Section 4(c) Contract Market Transactions; Swap Agreements
Federal RegisterOct 28, 1994
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COMMODITY FUTURES TRADING COMMISSION
17 CFR Parts 35 and 36
Section 4(c) Contract Market Transactions; Swap Agreements
AGENCY: Commodity Futures Trading Commission.
ACTION: Proposed rules.
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SUMMARY: On August 16, 1993, the Commodity Futures Trading Commission
(``Commission'') published a notice of petitions for exemptive relief
submitted by the Chicago Mercantile Exchange (``CME'') and the Board of
Trade of the City of Chicago (``CBOT'') and request for comment. The
petitions requested exemptions from most of the requirements of the
Commodity Exchange Act (``CEA'' or ``Act'') and Commission regulations
for certain exchange-traded futures and option contracts pursuant to
Section 4(c) of the Act, added October 28, 1992.
The comment period closed December 15, 1993, and the Commission has
carefully considered the comments received. Based upon its review of
the comments and its own consideration of the exemption requests, the
Commission is proposing rules which will permit certain contract market
transactions (as defined herein) meeting specified criteria to trade
pursuant to exemption from certain requirements under the Act and
Commission regulations on a section 4(c) contract market. The
Commission is also seeking comment on whether Part 35 (exemption of
swap agreements) should be amended to include stand-alone prohibitions
on fraud and price manipulation.
DATES: Written comments must be received by the Commission by the close
of business on December 12, 1994. Reference should be made to section
4(c) contract market transactions.
ADDRESSES: Interested persons should submit their written views and
comments to Jean A. Webb, Secretary, Commodity Futures Trading
Commission, 2033 K Street, N.W., Washington, D.C. 20581.
FOR FURTHER INFORMATION CONTACT: Pat G. Nicolette, Acting General
Counsel, David R. Merrill, Deputy General Counsel, or Ellyn S. Roth,
Attorney, Office of the General Counsel, Commodity Futures Trading
Commission, 2033 K Street, N.W., Washington, D.C. 20581. Telephone:
(202) 254-9880.
SUPPLEMENTARY INFORMATION:
I. Statutory Background
Section 2(a)(1)(A) of the Act grants the Commission exclusive
jurisdiction over ``accounts, agreements (including any transaction
which is of the character of * * * an 'option' * * *), and transactions
involving contracts of sale of a commodity for future delivery traded
or executed on a contract market * * * or any other board of trade,
exchange, or market * * *'' 7 U.S.C. 2. The CEA and Commission
regulations require that transactions in commodity futures contracts
and commodity option contracts, with narrowly defined exceptions, occur
on or subject to the rules of contract markets designated by the
Commission.1
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\1\Sections 4(a), 4c(b) and 4c(c) of the Act, 7 U.S.C. 6(a),
6c(b), and 6c(c). Section 4(a) of the CEA specifically provides,
inter alia, that it is unlawful to enter into a commodity futures
contract that is not made ``on or subject to the rules of a board of
trade which has been designated by the Commission as a `contract
market' for such commodity.'' 7 U.S.C. 6(a). This prohibition does
not apply to futures contracts made on or subject to the rules of a
foreign board of trade, exchange or market. 7 U.S.C. 6(a).
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On October 28, 1992, the Futures Trading Practices Act of 1992
(``1992 Act'') was signed into law. P.L. No. 102-546. This legislation
added new subsections (c) and (d) to Section 4 of the Act. New Section
4(c)(1) authorizes the Commission, by rule, regulation, or order, to
exempt any agreement, contract or transaction, or class thereof, from
the exchange-trading requirements of Section 4(a) or any other
requirement of the Act other than Section 2(a)(1)(B), 7 U.S.C. 2.2
New Section 4(c)(2) provides that the Commission may not grant an
exemption from the exchange-trading requirement of the Act unless,
inter alia, the agreement, contract or transaction being exempted will
be entered into solely between ``appropriate persons'' as defined in
new Section 4(c)(3)3 subject to such limitations as may be deemed
appropriate by the Commission, in the public interest.4 In
granting such an exemption, the Commission must also determine that the
agreement, contract or transaction in question 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 and
that the exemption would be consistent with the public interest and the
purposes of the Act.5 In vesting the Commission with this new
exemptive authority, Congress recognized the need to create legal
certainty for instruments that may contain some features similar to
those of regulated exchange-traded products but that are sufficiently
different in their purpose, function or design, or other
characteristics such that traditional futures regulation may be
unnecessary.6
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\2\Specifically, Section 4(c)(1), 7 U.S.C. 6(c)(1), provides:
In order to promote responsible economic or financial innovation
and fair competition, the Commission by rule, regulation, or order,
after notice and opportunity for hearing, may (on its own initiative
or on application of any person, including any board of trade
designated as a contract market for transactions for future delivery
in any commodity under section 5 of this Act) exempt any agreement,
contract, or transaction (or class thereof) that is otherwise
subject to subsection (a) (including any person or class of persons
offering, entering into, rendering advice or rendering other
services with respect to, the agreement, contract, or transaction),
either unconditionally or on stated terms or conditions or for
stated periods and either retroactively or prospectively, or both,
from any of the requirements of subsection (a), or from any other
provision of this Act (except section 2(a)(1)(B)), if the Commission
determines that the exemption would be consistent with the public
interest.
\3\Section 4(c)(3), 7 U.S.C. 6(c)(3), provides that the term
``appropriate person'' shall be limited to the following persons or
classes thereof:
(A) A bank or trust company (acting in an individual or
fiduciary capacity).
(B) A savings association.
(C) An insurance company.
(D) An investment company subject to regulation under the
Investment Company Act of 1940 (15 U.S.C. 80a-1 et seq.).
(E) A commodity pool formed or operated by a person subject to
regulation under this Act.
(F) A corporation, partnership, proprietorship, organization,
trust, or other business entity with a net worth exceeding
$1,000,000 or total assets exceeding $5,000,000, or the obligations
of which under the agreement, contract or transaction are guaranteed
or otherwise supported by a letter of credit or keepwell, support,
or other agreement by any such entity or by an entity referred to in
subparagraph (A), (B), (C), (H), (I), or (K) of this paragraph.
(G) An employee benefit plan with assets exceeding $1,000,000,
or whose investment decisions are made by a bank, trust company,
insurance company, investment adviser registered under the
Investment Advisers Act of 1940 (15 U.S.C. 80a-1 et seq.), or a
commodity trading advisor subject to regulation under this Act.
(H) Any governmental entity (including the United States, any
state, or any foreign government) or political subdivision thereof,
or any multinational or supranational entity or any instrumentality,
agency, or department of any of the foregoing.
(I) A broker-dealer subject to regulation under the Securities
Exchange Act of 1934 (15 U.S.C. 78a et seq.) acting on its own
behalf or on behalf of another appropriate person.
(J) A futures commission merchant, floor broker, or floor trader
subject to regulation under this Act acting on its own behalf or on
behalf of another appropriate person.
(K) Such other persons that the Commission determines to be
appropriate in light of their financial or other qualifications, or
the applicability of appropriate regulatory protections.
\4\See H.R. Rep. No. 978, 102d Cong., 2d Sess. 79 (1992).
\5\Specifically, Section 4(c)(2), 7 U.S.C. 6(c)(2), states:
The Commission shall not grant any exemption under paragraph (1)
from any of the requirements of subsection (a) unless the Commission
determines that--
(A) The requirement should not be applied to the agreement,
contract, or transaction for which the exemption is sought and that
the exemption would be consistent with the public interest and the
purposes of this Act; and
(B) the agreement, contract, or transaction--
(i) will be entered into solely between appropriate persons; and
(ii) 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 this Act.
\6\See H.R. Rep. No. 978, 102d Cong., 2d Sess. 80 (1992).
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II. The Petitions for Exemptive Relief
On August 16, 1993, the Commission published in the Federal
Register a notice of petitions for exemption submitted by the CME and
CBOT pursuant to Section 4(c) of the Act, 7 U.S.C. 6(c), and a request
for comment.7 In its petition, submitted on April 8, 1993 (and
supplemented June 18, 1993), the CME sought an exemption from most of
the provisions of the Act and Commission regulations with regard to the
purchase and sale of certain contracts denominated by the CME as
Rolling SpotTM futures and options contracts (``Rolling Spot
Contracts''). The CBOT's petition, submitted on June 30, 1993,
requested that the Commission establish a ``professional trading market
exemption'' from most of the provisions of the Act and regulations for
trading in any instrument of the CBOT and other boards of trade,
including those designated previously as contract markets by the
Commission. Under both petitions, trading in exempted instruments would
have been limited to certain participants, and trades would have been
cleared through an exchange clearing system approved by the Commission.
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\7\58 FR 43414 (Aug. 16, 1993); 58 FR 44402 (Aug. 20, 1993)
(correction); 58 FR 52948 (Oct. 13, 1993) (extension of comment
period to Dec. 15, 1993).
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In the Federal Register notice, the Commission requested comment
concerning the appropriate disposition, pursuant to Section 4(c) of the
Act, 7 U.S.C. 6(c), of the applications submitted by the CME and the
CBOT. Specifically, the Commission requested comment on approximately
100 issues under the following general headings, corresponding to the
determinations that the Commission must make in order to grant an
exemption under Section 4(c), 7 U.S.C. 6(c): (1) Whether the exemption
is consistent with the public interest and purposes of the Act; (2)
whether the contracts to be exempted will be entered into solely
between ``appropriate persons'' as defined in Section 4(c)(3) of the
Act, 7 U.S.C. 6(c)(3); and (3) whether the exemption will 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.
III. Comments Received
The Commission received 36 comment letters on the proposal: seven
from futures exchanges;\8\ two from securities exchanges; one from the
National Futures Association; six from trade associations;\9\ three
from foreign regulatory bodies; two from university professors; four
from federal regulatory agencies; one from a member of Congress; one
from a publisher of a futures publication; five from futures traders;
one from a bar association; two from investment companies; and one from
a futures lawyer.\10\
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\8\The seven comment letters consist of an interim letter signed
by the presidents of eight exchanges, a 134-page letter signed by
the presidents of seven exchanges, a letter from the New York
Mercantile Exchange (``NYMEX''), a letter from the CME responding to
a comment letter, and three joint letters from the CME and CBOT
supplementing the record and responding to other comment letters. In
addition, by letter dated September 20, 1994, the NYMEX sought to
join in the CBOT's petition.
\9\The six include an extension of time request.
\10\In addition, on November 23, 1993, the Commission held a
roundtable discussion, during which industry experts, including
representatives of end users and dealers in over-the-counter
(``OTC'') and exchange-traded derivatives, presented their views on
the exchange petitions. A number of concerns were expressed
regarding the way in which the exchanges' ``professional trading
market'' would operate.
