other
branches of the government, and counterpart foreign regulators that
a market is regulated, then it should be, in fact, regulated.
At the DTF level, it seems clear that some markets will not be
subject to Commission oversight because the Commission's
jurisdiction--over transactions for future delivery and commodity
options--will not attach to markets for certain products traded on
DTFs. The nature of the Commission's mixed jurisdiction was not lost
on commenters to the proposed framework; while some saw this as a
flaw in the
[[Page 77993]]
proposal,\1\ others took comfort in it.\2\ Despite this ``don't ask,
don't tell'' approach, DTFs all will be ``recognized'' by the
Commission as regulated markets.\3\ In turn, these DTF markets will
hold themselves out to the public as markets regulated by the CFTC.
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\1\ See Mercatus letter, Aug. 21, 2000, p. 4 (``While it may be
appropriate for the CFTC to avoid such a determination in granting
an exemption from regulation, it is not clear that the CFTC can
exercise its antifraud authority in relation to a particular
transaction without determining that the CFTC is authorized to
exercise jurisdiction in the first instance.'') The drafters of the
Mercatus letter further note that the ``broad definition of MTEF''
in the proposed rules could even be read ``to cover auction markets
such as eBay and all other forms of B2B trading facilities, whether
electronic or not.'' Id. at 5. The Commission attempts to deflect
this criticism in the final rules, stating that ``so long as a
facility auctions instruments outside of the Commission's regulatory
jurisdiction under the Act, [the] exemptions therefrom and this
framework would have no application to its business.'' See Final
Rules for a New Regulatory Framework for Multilateral Transaction
Execution Facilities, Intermediaries and Clearing Organizations, pp.
13-14. The Commission's response misses the rudimentary point that
it will be anyone's guess whether some instruments possibly traded
on DTFs are within or outside the Commission's jurisdiction.
\2\ See Lehman Brothers letter, Sept. 5, 2000, p. 2 (``[T]he
Commission's jurisdiction extends solely to futures and commodity
options, such that reserving anti-fraud and anti-manipulation
authority over futures and commodity options merely restates the
current state of law. Such a reservation of authority cannot,
legally, extend to transactions other than futures and commodity
options and repeating the nature of the agency's statutory
jurisdiction carries no legal baggage.'')
\3\ The only apparent penalty for refusing to comply with
Commission rules is the market's loss of recognition as a DTF. I am
not comfortable with this after-the-fallout remedy, and I cannot
imagine potential market participants or domestic or international
regulators being any more pleased.
\4\ See A New Regulatory Framework for Multilateral Transaction
Execution Facilities, Intermediaries and Clearing Organizations, p.
11, citing H.R. Rep. No. 978, 102d Cong., 2d Sess. 82-83 (1992).
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The Commission and certain commenters within the industry find
the possible mix of futures and non-futures products on DTFs
acceptable. They rely on Congressional report language from the 1992
legislation that, in effect, allows the Commission to exempt
transactions without first determining that they are in the agency's
jurisdiction.\4\
In the context of bilateral, privately negotiated transactions--
such as those swaps the Commission was directed by Congress to
``promptly exempt--such an exemption makes a certain amount of
sense. The consequence of any performance failure or fraud is borne
solely by the parties to the transaction.
However, today the Commission extends this rationale to entities
that are, in fact, exchange markets. Global participants and
international regulators rely on our representations that these
markets are regulated. I will not be comfortable making such
representations with regard to DTFs where the Commission's
jurisdiction is so questionable.
As a secondary matter, I am concerned with the level of
oversight that will be applied to all DTF markets. Under the new
framework, DTFs generally will not be required to maintain or
provide the Commission with reports of futures positions held by
their customers that exceed certain thresholds. In what appears to
be a nod to the need for these reports, known as ``large trader
reports,'' the Commission contemplates collecting this information
only in a select, few markets. But the vast majority of markets
trading at the DTF level--generally those without retail
participants--will have no obligation or duty to the Commission or
the public with regard to this important information.
Large trader reports are an essential tool in the Commission's
effort to detect and deter market manipulations. Deterrence is
important because the effects of market manipulations reach far
beyond the market's participants. Consumers ultimately pay for
manipulations in commodity markets: Home buyers pay higher interest
rates; commuters pay higher prices for gasoline; and we all pay
higher prices for heating oil and food. For these reasons, I would
require large trader reports in all DTF markets, regardless of the
type of commodity product or participant involved.
The Department of the Treasury identified this issue in its
comment letter, stating that ``large trader reporting requirements
have worked well in the market for treasury futures, both for the
information they reveal to regulators and their deterrent effect.''
\5\ I could not agree more strongly with the Treasury Department on
this point. While it appears that large trader reporting will attach
to government securities markets, I do not understand why the
Treasury's views have not provided just as compelling a rationale
for other markets which are not nearly as deep or liquid.
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\5\ See Department of Treasury letter, Aug. 16, 2000, p. 4.
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I believe that DTF markets may prove to be very successful,
commercially. They may well grow to be the commercial markets where
pricing and price-basing of commodities occurs. The Commission would
be wise to retain its ability to detect and deter manipulations at
their incipience.
Dated: November 20, 2000.
Thomas J. Erickson,
Commissioner.
[FR Doc. 00-30267 Filed 12-12-00; 8:45 am]
BILLING CODE 6351-01-P