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There were three general sets of commenters: those who expressed
unqualified support in favor of the petitions; those who were generally
in favor of the petitions but who thought they should be modified
somewhat, either by limiting the scope of the exemptions and/or by
granting the exemptions on a trial basis; and those who were generally
against the petitions. The CME and the CBOT were joined by six other
exchanges in expressing their support for the proposals. The group in
favor of the exemptions also included certain futures professionals and
academics. The industry's views, however, were not uniform. Futures
trade associations as well as other futures professionals comprised the
group giving their qualified support to the CME and CBOT petitions.
Those opposing the petitions largely consisted of regulatory agencies,
both foreign and domestic. In addition, portions of the petitions were
criticized by some investment professionals.
Those supporting the petitions generally believed that the
exchanges are operating at a handicap in competing with the OTC markets
because of what they characterized as burdensome, costly, and
unnecessary federal regulation. Removing such regulation would,
according to supporters, enhance the competitive posture of the U.S.
exchanges in the world marketplace. Supporters further asserted that
professional and institutional traders do not require the same level of
regulatory protection as the small retail speculator. They argued that
the Commission should treat transactions occurring in centralized
``professional trading markets'' the same way that it did swaps,
hybrids, and certain energy transactions, all previously exempted from
most or all of the provisions of the Act and Commission regulations.
Some supporters commented that the exemptions would allow flexible
product development, the hallmark of the OTC market, but in a far more
structured regulatory environment. According to these commenters,
exchange self-regulation over derivatives is preferable to no market
regulation, the present situation in connection with OTC transactions.
Those giving the petitions qualified support generally also
endorsed permitting more flexible approaches than the current
designation process as well as enhancing the exchanges' ability to
respond to the needs of sophisticated and institutional market
participants and competitive demands of the international marketplace.
Nonetheless, commenters in this category expressed concerns with the
petitions, and highlighted the need to ensure the integrity of both the
non-exempt as well as the exempt markets, particularly with regard to
financial requirements, customer funds protections, trade practice
rules, market surveillance, exchange governance, and the integrity of
the clearing system. In addition, some of these commenters were not
thoroughly convinced that the rules for preventing fraud and
manipulation proposed by the CME and CBOT would be as effective as the
current procedures.\11\ The commenters further noted the importance of
maintaining public confidence in the integrity of the futures markets.
Some emphasized that public markets like the CME and CBOT imply a
comprehensive regulatory environment, including the imposition of
fitness standards for commodity professionals.
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\11\In addition, two commenters suggested that the CBOT's
proposed antifraud rule might exceed the Commission's jurisdictional
scope.
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Finally, some commenters giving the petitions qualified support
believed that the absence of defining criteria for the proposed
transactions made their evaluation of the potential consequences of the
exchanges' petitions difficult. Accordingly, commenters in this group
generally recommended caution--either by limiting the commodities which
could be traded on a ``professional trading market'' or by granting the
exemptions on a trial basis, or both.
Commenters opposing the petitions, in particular other financial
regulatory agencies, essentially contended that the exemption proposals
were too broad and lack sufficient justification. Specifically,
according to some commenters, the exchanges failed to make their case
that approval of their proposals would be in the public interest. They
further argued that the exchanges have not presented evidence showing
that the existing regulatory structure is so harmful to competition
that such broad relief is necessary in order for exchanges to compete
effectively. Commenters against the petitions contended that granting
such broad exemptions may have unintended effects on market integrity,
in particular, unexpected consequences for the non-exempt markets and
the safety of the clearing system.\12\
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\12\Some commenters stated that although the exchanges have
indicated that they do not intend to trade identical exempt and non-
exempt contracts, the theoretical possibility of allowing such two-
tier trading would raise a number of concerns, including the drain
of liquidity from the non-exempt market and the resulting
implications for price discovery, the potential for manipulation,
trading ahead, and other issues relating to the integrity of both
the exempt and non-exempt markets.
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Some commenters further noted that Congress warned the Commission
to use its new exemptive authority sparingly, and not as a means of
effecting wholesale deregulation of the futures markets. Commenters
stated that, contrary to the exchanges' assertions, there are
distinctions between the OTC derivative markets (including the
instruments previously exempted by the Commission) and the contracts
traded on the CME, CBOT, and other exchange markets. Whereas swaps and
other OTC derivatives are primarily dispersed, non-fungible, privately-
negotiated, principal-to-principal transactions in which individual
credit determinations have been made about disclosed counterparties,
exchange-traded futures contracts are traded among anonymous
counterparties and on an agency basis in a public market established by
a third party. Commenters in this category emphasized that an
appropriate level of federal regulatory oversight of exchange markets
is necessary to maintain market integrity, and, moreover, that the need
for such oversight is not diminished by the exclusion of certain market
participants since exchange regulation is designed to address the
characteristics of that market and many regulatory provisions are
designed to protect the market itself.
Moreover, according to some commenters, the ultimate and the
appropriate regulatory structure for OTC derivatives is not settled;
rather, Congress and financial regulators are reviewing the need for
OTC derivatives regulation. Some commenters asserted that the entire
derivatives market requires more, not less, regulation.
IV. The Proposed Rules
In granting the Commission exemptive authority, Congress cautioned
the Commission to use its authority ``sparingly'' and not as a way of
prompting a ``wide-scale deregulation of markets falling within the
ambit of the Act.''\13\ In light of this admonition as well as the
advice of commenters, in particular that of other financial regulators,
the Commission believes that the scope of the exchanges' petitions,
which requested exemptive relief from most of the provisions of the Act
and regulations for all instruments traded by sophisticated
participants, is too broad. Notwithstanding the exchanges' assertions
to the contrary, the Commission's previous exemptions for swaps,
hybrids, and certain energy contracts, granted shortly after the
Commission was provided with exemptive authority,\14\ cannot be equated
with the exchanges' requests for exemptive relief. The previous
exemptions, which followed extensive periods of consideration of the
issues raised by such instruments,\15\ arose out of a need specifically
recognized by Congress to enhance the legal certainty as to the
regulatory status of those instruments. Each such exemption related to
types of transactions that the Commission had previously found to be
beyond the scope of the CEA or unsuitable for regulation thereunder
because of the nature of the transaction, the parties, the
applicability of other regulatory regimes or otherwise.\16\
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\13\H.R. Rep. No. 978, 102d Cong., 2d Sess. 81 (1992).
\14\The Commission exempted from most provisions of the Act and
regulations the following: (1) hybrid instruments that are not
predominantly composed of a commodity interest (17 CFR Part 34; 58
FR 5580 (Jan. 22, 1993)), (2) swap transactions meeting certain
criteria (17 CFR Part 35; 58 FR 5587 (Jan. 22, 1993)), and (3)
certain contracts between commercial participants for the deferred
purchase or sale of energy products (58 FR 21286 (April 20, 1993)).
\15\Each of the Commission's exemptions for swaps, hybrids, and
energy products was a culmination of a deliberate and cautious
exercise by the Commission of its regulatory authority that spanned
several years. Specifically, the Commission's consideration of an
appropriate regulatory approach for swaps began in December 1987
with the publication of an Advanced Notice of Proposed Rulemaking
which addressed a number of types of off-exchange instruments and
which solicited public comments on a wide range of issues.
Subsequently, in July 1989, after a second notice-and-comment
period, the Commission issued a policy statement which established a
safe harbor for swap agreements meeting certain specified criteria.
This was the foundation upon which the Commission ultimately adopted
final rules in January 1993.
The Commission's examination of a regulatory approach with
regard to hybrid instruments also began with the same December 1987
Advanced Notice of Proposed Rulemaking and request for comments.
Based upon the comments received and its subsequent experience, the
Commission in January 1989 proposed rules to exempt certain types of
hybrid instruments meeting specified criteria, and adopted a
statutory interpretation which recognized an exclusion from
regulation for other types of hybrids. Following an extensive
comment period on its proposed rules, the Commission adopted final
rules in July 1989. These rules and the statutory interpretation,
together with the experience gained by the Commission in
administering them, served as the basis for the proposal and
ultimate adoption by the Commission in January 1993, pursuant to its
new authority, of rules exempting certain hybrid instruments.
Finally, with respect to commercial contracts involving energy
products, the Commission received inquiries concerning the
applicability of the Act to transactions of this type following the
issuance of the judicial decision in Transnor (Bermuda) Limited v.
BP North American Petroleum, et al., 738 F. Supp. 1472 (S.D.N.Y.
1990). In response, the Commission in September 1990 issued a
statutory interpretation taking the position that commercial
transactions of this type which met certain criteria were excluded
from regulation under the Act as ``cash forward'' contracts.
Following the enactment of the 1992 Act, the Commission in November
1992 received a petition for exemptive relief concerning similar
transactions. In response, the Commission published a proposed order
which would provide exemptive relief to certain persons engaged in
contracts involving energy products that meet certain criteria and,
following a public comment period, adopted a final order in this
regard in April 1993.
\16\In granting exemptive authority to the Commission under new
Section 4(c), the Conferees on the 1992 Act recognized the need to
create legal certainty for a number of existing categories of
instruments which traded outside the forum of a designated contract
market. These instruments were noted to contain some features
similar to those of regulated exchange-traded products but are
sufficiently different in their purpose, function, design or other
characteristics that, as a matter of policy, traditional futures
regulation and the limitation of trading to the floor of an exchange
may be unnecessary to protect the public interest and may create an
inappropriate burden on commerce. H.R. Rep. No. 978, 102d Cong., 2d
Sess. 80 (1992).
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Moreover, the Commission does not subscribe to the exchanges'
apparent view that there are no significant distinctions between
dispersed dealer and central auction markets that would be reflected in
assessing the appropriate level and manner of regulation of
transactions undertaken in either forum or that should cause the
Commission, in applying the exemptive criteria of the Act, to treat OTC
and central exchange products identically. This is true irrespective of
whether further regulation of the dealer market may be found, as a
result of ongoing inquiries, to be desirable. The federal regulation of
futures exchange markets dates from 1922. In 1974, Congress expressly
expanded coverage of the CEA to ``all services, rights and interests in
which contracts for future delivery are presently or in the future
dealt in,'' to assure that the prices generally quoted and disseminated
from those contracts could be used as a fair basis for determining
consumer and producer prices.\17\ To reflect the public interest in the
appropriate functioning of price discovery markets and to assure market
integrity and customer protection, a number of regulatory protections
are currently required. These requirements reflect the fact that
exchange transactions are conducted between anonymous counterparties
and support the financial integrity of such transactions with marking-
to-market, daily or more frequent cash settlement, segregation of
customer funds, capital requirements, margin, recordkeeping and
inspection rules, and clearing guarantees.
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\17\Sections 1a and 3 of the Act, 7 U.S.C. 1 and 5. In 1974,
Congress described a ``fundamental purpose'' of the Act as follows:
``* * * to insure fair practice and honest dealing on the
commodity exchanges and to provide a measure of control over those
forms of speculative activity which too often demoralize the markets
to the injury of producers and consumers and the exchanges
themselves.''
Report of the Senate Committee on Agriculture and Forestry, S.
Rep. No. 1131, 93d Cong., 2d Sess. 14 (1974).
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Thus, the fact that a centralized market is composed solely of
institutional or ``sophisticated'' participants does not obviate the
need to ensure market integrity, price dissemination, and adequate
protections against fraud, manipulation, and other trading abuses by
continued Commission regulation and oversight. In this regard, the term
``institutional'' may encompass customers with a wide range of
financial experience, acumen and resources. The Commission believes,
moreover, that the Act and Commission regulations serve a vital
function, even where such a market includes only sophisticated
participants, in that the regulatory requirements substitute for
individualized credit determinations and permit increased access to the
markets by secondary participants and customers. Further, a premise of
the CEA for over 70 years has been that all traders require not only an
efficient, but also a fair marketplace in which to trade, which
Congress has previously determined to be best effectuated by a
regulatory framework in which federal regulation is paramount.
Moreover, notwithstanding the exchanges' arguments to the contrary,
since the enactment of the CEA the exchanges have grown and thrived,
not despite, but at least in part, because of the regulatory scheme
under which they operate and the resulting public confidence in the
fairness of the markets. The Commission agrees with the commenters who
stated that regulatory safeguards promote public confidence in the
integrity of the markets, confidence likely to be eroded without
federal oversight. Accordingly, the Commission is not convinced that a
broad exemption of the kind requested by the exchanges is in the public
interest.
Nevertheless, the Commission has in the past taken into account in
fashioning its regulations, granting exemptions, and establishing
policies, whether the general public is excluded from a market or
transaction or is permitted to participate. The Commission considers
the exclusion of non-sophisticated market participants as the single
most important rationale supporting the various forms of relief
proposed herein. The proposed relief from certain aspects of exchange
regulation should enhance the exchanges' ability to innovate and their
competitive posture. Indeed, the Commission is cognizant, as the
exchanges and other commenters noted, that its exemptive authority is
``intended to promote responsible economic and financial innovation and
fair competition.''18 In issuing its study on U.S. market
competitiveness, the Commission stated that it was committed to keeping
its regulatory programs under continuous review to assure that
``consistent with our responsibilities for market integrity and
customer protection, they: (1) keep pace with changes in the
marketplace; and (2) do not unnecessarily impede domestic exchanges
from evolving to remain competitive, especially with regard to the cost
of compliance relative to non-U.S. exchanges.''19
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\1\8H.R. Rep. No. 978, 102d Cong., 2d Sess. 78 (1992).
\1\9Commodity Futures Trading Commission, A Study of the Global
Competitiveness of U.S. Futures Markets 2 (April 1994).
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To that end, the Commission recognizes that some regulatory
controls, such as certain procedures for Commission review and approval
of new instruments, could be streamlined in order to facilitate the
introduction of products and the on-exchange offering of more varied
contract designs. More flexibility to permit some customizing of
exchange-traded products also may attract certain institutional
participants for which the efficiency of exchange markets and other
protections they afford may be preferable to off-exchange transactions
where prices are often opaque and credit risk is a more profound issue.
The Commission also believes that exchange transactions traded by
professional traders may not require the full panoply of regulatory
requirements. In that regard, the Commission believes that a more
flexible approach to risk disclosure for products offered to
sophisticated market participants may be preferable to existing
requirements. In addition, the Commission preliminarily agrees with the
commenters who suggested that certain registration requirements could
be streamlined for professional traders licensed with other financial
regulators to facilitate new entrants to the exchange markets by
persons currently selling OTC products to sophisticated customers.
Finally, the Commission preliminarily believes that the long-standing
traditional requirements of open and competitive trading could be
relaxed for sophisticated, eligible participants in order to facilitate
the execution of large orders, as long as appropriate post-trade
transparency, customer, and other market protections from trading
abuses are maintained.
For these reasons, after reviewing the exchanges' petitions and the
general comments, the Commission is proposing to test some ways of
giving the exchanges flexibility and greater latitude in order to
enhance their ability to devise innovative responses both to other
centralized and to less regulated, non-centralized markets. The
Commission believes that the exemptive relief that it is proposing
preserves regulatory safeguards but also acknowledges that non-
centralized markets have a far lower regulatory burden and that several
comparable markets of other jurisdictions provide certain trading
mechanism concessions not currently afforded the U.S. futures markets.
In that regard, the Commission proposes a new Part 36, which exempts
contracts termed ``section 4(c) contract market transactions'' meeting
specified criteria from certain specific requirements and regulations
under the Act. There are four main proposed limitations on the
exemption: (1) The duration, (2) the scope, (3) the persons who are
eligible to enter into the transactions, and (4) the transactions which
may trade as section 4(c) contract market transactions. The Commission
believes that this proposal strikes the appropriate balance between the
need to detect and deter abuses and the need for an innovative central
market tailored to the needs of sophisticated and institutional market
participants. The Commission requests comments concerning the specifics
of the proposed criteria for the transactions as well as the proposed
provisions from which the transactions will be exempt.
A. Duration and Scope of Exemption
In Sec. 36.1(a), the Commission proposes to implement the exemption
under a three-year pilot program. The pilot program is designed to give
the exchanges and the Commission a trial period to test the operation
of the exemption. More importantly, it affords the Commission an
opportunity to determine the effect of section 4(c) contract market
transactions on the integrity of the marketplace as a whole and whether
continued trading under the exemption would be in the public interest.
The trial nature of the program reflects the Commission's belief that
the exemption constitutes a significant departure from the regulatory
scheme under which futures and option contracts have been trading for
over 70 years. The Commission believes that the pilot program will
enable the Commission to obtain sufficient data on which to base a
permanent program. In this regard, at the conclusion of the pilot
program, the Commission intends to evaluate section 4(c) contract
market transactions exempted by this Part in order to determine whether
to extend the exemptive relief granted herein, and whether it would be
appropriate to alter the requirements of this Part or expand the
exemptive relief provided to other transactions or markets. The
Commission requests comment specifically addressed to whether a pilot
program is feasible and appropriate.
Proposed Sec. 36.1(b) sets forth the scope of the exemption. It
states that each board of trade on which section 4(c) contract market
transactions are traded is deemed to be a contract market and must
comply with all provisions of the Act and Commission regulations,
including the requirement of a clearing facility subject to Commission
oversight,20 except for those provisions which are ``specifically
inconsistent'' with Part 36. Moreover, new markets that seek to use
this exemption must submit all rules relative to governance,
disciplinary proceedings, financial requirements, et cetera, under the
current provisions of Section 5a(a)(12) of the Act, 7 U.S.C. 7a(12).
Therefore, the Commission intends that section 4(c) contract market
transactions trade pursuant to the following provisions: 36.3 (trading
rules), 36.4 (listing of transactions), 36.5 (reporting requirements),
36.6 (registration requirements), 36.7 (risk disclosure), and 36.9
(fraud and manipulation). Except where specifically indicated in Part
36, the provisions of Part 36 govern in lieu of the provisions of the
Act and Commission regulations that would otherwise apply to futures
and option transactions. Thus, these provisions of Part 36, explained
in detail below, constitute the scope of the exemption for section 4(c)
contract market transactions; all other provisions of the Act and
Commission rules, including, among other things, segregation, net
capital, supervision, bankruptcy, exchange emergency actions,
availability of reparations, and private rights of action, would
continue to apply. In any submission under proposed Part 36, a contract
market should specify those provisions of the Act and Commission rules
which the contract market deems to be specifically inconsistent with
the contract market rules being submitted. The Commission requests
comments concerning the scope of the exemption.
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\2\01.41(a)(3), 17 CFR 1.41(a)(3) (1994). The term ``contract
market'' includes a clearing organization that clears trades for the
contract market. The Commission does not intend to alter this aspect
of the markets it regulates by virtue of this proposal.
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In proposed Sec. 36.1(b), the Commission does not intend to limit
contract markets in section 4(c) contract market transactions to
current contract markets or exchanges. In order to qualify, such an
entity would be treated similarly to a board of trade seeking an
initial designation as a contract market. In addition, under the
structure of the Act, the Commission's regulations, and this exemption,
any entity wishing to offer a facility for trading section 4(c)
contract market transactions would be required to become a contract
market in these transactions.
B. Appropriate Persons
In considering the persons that may enter into section 4(c)
contract market transactions, that is, ``eligible participants,'' the
Commission is proposing to use a list of ``appropriate persons''
modeled on the list set forth in Section 4(c)(3) (A) through (J) of the
Act, 7 U.S.C. 6(c)(3) (A) through (J), with revisions tailored to this
particular market and reflecting the Commission's experience in
applying similar concepts in other exemptions. In this regard, the
Commission is requesting comment whether these proposed requirements
should be applied to the Commission's previously-granted exemptions as
well.
Of note is that under proposed Sec. 36.1(c)(1), all eligible
participants may enter into section 4(c) contract market transactions
for their own accounts; in addition, futures commission merchants
(``FCMs'') and floor brokers may trade section 4(c) contract market
transactions on behalf of other eligible participants. In addition,
under proposed Sec. 36.1(c)(2)(vii), the Commission is intending to
limit eligible employee benefit plans to those with total assets
exceeding $5 million and (rather than the ``or'' provided in Section
4(c)(3)(G) of the Act, 7 U.S.C. 6(c)(3)(G)) whose investment decisions
are made by a bank, trust company, insurance company, investment
adviser under the Investment Advisers Act of 1940, or a commodity
trading advisor under the CEA. In this regard, the Commission
specifically seeks comment concerning whether there is an asset level
for such employee benefit plans which should qualify them as an
eligible participant irrespective of whether their investment decisions
are made by a bank, trust company, insurance company, investment
adviser or commodity trading advisor. In addition, in the context of
proposed Sec. 36.1(c)(2)(viii), the Commission seeks comment on whether
municipalities should be included as ``eligible participants,'' and, if
so, what, if any, limitations would be appropriate in this context.
Finally, the Commission is interested in comments addressing whether
the list of appropriate persons as proposed would exclude any
individuals, entities, collective investment vehicles or others who
should be considered suitable to engage in section 4(c) contract market
transactions, and in particular whether Part 36 should be conformed to
Part 35 in this regard.
Section 4(c)(3)(K) of the Act, 7 U.S.C. 6(c)(3)(K), also authorizes
the Commission to determine other persons to be ``appropriate persons''
for section 4(c) contract market transactions in light of their
financial or other qualifications, or if appropriate regulatory
protections are applicable. The Commission is therefore proposing under
Sec. 36.1(c)(2)(xi) to permit persons, including natural persons, to
enter into section 4(c) contract market transactions provided their
total assets exceed $10 million. The Commission requests comments
specifically addressed to whether these thresholds are appropriate and
whether any additional or different financial criteria (such as net
worth standards) should be added to any other category of ``eligible
participants'' and, if so, whether part 36 should be conformed to part
35.
The Commission is proposing, in Rule 36.1(c)(2)(x), to include
floor brokers and floor traders within the class of ``appropriate
persons'' that may participate in section 4(c) contract market
transactions. Furthermore, proposed Rule 36.1(c)(1) would permit floor
brokers to enter into section 4(c) contract market transactions on
behalf of other eligible participants. The Commission is not proposing
separate financial standards for eligible floor brokers and floor
traders at this time based upon its understanding that each such
participant would, by necessity, be a member in good standing of the
section 4(c) contract market whose transactions thereon would be
guaranteed by an exchange clearing member. The Commission seeks comment
on whether it should make a requirement of a clearing member guarantee
explicit in the rule and whether it should impose separate financial
requirements on floor brokers and floor traders.
C. Transactions Eligible to Trade
Proposed Sec. 36.2 establishes the breadth of the exemption,
delineating those transactions eligible to trade as section 4(c)
contract market transactions. In that sense, proposed Sec. 36.2
modifies the broad definition of section 4(c) contract market
transactions set forth in proposed Sec. 36.1(c)(1). Proposed
Sec. 36.2(a)(1) provides that except for a major foreign currency, the
transaction must be settled either in cash, at a price that meets the
existing Commission requirements for cash-settled contracts set forth
in Guideline No. 1, 17 CFR part 5, Appendix A, ``or by means other than
the transfer or receipt of any commodity.'' The phrase ``or by means
other than the transfer or receipt of any commodity'' would permit the
delivery of a subsequent contractual agreement, such as a subsequent
position in a swaps agreement.
Proposed Sec. 36.2(a)(2) states that the transaction must be
cleared through a clearing organization subject to Commission
oversight, a provision originally part of the CME and CBOT's petition
for exemptive relief. The rules of clearing organizations subject to
Commission oversight as adjuncts to contract markets must be submitted
to the Commission pursuant to section 5a(a)(12) of the Act, 7 U.S.C.
7a(12).21 Additionally, as the result of section 4d(2) of the Act,
7 U.S.C. 6d(2), such organizations must settle accounts or positions
daily. The rules would require section 4(c) contract market
transactions to be separately identified on the books of the
participant in clearing records to facilitate surveillance of these
transactions.
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\2\1See Board of Trade Clearing Corporation, et al. v. United
States of America, et al., [1977-1980 Transfer Binder] Comm. Fut. L.
Rep. (CCH) 20,534 (D.D.C. Jan. 11, 1978).
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Proposed Sec. 36.2(a)(3) prohibits section 4(c) contract market
transactions on the agricultural commodities enumerated in section 1a
of the Act, except for contracts on a broad-based index thereof. In
this regard, the Commission notes that it did not provide specifically
for an exemption from Commission rules concerning speculative position
limits. Under Rule 150.2, 17 CFR 150.2 (1994), the Commission directly
administers position limits for futures contracts on those agricultural
commodities. Commission Rule 1.61, 17 CFR 1.61 (1994), requires
contract markets to adopt speculative position limits for futures and
option contracts which do not have Commission-set speculative limits.
While in theory Rule 1.61 would apply to section 4(c) contract market
transactions, the exemption from that requirement, 1.61(e), 17 CFR
1.61(e) (1994), has been interpreted flexibly to permit the exchanges
to substitute for speculative position limits various position
accountability rules for certain futures and option contracts.22
Therefore, the exchanges have already been afforded substantial
flexibility in this area. In addition, additional flexibility in this
regard would be afforded by proposed Rule 36.3 which should permit
exempt contract markets to implement trading rules more expeditiously
and without formal approval by the Commission. The Commission requests
comment on whether any further relief is appropriate for section 4(c)
contract market transactions.
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\2\2See 57 FR 29064 (June 30, 1992).
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In Sec. 36.2(a)(4), the Commission is proposing to limit section
4(c) contract market transactions to those transactions which can
``reasonably be distinguished'' from futures or option contracts
designated by the Commission for trading on a traditional contract
market at the time of application to trade a section 4(c) contract
market transaction. The distinguishing factors are described in
relation to the contract's hedging function and/or pricing basis. The
Commission will base determinations as to whether section 4(c) contract
market transactions are ``reasonably distinguished'' from traditional
designated futures and option contracts on the same considerations that
it now applies in deciding whether proposed new futures and options
contracts shall be treated as separate designation applications.
Proposed Sec. 36.2(a)(4) is intended to address, among other things,
the concerns expressed by some commenters regarding the problems of a
two-tier marketplace. Although the CME and CBOT have indicated that
they do not intend to trade the same contract on both a section 4(c)
contract market and a traditional contract market, this provision would
prevent a section 4(c) contract market transaction from trading if a
traditional contract were already trading on any existing contract
market. A section 4(c) contract market transaction could potentially be
submitted for designation for traditional trading. If so, the full
5a(a)(12) process, including publication for comment, would be followed
and further attention directed to whether delisting as a section 4(c)
contract market transaction would be required. As a consequence, the
concern of side-by-side trading of identical contracts subject to
different trading regimes without further review is addressed by this
proposal. General disclosure obligations nonetheless would require
purveyors of section 4(c) contract market transactions to clarify that
different rules are applicable to those transactions than for
transactions traded pursuant to traditional requirements.
Under proposed Sec. 36.2(a)(4), the Commission contemplates that a
broad array of contracts would be eligible for section 4(c) contract
market transactions. Thus, the following are examples of potentially
permissible section 4(c) contract market transactions in that they are
cash-settled and can reasonably be distinguished from currently
designated futures and options contracts: (1) Newly-issued 30-year U.S.
Treasury bonds, which are cash-settled based on either cash transaction
prices or firm quotes obtained from electronic information vendors; (2)
six-month London interbank offered rates (LIBOR), which are cash-
settled based on a survey of British Bankers Association rates; and (3)
two-year interest rate swaps, which are cash-settled based on a survey
of swap dealers to obtain the rates they are willing to pay or to
receive for fixed-rate payments on generic two-year swaps, given a
specified notional amount.23
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\2\3The Commission notes that while these specific, hypothetical
contracts can reasonably be distinguished from currently designated
futures and option contracts and therefore permitted to trade under
these proposed rules, that may not necessarily be true at the time a
board of trade applies to trade a specific section 4(c) contract
market transaction.
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In addition, proposed Sec. 36.2(a)(4) provides for certain specific
contracts to be eligible section 4(c) contract market transactions.
First, flexible commodity options, which trade under contract market
option rules, but are not separately designated, may trade as section
4(c) contract market transactions.24 In addition, contracts in
foreign currency known as Rolling SpotTM Contracts, the subject of
the CME's petition for exemptive relief, as well as five- and ten-year
interest rate swaps contracts, and foreign currency forward futures
contracts and options thereon are specifically eligible to trade as
section 4(c) contract market transactions.25
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\2\4Under the proposal, when such options become regular
options, they would no longer qualify to trade as section 4(c)
contract market transactions, and the full panoply of the
Commission's regulatory requirements would apply.
\2\5Eligible swaps contracts include the contract markets of the
CBOT which the Commission designated in cash-settled three- and
five-year interest rate SWAP (IR-SWAP) futures contracts on January
29, 1991. Options based on those futures contracts were approved by
the Commission on February 26, 1991. On September 4, 1992, the
Commission approved amendments submitted by the CBOT to convert the
three-year IR-SWAP contracts to 10-year IR-SWAP contracts.
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Finally, proposed Sec. 36.2(a)(5) provides that any transaction
subject to Section 2(a)(1)(B) of the Act, 7 U.S.C. 2, including stock
index futures contracts, is not within the scope of the exemptive
rules. Because of special considerations applicable to such
transactions, including the approval procedures of Section 2(a)(1)(B),
the Commission believes that such contracts may not be appropriate for
exemption under the proposed rules.
The Commission requests comment on whether the proposed
restrictions on section 4(c) contract market transactions are
appropriate.
D. Section 4(c) Contract Market Trading Rules
Proposed Section 36.3, which permits a board of trade to submit for
Commission approval trading procedures for section 4(c) contract market
transactions, is intended to facilitate trading in section 4(c)
contract market transactions which do not comply in all respects with
certain Commission regulations setting forth trading standards and
related recordkeeping requirements for an open outcry double auction
trading environment. In general, Section 36.3 is intended to permit,
subject to certain conditions, section 4(c) contract market
transactions to trade pursuant to innovative trading strategies which
may not satisfy existing competitive trading requirements and other
trading standards relative to the exposure of orders and trades. In
proposing Sec. 36.3 the Commission intends to provide the flexibility
for transactions in a section 4(c) contract market to occur either on
the exchange floor, off the floor, or in both locales subject to
immediate post-trade reporting and clearing requirements. The
Commission regulations for which exchange alternatives could be
submitted include Regulations 1.35, 1.38(a), 1.39, 155.2, 155.3, and
155.4, 17 CFR 1.35, 1.38(a), 1.39, 155.2, 155.3 and 155.4 (1994).
Proposed Section 36.3 represents a substantial change in the
assumptions underlying the method of trading futures and options
contracts. Section 4c(a) of the Act, 7 U.S.C. 6c(a), enumerates certain
trading practices which are prohibited, namely, wash sales, cross
trades, accommodation trades, and fictitious sales.26 The
Commission has viewed the ``common denominator'' of the abuses
prohibited by Section 4c(a) of the Act, 7 U.S.C. 6c(a), as the ``use of
trading techniques that give the appearance of submitting trades to the
open market'' while in reality ``negating the risk or price competition
incident to such a market.''27 Commission Regulation 1.38
explicitly requires open and competitive execution.28 The primary
purpose of Rule 1.38 was summarized as follows in a Senate Report
issued in connection with the Commodity Futures Trading Commission Act
of 1974:
\2\6Section 4c(a) of the Act, 7 U.S.C. 6c(a), provides that:
(a) It shall be unlawful for any person to offer to enter into,
enter into or confirm the execution of, any transaction involving
any commodity * * *
(A) if such transaction is, is of the character of, or is
commonly known to the trade as, a ``wash sale'', ``cross trade'', or
``accommodation trade'', or is a fictitious sale; or
(B) if such transaction is used to cause any price to be
reported, registered, or recorded which is not a true and bona fide
price.
\2\7In re Collins, [1986-1987 Transfer Binder] Comm. Fut. L.
Rep. (CCH) 22,982 at 31,902 (CFTC Apr. 4, 1986), reversed on other
grounds sub nom. Stoller v. Commodity Futures Trading Commission,
834 F.2d 262 (2d Cir. 1987). See also, e.g., In re Bear Stearns &
Co., [1990-1992 Transfer Binder] Comm. Fut. L. Rep. (CCH) 24,994
(CFTC Jan. 25, 1991); In re Gimbel, [1987-1990 Transfer Binder]
Comm. Fut. L. Rep. (CCH) 24,213 (CFTC Apr. 14, 1988).
\2\8Rule 1.38, 17 CFR 1.38 (1994), provides:
All purchases and sales of any commodity for future delivery,
and of any commodity option, on or subject to the rules of a
contract market shall be executed openly and competitively by open
outcry or posting of bids and offers or by other equally open and
competitive methods, in the trading pit or ring or similar place
provided by the contract market, during the regular hours prescribed
by the contract market * * *
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The purpose of this requirement [Regulation 1.38] is to ensure
that all trades are executed at competitive prices and that all
trades are focused into the centralized marketplace to participate
in the competitive determination of the price of futures contracts.
This system also provides reasonable access to the market for all
orders and results in a continuous flow of price information to the
public.29
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\2\9Report of the Senate Committee on Agriculture and Forestry,
S. Rep. 93-1131, 93d Cong., 2d Sess. 16 (1974).
Thus, a long-standing fundamental premise of the Commission's
regulatory scheme has been that trades must be executed competitively.
The Commission has shown some flexibility in the methods it has
permitted to implement this competitive execution requirement.
Historically, execution of orders in the futures industry has been
conducted by open outcry on the floor of an exchange. The Commission
has indicated, however, that other methods are acceptable under the
Act. In this regard, in 1989, the Commission approved trading on
GLOBEX, an electronic computerized trading system for trading futures
and options contracts after regular hours. Under GLOBEX, trading is
generally conducted on computer terminals through a competitive auction
process pursuant to an algorithm, under which orders at the best prices
would be executed first. Each terminal provides an equal opportunity
for obtaining order execution.30 Despite the fact that trading in
GLOBEX is not conducted on the floor of the exchange, the Commission
has viewed this order execution procedure as competitive and consistent
with the Act and regulations.31
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\3\0See, e.g., CME's Proposed Amendments Relating to the
Implementation of the GLOBEX System, 53 FR 25528 (July 7, 1988).
\3\1See also, the rules applicable to the NYMEX ACCESS System,
and the CBOT's Project A, which have been approved by the
Commission.
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Notwithstanding the fact that the Commission has afforded market
participants some flexibility in this area, until recently the
Commission has not permitted any procedures that provide for off-floor
discussion of trades.32 In 1991, however, the Commission amended
Rule 1.39 to permit large order execution (``LOX'') procedures and the
crossing of orders, procedures which contemplate some off-floor
discussion prior to executing the orders in the pit.33 In the
Federal Register release approving LOX, the Commission emphasized that
although off-floor discussions are permitted in LOX transactions, LOX
procedures nonetheless ultimately ``allow participation by the entire
pit'' when the trade is executed.34 The Commission further noted
that ``LOX transactions would be conducted only pursuant to exchange
rules approved by the CFTC, and enforced through a contract market
surveillance program, including measures specifically tailored to LOX
procedures, designed to ensure compliance with the Commodity Exchange
Act.''35 Accordingly, the Commission determined that LOX could be
consistent with the Act.36
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\3\2Although prearranged trading is not expressly prohibited by
the CEA, the Commission has held it to be a form of anticompetitive
trading in violation of Regulation 1.38 as well as a form of
fictitious sale under Section 4c(a) of the Act. See Collins, 22,982
at 31,903; Gimbel, 24,213 at 35,003.
\3\3See 56 FR 12336 (March 25, 1991).
\3\456 FR at 12341. In contrast, the Commission has held illegal
trading activities which do not provide real opportunities for the
entire pit to participate in the trades. See, e.g., In re Murphy and
Rudman, [1984-1986 Transfer Binder] Comm. Fut. L. Rep. (CCH) 22,798
(CFTC Sept. 25, 1985).
\3\556 FR at 12341.
\3\6The principal statutory basis for Regulation 1.39 is Section
4b(b) of the Act, 7 U.S.C. 6b (as amended 1992), which addresses
simultaneous buying and selling orders of different principals. The
provision states that such orders can be executed ``at the market
price,'' but requires that the orders be executed ``on the floor of
the exchange'' and ``at public outcry across the ring.'' The
Commission stated that the legislative history of this provision
indicates that its purpose was to ensure that one order was not
disadvantaged to the benefit of the other order or that both orders
were not disadvantaged to the benefit of the broker. According to
the Commission, since the statute did not prescribe the way in which
this was to be accomplished, the Commission had the discretion to
craft an appropriate method or methods ``to provide for the
protection of customers in this area,'' including the discretion to
amend Rule 1.39. 56 FR at 12338.
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Proposed Sec. 36.3 goes beyond LOX in that it not only allows off-
floor discussion prior to execution but also allows execution without
exposing the trades to the pit. In proposing a means of permitting
these procedures, it is the Commission's intention to provide a way for
exchanges to develop new trading procedures and standards intended to
address the needs of their increasingly institutional market
participants. The Commission did not attempt to describe whether there
should be other limits on the procedures as it had no specific
proposals to change pending methodologies before it and wanted to leave
the exchanges free to develop designs consistent with the parameters
set forth herein.37 This also reflects the Commission's
willingness to experiment through a pilot program with rules that
relax, for certain market participants, the traditional Commission
requirements for competitive trading. Specifically, the approach taken
affords those participants the opportunity to execute large
transactions with greater immediacy than might be available under
existing contract market trading procedures. The Commission
preliminarily believes that by permitting section 4(c) contract market
participants to trade in this manner, the futures exchanges' ability to
draw institutional participants to the more transparent exchange (as
opposed to OTC) markets will be enhanced.
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\3\7Compare, however, New York Stock Exchange (``NYSE'') Rule
76, which governs block trading and requires that a member who has
set up a block trade and is bringing it to the floor to be crossed
must first announce the proposed bid, offer, and transaction size to
the floor. The member must then wait a reasonable amount of time to
allow the ``crowd'' (including specialists) to trade against either
side before completing the transaction. See also NYSE Rule 72, which
provides priority to an agency cross transaction where both orders
consist of 25,000 shares or more.
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At the same time, however, the Commission is concerned with
maintaining essential market and appropriate customer protections.
Therefore, it is proposing regulatory safeguards with which the
exchanges must comply in formulating any innovative trading procedures.
Proposed Sec. 36.3(b) lists those requirements which must be satisfied
by a contract market seeking to establish such rules for section 4(c)
contract market transactions. In this connection, the Commission
requests comment as to whether additional or different requirements
should apply.
First, transactions generally must satisfy Commission recordkeeping
and audit trail requirements. Proposed paragraph (b)(1) of Rule 36.3
requires the contract market to provide for record maintenance and
retention consistent with Regulation 1.31, 17 CFR 1.31 (1994). Under
proposed Sec. 36.3(b)(2), the audit trail for such transactions must
meet the trade register, trade timing, and contract market oversight
requirements in Regulations 1.35(e), (g), and (i), 17 CFR 1.35(e), (g),
and (i) (1994), respectively. In addition, the recordkeeping
requirements set forth in Regulation 1.38(b), 17 CFR 1.38(b) (1994),
for noncompetitive trades and the audit trail documentation required
under the other provisions of Regulation 1.35, 17 CFR 1.35 (1994), must
be satisfied to the extent they are applicable to the subject trading
procedures.38 A contract market must demonstrate in a clear and
convincing manner that these and any other regulations referenced in
paragraph (b) that it believes are inapplicable to its proposed trading
procedures are, in fact, inapplicable.
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\3\8For example, Regulation 1.35, 17 CFR 1.35 (1994), provides
for two orders, an office order (1.35(a-1)(1)) and a floor order
(1.35(a-1)(2)(i)). A contract market's proposed procedures may
render the requirement for a floor order inapplicable.
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Second, the Commission is proposing to maintain customer protection
standards. Commission Regulations 155.2, 155.3, and 155.4, 17 CFR
155.2, 155.3 and 155.4 (1994), set forth customer protection trading
standards for floor brokers, FCMs, and introducing brokers (``IBs'')
respectively. Under proposed Sec. 36.3(b)(3), the contract market's
proposed procedures must comply with these provisions to the extent
they are applicable.39
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\3\9For example, Regulation 155.2, 17 CFR 155.2 (1994), sets
forth standards for floor brokers. If, however, under proposed
section 4(c) contract market trading rules, a function analogous to
that of a floor broker does not exist, that rule would not apply.
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Third, the transactions must be transparent. The Commission is
proposing in paragraphs (b)(4) and (b)(5) of Rule 36.3 certain
requirements for the reporting and identifying of section 4(c) market
transactions after they are executed. Specifically, in addition to the
trade recordation requirements listed above, the transactions are to be
reported immediately to the floor of the exchange and are to be
disseminated immediately on the relevant market floor, trading screen,
and/or vendor services through the exchange's market quotation system.
Records must be maintained of the time of execution to this end.40
The information to be so reported must include, at a minimum, price,
quantity, and contract. To the extent that a proposal for section 4(c)
contract market transactions might provide for trading when the
exchange floor is closed, the Commission would still require the
immediate report and dissemination of that transaction information.
Brokers engaging in such transactions will need to have supervisory
procedures in place reasonably designed to achieve such post-trade
transparency. The Commission believes that these proposed requirements
to report and specifically identify section 4(c) contract market
transactions will provide the public with notice of the way in which
the prices in this market have been reached. As such, persons relying
on these prices for price basing purposes will have the opportunity to
take that information into account. The Commission requests comment on
these requirements.
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\4\0To the extent applicable, all Regulation 1.35 audit trail
requirements will apply to the production of upstairs trading
records.
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Fourth, the Commission is proposing requirements intended to ensure
the financial integrity of the transactions. Proposed paragraph (b)(5)
of Rule 36.3 requires section 4(c) contract market trading rules to
provide that section 4(c) contract market transactions be reported to
clearing and be cleared by the contract market on the same schedule as
required for trades subject to Regulations 1.38 and 1.39. Should there
be no such schedule, then the report to clearing must be immediate. The
Commission requests comment as to whether clearing procedures should be
further articulated in that case. In this connection, the Commission
notes that the clearing arrangements would be subject to Commission
oversight and that proposed clearing rules would require prior
Commission review under Section 5a(a)(12)(A) of the Act, 7 U.S.C.
7a(12), and Regulation 1.41, 17 CFR 1.41 (1994). The section 4(c)
contract market clearing organization would have an affirmative duty
under the Act and Commission regulations to enforce its rules, and
would be subject to recordkeeping, document retention, and other
applicable requirements.
According to NYSE market surveillance staff, block trades are not
separately identified as such on the exchange's audit trail/time and
sales register. However, NYSE would be able to ascertain whether a
trade is a block trade by contacting the transacting members, each of
whom must keep a record reflecting which of its trades are blocks.
Interestingly, while not separately identifying block trades in its
audit trail, NYSE and its vendors do have a separate ``block trade''
ticker which runs throughout the day reflecting size and price of block
trades alone. The Commission requests comment on whether to require the
dissemination of separate pricing information for block trades.
Pursuant to proposed paragraph (c), any submission made hereunder
for proposed section 4(c) contract market transactions must describe
fully the contract market procedures and systems that will assure
compliance with Sections 4b and 4c(a) of the Act, 7 U.S.C. 6b and
6c(a), with respect to prohibitions on abuse of customer orders,
including frontrunning of such orders, misuse of information, and wash
sales and fictitious trades. This provision reflects, among other
things, the Commission's continuing concern that customer orders
receive appropriate priority and that trading between markets or
locations does not cause distortions in prices or provide advantages to
one class or user of the markets over others.
In this connection, proposed paragraph (g) of Rule 36.3 states that
trades entered into in compliance with section 4(c) contract market
trading rules shall not be in violation of Sections 4b(a)(iv), 4b(b) or
4c(a) of the Act, 7 U.S.C. 6b(D), 6b or 6c(a), ``based solely on having
been executed noncompetitively.'' Failure to comply explicitly with
such contract market rules will render the conduct involved subject to
Commission action under Sections 4b and 4c(a) of the Act, 7 U.S.C. 6b
and 6c(a), and Regulations 1.38 and 1.39, 17 CFR 1.38 and 1.39 (1994),
in addition to any other applicable provisions of the Act and
Regulations.
Pursuant to proposed paragraphs (d) and (e) of Rule 36.3, section
4(c) contract market trading rules must be submitted to the Commission
for review prior to being put into effect.41 Such submitted rules
may become effective ten days after receipt by the Commission unless
the Commission, within that ten-day period, notifies the submitter that
the proposal does not meet the conditions of this section. In the event
the trading rules are not permitted to go into effect, they shall be
subject to the usual rule approval procedures under Section
5a(a)(12)(A) of the Act, 7 U.S.C. 7a(12), and Regulation 1.41(b), 17
CFR 1.41(b) (1994). In accordance with paragraph (f) of Rule 36.3, any
subsequent proposed modifications of such rules shall be subject to the
same Commission review procedures.
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\4\1Section 4(c) contract market trading rules may be submitted
prior to trading of section 4(c) contract market transactions or at
any time after the transactions begin trading under Commission
regulations.
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E. Listing of Section 4(c) Contract Market Transactions
Proposed Sec. 36.4 provides that a board of trade which meets other
requirements of the Act seeking an exemption for section 4(c) contract
market transactions shall furnish to the Commission the terms and
conditions of the transaction at least ten days prior to the proposed
effective date.42 Section 4(c) contract market transactions
meeting the requirements of Sec. 36.2 may be traded or executed ten
days after receipt of the submission unless, within the ten-day period,
the Commission notifies the board of trade in writing that the
submission does not meet the conditions of this section.43 In that
event, the terms and conditions of the transaction shall be subject to
the usual rule approval procedures under Section 5a(a)(12)(A) of the
Act, 7 U.S.C. 7a(12), and Regulation 1.41(b), 17 CFR 1.41(b) (1994).
The proposed rule further provides that any modification to the terms
and conditions of a section 4(c) contract market transaction shall be
submitted to the Commission. Such modification shall be subject to the
same procedures applicable to the initial listing of section 4(c)
contract market transactions.
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\4\2As noted above, a board of trade which is not currently an
exchange must first get initial designation as a contract market
pursuant to Sections 5 and 5a of the Act (other than Section
5a(a)(12), which sets forth the procedures for Commission approval
of terms and conditions of contracts and contract market rules). An
initial designation generally requires the Commission to review and
approve the applicant's core rules regarding, among other things,
clearing, governance, and discipline.
\4\3Section 2(a)(8)(B)(ii) of the Act, 7 U.S.C. 4a(g), allows
forty-five days for the Department of the Treasury and the Board of
Governors of the Federal Reserve System to comment on any
application by a board of trade for designation as a contract market
involving transactions for the future delivery of any security
issued or guaranteed by the United States or any agency thereof. In
light of the ten-day time frame for new filings and amendments, the
Commission intends to waive Section 2(a)(8)(B)(ii) for section 4(c)
contract market transactions. The Commission requests comment on
waiving this provision.
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This limited, ten-day advance notice period for new filings and for
amendments to existing terms and conditions is designed to remove
potential impediments to the development of new products which are
eligible for the proposed section 4(c) contract market transactions.
The Commission believes that a streamlined approach will not only give
the exchanges flexibility but also will permit them to launch new
products rapidly to meet the competitive demands of the marketplace and
to take advantage of opportunities in a fast-changing market. This
procedure is limited to certain cash-settled contracts in order to
avoid issues related to delivery.
Although the proposed ten-day notification requirement for section
4(c) contract market transactions does not contemplate the same level
of prior Commission review and approval of terms and conditions as is
required by Commission Rule 1.41(b), 17 CFR 1.41(b) (1994), for
contracts traded on traditional contract markets, the Commission has
continuing authority to ensure that section 4(c) contract market
transactions remain consistent with the public interest and the
purposes of the Act. In this regard, proposed Sec. 36.8 provides that
the Commission can suspend or revoke an exemption if it fails to meet
these requirements.44
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\4\4Furthermore, under Rule 1.50, 17 CFR 1.50 (1994), at any
time the Commission can request from a contract market demonstration
of continued compliance with the requirements of contract market
designation. In addition, the Commission retains its authority under
Section 8a(7) of the Act, 7 U.S.C. 12a(7), to alter or supplement
contract market rules.
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The Commission requests comment on the ten-day advance notification
period for the terms and conditions of section 4(c) contract market
transactions.
F. Reporting Requirements
The Commission is proposing that contract markets, FCMs, and large
traders who conduct section 4(c) contract market transactions comply
with certain reporting requirements similar to those currently in
effect for persons trading in non-exempt commodity futures and/or
options. These requirements are being proposed in lieu of the
requirements set forth in Parts 16, 17, 18, and 19 of the Commission
regulations, 17 CFR Parts 16, 17, 18, and 19 (1994).
1. Reporting Requirements for Contract Markets
The Commission is proposing in Secs. 36.5 (c)(1) and (e) that
contract markets operating pursuant to this section provide information
daily to the Commission and to the public concerning total open
interest, transactions, and prices for each commodity or type of
contract similar to that required under Rule 16.01 for non-exempt
futures and options. This information is intended to give the
Commission an overview of the size and development of these markets and
provide potential participants with important information concerning
the depth and breadth of the markets as well as the opportunity to
compare transaction prices against other markets trading the same
commodity. In addition, in Sec. 36.5(c)(2), the Commission is proposing
that contract markets provide open interest and transaction information
for each clearing member similar to that required under Rule 16.00, 17
CFR 16.00 (1994). This information is necessary for market
surveillance, providing needed input into the Commission's financial
monitoring system for clearing member FCMs.
Last, in Sec. 36.5(c)(3), the Commission is proposing that contract
markets supply information concerning large traders conducting section
4(c) contract market transactions, but only on call by the Commission.
In order to ensure that the financial integrity protections currently
provided by using such reports are maintained, the Commission
anticipates that contract markets trading section 4(c) contract market
transactions will by rule require members to file daily reports
concerning accounts carried by large traders similar to the information
now provided by FCMs, clearing members, and foreign brokers under Rules
16.02, 17.00, and 17.02, 17 CFR 16.02, 17.00, and 17.02 (1994), for
large traders in non-exempt futures and options. The Commission will
rely on contract markets to define, subject to Commission approval,
position levels at which a trader is considered large. Under this
proposal, the Commission would monitor the development of the markets
to determine if and when it would require that the contract markets
submit large trader reports. If these exempt contract markets develop
rapidly, the Commission may require large trader reports on a daily
basis to augment the information it currently receives.
The Commission is proposing that all information, with the
exception of account identification forms, be provided in machine-
readable form using a format and coding structure approved in writing
by the Commission or its designee. Contract markets currently provide
option and futures data pursuant to similar requirements.
2. Reporting Requirements for FCMs, Introducing Brokers and Traders
The Commission is proposing to incorporate into Sec. 36.5 the
provisions of Commission Rules 15.05 and Part 21, 17 CFR 15.05 and Part
21 (1994). Section 15.05 states that any FCM who makes or causes to be
made any futures or option contract for the account of any foreign
broker or foreign trader, and any IB who introduces such an account to
an FCM is deemed to be the agent of the foreign broker 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 or the foreign trader with respect to any futures or option
contracts maintained in such accounts carried by the FCM.45 This
provision is used routinely for traditional futures and options, and
has proven to be effective in obtaining information from foreign
traders for market surveillance purposes.
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\4\5The FCM or IB is considered an agent only if the foreign
broker or trader has not duly executed or does not maintain a
written agency agreement with a person domiciled in the United
States. 17 CFR 15.05(d) (1994).
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The provisions of Part 21 provide that FCMs, IBs, foreign brokers,
and foreign traders must furnish on call by the Commission certain
information concerning their futures and options trading. Special calls
under Part 21 may be made to obtain market-wide summary information on
demographics and market uses of participants (Secs. 21.02 and 21.02a,
17 CFR 21.02 and 21.02a (1994)) or, in the case of special market
situations (Sec. 21.03, 17 CFR 21.03 (1994)), when information is
needed about all, rather than only reportable, traders in a market. The
Commission believes that it is important to retain this authority with
respect to participants operating under Part 36 so that the Commission
can make informed decisions and take appropriate action as special
situations warrant.
The Commission is also proposing that eligible participants in
section 4(c) contract market transactions be subject to requirements
similar to those contained in Secs. 18.00, 18.04, and 18.05, 17 CFR
18.00, 18.04, and 18.05 (1994), for large futures and options traders
trading in the non-exempt market. The requirements proposed in
Sec. 36.5(f) paragraphs (2) (i) and (ii) would require large traders to
file, on call by the Commission, information concerning their positions
and transactions in the subject market as well as identifying and other
information contained on CFTC Form 40. Proposed Sec. 36.5(f)(1) would
require large traders to maintain books and records concerning section
4(c) contract market transactions and commercial activities that the
trader hedges in the commodity underlying such transactions. Reports
concerning these transactions and activities would have to be furnished
on request to the Commission or the U.S. Department of Justice.
G. Special Temporary License, Registration or Principal Listing
Procedures
The Commission is also proposing, in Sec. 36.6, to allow special
procedures that would be available to a person associated with an FCM
or IB who limits his or her activities to certain specified
instruments. If this rule were to be adopted, the Commission would
expect to set forth in an Appendix A to Part 36 those instruments to
which the special registration procedures would apply. An instrument
would be included in such an Appendix A only upon petition by a
contract market demonstrating that it is not contrary to the purpose of
the Act and the registration rules promulgated thereunder or to the
public interest to permit special temporary license, registration or
principal listing procedures for persons licensed with another federal
financial regulatory authority and involved only with that instrument.
Although to obtain a temporary license, such persons would have to
certify that they are not subject to statutory disqualification under
Section 8a(2) of the Act, 7 U.S.C. 12a(2), the National Futures
Association (``NFA'') could, for example, waive the fingerprint
requirement. Further, the Commission notes that although proficiency
testing requirements are governed by NFA Rules 401 and 402 and
interpretive notices related thereto, such a contract market petition
could also address whether alternative proficiency testing requirements
would be appropriate. Registration, of course, could continue to be
denied under Sections 8a(3) or 8a(4) of the Act, 7 U.S.C. 12a(3) or
12a(4). If the Commission were to approve the contract market petition,
NFA could then adopt and submit for Commission approval special
registration procedures to govern those persons involved only with the
particular instrument that is the subject of the petition. The
Commission, nonetheless, wishes to make clear that a contract market
seeking special registration procedures with respect to persons
limiting their activities to a particular new instrument may consult
with NFA and develop such procedures to be submitted in conjunction
with the contract market application for simultaneous consideration by
the Commission. Such NFA rules could vary depending upon the instrument
involved and would be considered by the Commission on a case-by-case
basis. The Commission would expect to include in Appendix A to Part 36
those instruments covered by the pending petitions of the CBOT and the
CME to which Part 36 applies. This authority would be comparable to
that already established under Part 3 of the Commission's regulations.
See Commission Rule 3.12(j), 17 CFR 3.12(j) (1994). The Commission
requests comment on these special registration procedures, in
particular their practicability.
H. Risk Disclosure
The Commission is proposing, in Sec. 36.7, to permit accounts to be
opened for section 4(c) contract market transactions without furnishing
an eligible participant with the basic risk disclosure statements
applicable generally to non-exempt futures and option contracts under
Commission Rules 1.55, 1.65, 33.7, and 190.10, 17 CFR 1.55, 1.65, 33.7,
and 190.10 (1994), or the Commission's newly-adopted generic risk
disclosure statement.46 These basic risk disclosure statements are
intended to provide a brief description of some of the risks attendant
to futures and options trading and are designed to be understood by all
customers. Since section 4(c) contract market transactions would be
entered into only by sophisticated or high net worth persons or those
engaged in the futures industry, and since the products themselves may
be different from traditional futures and option contracts, the
Commission believes that it may be appropriate to substitute for
standard disclosure statements such disclosure as may be appropriate to
the customer's expertise and financial capacity, tailored to the
particular product. Therefore, in lieu of requiring a specific
statement or format, the proviso to proposed Sec. 36.7(a) would require
an FCM or, in the case of an introduced account, an IB, to furnish an
eligible participant with disclosure appropriate to the particular
instrument and the eligible participant prior to the eligible
participant's entry into the first section 4(c) contract market
transaction involving a particular instrument.
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\4\659 FR 34376 (July 5, 1994). This statement currently can be
used in the U.S., in the United Kingdom, in Ireland and in Belgium.
Several other jurisdictions are considering its adoption.
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In this regard, the Commission notes that Rule 1.55(f), 17 CFR
1.55(f) (1994), currently states that furnishing the required
disclosure statement under that rule does not relieve an FCM or IB from
any other disclosure obligation it may have under applicable
law.47 The Commission further notes that exchanges with non-
traditional trading systems have required, on their own initiative,
special risk disclosures applicable to such systems.48 The
Commission further notes that in order to qualify for the exemption of
swap agreements under Part 35 of its rules, an agreement must be
entered into by an eligible swap participant, the definition of which
is closely followed by proposed Rule 36.1(c)(2), and there are no
specific disclosure requirements under Part 35 of the Commission's
rules, 17 CFR Part 35 (1994).49 The Commission therefore
preliminarily believes that it is striking the appropriate balance in
proposed Rule 36.7 with respect to disclosure in light of the eligible
participants and products involved. The Commission requests comment
concerning the risk disclosure requirements for section 4(c) contract
market transactions.
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\4\7The Commission notes that proposed Sec. 36.7(b), which
provides that ``[t]his section does not relieve a futures commission
merchant or introducing broker from any other disclosure obligations
it may have under applicable law,'' is included as a reminder that
Section 4b of the Act requires all material information to be
disclosed. The fact that other proposed sections of Part 36 do not
have a similar ``catch-all'' provision should not be interpreted to
mean that the Act or Commission regulations do not apply to those
sections.
\4\8See CME Rule 577 and New York Mercantile Exchange Rule 6.22,
which address the risk disclosure requirements applicable to the
users of the GLOBEX and ACCESS electronic trading systems,
respectively. See also Commission Rules 4.7 and 4.8, 17 CFR 4.7 and
4.8 (1994), wherein the Commission has provided exemptions from
disclosure, reporting and recordkeeping requirements for CPOs
privately offering commodity pools to certain highly-accredited
investors and for CTAs providing commodity interest trading advice
to such persons.
\4\9See also Part 34 of the Commission's rules, 17 CFR Part 34
(1994), regarding regulation of hybrid instruments.
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I. Suspension or Revocation of Section 4(c) Contract Market Transaction
Exemption
Proposed Sec. 36.8 mirrors the requirements for exemptive relief
under Section 4(c) of the Act, namely that any exemption must be
consistent with the public interest and the purposes of the Act. If the
Commission determines otherwise, Sec. 36.8 provides that, after notice
and opportunity for a hearing, the exemption may be suspended or
revoked.
J. Fraud and Manipulation in Connection With Section 4(c) Market
Transactions
Proposed Sec. 36.9 applies to section 4(c) contract market
transactions the antifraud proscriptions of Sections 4b(a) and 4o of
the Act, 7 U.S.C. 6b and 6o, those provisions of Sections 6(c), 6(d),
and 9(a) of the Act, 7 U.S.C. 9, 15, 13b and 13(a), that prohibit price
manipulation, and Commission Rules 33.9 and 33.10, 17 CFR 33.9 and
33.10 (1994), which prohibit fraudulent conduct and price manipulation
in connection with commodity option transactions.
In its petition for exemption, the CBOT included a rule
specifically prohibiting fraud and manipulation relating to
professional market transactions. The CBOT petition explains:
Fraud and manipulation are the core proscriptions of the
Commodity Exchange Act* * *. Rather than engage in a hyper-technical
legal effort to mesh certain exempt transactions with the
requirements of the CEA's existing fraud and manipulation
provisions, the proposal contains a special antifraud and
antimanipulation provision. That approach will make certain that any
party committing fraud or engaging in manipulative practices in
connection with an otherwise exempt transaction * * * would not be
able to wriggle out of liability under the CEA under some legal
technicality.
58 FR 43414, 43433 (August 16, 1993). The CME did not suggest the
adoption of a specific fraud and manipulation rule; nonetheless, it did
not request an exemption from the antifraud and antimanipulation
provisions of the Act and Commission regulations.
In its consideration of the petitions and the comments received
thereon, the Commission is also considering whether to adopt specific
stand-alone rules prohibiting fraud and manipulation to supplement
proposed Sec. 36.9. In this regard and as noted above, the exemption
being proposed would relieve the exchanges and their members from some
provisions of the Act and regulations that are intended to provide
prophylactic protection for customers. In the absence of these
protections, it may be appropriate to apply broader antifraud and
antimanipulation prohibitions to effectively control certain abusive
conduct, such as trading ahead of customer orders in any form and
failure to disclose material information. As a result, the Commission
is proposing, in Sec. 36.9(a), a free-standing antifraud rule for
section 4(c) contract market transactions modeled after Commission Rule
33.10, 17 CFR 33.10 (1994). The Commission specifically requests
comments concerning whether it should adopt such a rule.
The Commission is also requesting comment concerning whether those
provisions of the Act and rules thereunder reserved in the manipulation
provision, Sec. 36.9(b), are adequate in this regard or whether the
Commission should also adopt an additional free-standing
antimanipulation rule. Should commenters believe that a free-standing
antimanipulation rule is warranted, comment is requested concerning
whether a rule prohibiting manipulation or attempted manipulation of
the price of any section 4(c) contract market transaction or of any
commodity in interstate commerce or any contract of sale of a commodity
for future delivery on or subject to the rules of any contract market,
would be appropriate.
In a related matter, the Commission is also seeking comment on
whether Part 35 of its rules, 17 CFR Part 35 (1994), which provides an
exemption for certain swap transactions, should be amended to include
specific stand-alone prohibitions of fraud and price manipulation like
those discussed above.\50\ While Section 4b of the Act has provided an
adequate tool to address fraud in traditional futures contract trading,
and Section 4o (which is also reserved in Part 35) addresses the giving
of advice, questions have been raised about the efficacy of these
provisions as applied to certain of the transactions included in the
ambit of Part 35. An amendment to Part 35 in this regard would
eliminate any such questions and could also provide desirable
consistency in the legal standards applicable to both section 4(c)
contract market transactions and exempt swap transactions. Comment is
requested concerning the type of antifraud and antimanipulation rules
that the Commission should adopt if it determines to do so.
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\50\Currently, Rule 35.2, 17 CFR 35.2 (1994), applies the
proscriptions of Sections 4b, 4o, 6(c), and 9(a)(2) of the Act, 7
U.S.C. 6b, 6o, 9, 15, and 13(a)(2), and Commission Rule 32.9, 17 CFR
32.9 (1994), to swap agreements.
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V. Related Matters
A. Regulatory Flexibility Act
The Regulatory Flexibility Act (``RFA''), Public Law No. 96-354, 94
Stat. 1164 (1980), 5 U.S.C. 601 et seq., requires each federal agency
to consider, in the course of proposing substantive rules, the effect
of those rules on small entities. A small entity is defined to include,
inter alia, a ``small business'' and a ``small organization.'' 5 U.S.C.
601(6).\51\ The Commission previously has formulated its own standards
of what constitutes a small business with respect to the types of
entities regulated by it. The Commission has determined that contract
markets,\52\ futures commission merchants,\53\ registered commodity
pool operators,\54\ and large traders\55\ should not be considered
small entities for purposes of the RFA.
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\5\1``Small organizations,'' as used in the RFA, means ``any
not-for-profit enterprise which is independently owned and operated
and is not dominant in its field * * *'' 5 U.S.C. 601(4). The RFA
does not incorporate the size standards of the Small Business
Administration (``SBA'') for small organizations. Agencies are
expressly authorized to establish their own definition of small
organization. Id.
\5\247 FR 18618 (April 30, 1982).
\5\3Id. at 18619.
\5\4Id.
\5\5Id. at 18620.
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The Commission believes that to the extent that firms defined as
small businesses under section 3 of the Small Business Act could offer
or be offered section 4(c) contract market transactions, the proposed
rules would not add any legal, accounting, consulting or expert costs.
No one is required to trade section 4(c) contract market transactions.
The proposed rules would merely provide exemptive relief for those
trading such transactions. The determination of whether a section 4(c)
contract market transaction would qualify for the proposed exemption
requires minimal analysis of data that will be readily accessible to
the offeror.
Accordingly, the Chairman, on behalf of the Commission, certifies
pursuant to section 3(a) of the RFA, 5 U.S.C. 605(b), that the proposed
rules will not have a significant economic impact on a substantial
number of small entities. Nonetheless, the Commission invites comment
from any firm which believes that these proposed rules would have a
significant economic impact on its operations.
B. Paperwork Reduction Act
The Paperwork Reduction Act of 1980, (``PRA'') 44 U.S.C. 3501 et
seq., imposes certain requirements on federal agencies (including the
Commission) in connection with their conducting or sponsoring any
collection of information as defined by the PRA. In compliance with the
PRA, the Commission has submitted these proposed rules and its
associated information collection requirements to the Office of
Management and Budget. The burden associated with these proposed rules,
is as follows:
Average burden hours per response
2.88
Number of respondents
300
Frequency of response
on occasion
Persons wishing to comment on the information which would be
required by these proposed rules should contact Gary Waxman, Office of
Management and Budget, Room 3228, NEOB, Washington, D.C. 20503, (202)
395-7340. Copies of the information collection submission to OMB are
available from Joe F. Mink, CFTC Clearance Officer, 2033 K Street,
N.W., Washington, D.C. 20581, (202) 254-9735.
List of Subjects in 17 CFR Part 36
Commodity futures, Commodity options, Prohibited transactions.
In consideration of the foregoing, and pursuant to the authority
contained in the Commodity Exchange Act, and in particular, Sections 2,
4, 4c, and 8a, 7 U.S.C. 2, 6, 6c, and 12a, as amended, the Commission
hereby proposes to add Part 36 to Chapter I of Title 17 of the Code of
Federal Regulations as follows:
PART 36--EXEMPTION OF SECTION 4(c) CONTRACT MARKET TRANSACTIONS
Sec.
36.1 Exemption and definitions.
36.2 Trading of section 4(c) contract market transactions.
36.3 Section 4(c) contract market trading rules.
36.4 Listing of section 4(c) contract market transactions.
36.5 Reporting requirements.
36.6 Special procedures relating to temporary licensing,
registration, and listing of principals.
36.7 Risk disclosure.
36.8 Suspension or revocation of section 4(c) contract market
transaction exemption.
36.9 Fraud and manipulation in connection with section 4(c)
contract market transactions.
Authority: 7 U.S.C. 2, 6, 6c, and 12a.
Sec. 36.1 Exemption and definitions.
(a) Duration of exemption. The provisions of this part apply to any
section 4(c) contract market transaction entered into on or after
[EFFECTIVE DATE OF FINAL RULES]. The provisions of this part expire,
and are no longer valid as to any such transaction entered into on or
after three years following the date the first contract trades pursuant
to this part.
(b) Scope of exemption. Each board of trade on which section 4(c)
contract market transactions are permitted to be traded pursuant to
this part shall be deemed for such purposes to be a contract market
within the meaning of the Act and, with respect to section 4(c)
contract market transactions, shall comply with and be subject to all
of the provisions of the Act and the Commission's regulations
applicable to a contract market other than those provisions which are
specifically inconsistent with this part, in which case the provisions
of this part shall govern.
(c) Definitions. As used in this part:
(1) Section 4(c) contract market transaction means: Any agreement,
contract, or transaction (or class thereof) entered into on or subject
to the rules of a contract market in accordance with the provisions of
this part, and that is executed by a member of the section 4(c)
contract market that is an eligible participant for its own account, or
a futures commission merchant or floor broker for its own account or on
behalf of an eligible participant.
(2) Eligible participant means:
(i) A bank or trust company;
(ii) A savings association or credit union;
(iii) An insurance company;
(iv) An investment company regulated under the Investment Company
Act of 1940 (15 U.S.C. 80a-1, et seq.) or an investment company
performing a similar role or function subject as such to foreign
regulation, provided that such investment company is not formed solely
for the purpose of constituting an eligible participant and has total
assets exceeding $5,000,000;
(v) A commodity pool formed and operated by a person regulated
under the Act or a foreign person performing a similar role or function
subject as such to foreign regulation, provided that such commodity
pool or foreign person is not formed solely for the purpose of
constituting an eligible participant and has total assets exceeding
$5,000,000;
(vi) A corporation, partnership, proprietorship, organization,
trust, or other entity, other than a commodity pool or other collective
investment vehicle, not formed solely for the purpose of constituting
an eligible participant (A) which has total assets exceeding
$10,000,000; or (B) which has a net worth of $1,000,000 and enters into
a section 4(c) contract market transaction in connection with the
conduct of its business; or (C) which has a net worth of $1,000,000 and
enters into a section 4(c) contract market transaction to manage the
risk of an asset or liability owned or incurred in the conduct of its
business or reasonably likely to be owned or incurred in the conduct of
its business;
(vii) An employee benefit plan subject to the Employee Retirement
Income Security Act of 1974 or a foreign person performing a similar
role or function subject as such to foreign regulation with total
assets exceeding $5,000,000 and whose investment decisions are made by
a bank, trust company, insurance company, investment adviser subject to
regulation under the Investment Advisers Act of 1940 (15 U.S.C. 80b-1,
et seq.), or a commodity trading advisor subject to regulation under
the Act;
(viii) Any governmental entity (including the United States, any
state, or any foreign government) or political subdivision thereof, or
any multinational or supranational entity or any instrumentality,
agency, or department of any of the foregoing;
(ix) A broker-dealer subject to regulation under the Securities
Exchange Act of 1934 (15 U.S.C. 78a, et seq.) or a foreign person
performing a similar role or function subject as such to foreign
regulation, acting on its own behalf: Provided, however, that if such
broker-dealer is a natural person or proprietorship, the broker-dealer
must also meet the requirements of paragraph (c)(2) (vi) or (xi) of
this section;
(x) A futures commission merchant, floor broker, or floor trader
subject to regulation under the Act or a foreign person performing a
similar role or function subject as such to foreign regulation; or
(xi) Any natural person with total assets exceeding at least
$10,000,000.
(3) Section 4(c) contract market trading rules means:
Contract market rules prescribing trading procedures applicable
only to section 4(c) contract market transactions.
(4) Terms and conditions has the same meaning as in Sec. 1.41(a)(2)
of this chapter.
Sec. 36.2 Trading of section 4(c) contract market transactions.
A section 4(c) contract market transaction may be traded pursuant
to the provisions of this part provided the following conditions are
met:
(a) The section 4(c) market transaction:
(1) Provides that settlement or delivery shall be in cash (at a
cash settlement price that reflects the cash market for the underlying
commodity and is based on a price series that is reliable, publicly
available, and timely) or by means other than the transfer or receipt
of any commodity, except a major foreign currency; provided however,
that the terms and conditions of such transaction are in conformity
with the underlying cash market (or, in the absence of conformity, are
necessary or appropriate) and that trading is not readily susceptible
to price manipulation, nor to causing or being used in the manipulation
of the price of any underlying commodity;
(2) Is cleared through a clearing organization subject to
Commission oversight;
(3) Except with respect to a broad-based index, does not involve
any, or the price of any, wheat, cotton, rice, corn, oats, barley, rye,
flaxseed, grain sorghums, millfeed, butter, eggs, onions, solanum
tuberous (Irish potatoes), wool, wool tops, fats and oils (including
lard, tallow, cottonseed oil, peanut oil, soybean oil, and all other
fats and oils), cottonseed meal, cottonseed, peanuts, soybeans, soybean
meal, livestock, livestock products, or frozen concentrated orange
juice;
(4) Does not involve any commodity futures contract or commodity
option for which any board of trade has been designated by the
Commission as a contract market prior to its application to trade as a
section 4(c) contract market transaction, unless it can reasonably be
distinguished from any such futures contract or commodity option based
on its hedging function and/or pricing basis; provided however, that
(i) the five- and ten-year interest rate swaps futures contracts, the
Rolling Spot Contracts in foreign currency, and foreign currency
forward futures contracts and options thereon may be traded as section
4(c) contract market transactions, and (ii) a flexible commodity option
may be listed as a section 4(c) contract market transaction prior to
listing such option for trading otherwise; and
(5) Does not involve any contracts of sale (or options on such
contracts) subject to the provisions of Section 2(a)(1)(B) of the Act,
including contracts for future delivery of a group or index of
securities (or any interest therein or based upon the value thereof).
(b) The contract market on which the section 4(c) contract market
transaction is traded or executed complies with the provisions of this
part.
Sec. 36.3 Section 4(c) contract market trading rules.
(a) A board of trade may, subject to the terms and conditions
stated herein, submit for Commission approval, section 4(c) contract
market trading rules to permit an on-floor and/or off-floor trading
procedure for section 4(c) contract market transactions that do not
satisfy all of the requirements of Secs. 1.38(a), 1.39, 155.2, 155.3,
and 155.4 of this chapter.
(b) Section 4(c) contract market trading rules submitted pursuant
to this section must provide for the following:
(1) Record maintenance and retention in accordance with Sec. 1.31
of this chapter;
(2) An audit trail that meets the requirements of Sec. 1.35(e),
(g), and (i) [trade register, trade timing, and contract market
oversight] and 1.38(b) of this chapter [identification of certain
transactions], and that otherwise complies with the provisions of
Sec. 1.35 of this chapter to the extent applicable;
(3) Compliance with Secs. 155.2, 155.3, and 155.4 of this chapter
[trading standards for floor brokers, futures commission merchants, and
introducing brokers] to the extent applicable;
(4) The immediate post-execution report of each purchase and each
sale transaction to and dissemination on the relevant market floor,
trading screen, and/or vendor service through the board of trade's
market quotation system of the price, quantity, and contract traded
pursuant to this section;
(5) The report to clearing, and clearing, of transactions concluded
pursuant to this section on the same schedule as trades subject to
Secs. 1.38 and 1.39 of this chapter and, otherwise, the immediate
report to clearing; and
(c) Any rules submitted pursuant to this section must describe the
manner in which such rules or contract market procedures and systems
will assure compliance with the provisions of Sections 4b and 4c(a) of
the Act prohibiting false reports, frontrunning, misuse of information,
fictitious sales, wash sales, and abuse of customer orders.
(d) A board of trade seeking approval of a section 4(c) contract
market trading rule shall furnish one copy of the information set forth
in paragraph (b) of this section to the Commission at its Washington,
D.C. headquarters. One copy shall also be transmitted by the board of
trade to the regional office of the Commission having local
jurisdiction over the board of trade. Each submission shall be labeled
as being submitted pursuant to this section.
(e) Rules submitted by a contract market pursuant to this section
shall become effective ten days after receipt of the submission (or
such earlier time as may be determined by the Commission or its
delegee) unless, within the ten-day period, the Commission or its
delegee notifies the board of trade in writing that the submission does
not meet the conditions of this section. Upon such notification by the
Commission or its delegee, the submission will be subject to the usual
procedures for rule approval under Section 5a(a)(12)(A) of the Act and
Sec. 1.41(b) of this chapter.
(f) Once trading in a section 4(c) contract market transaction has
commenced, any modification to any approved section 4(c) contract
market trading rule must be submitted to the Commission for review
pursuant to the standards and procedures for section 4(c) contract
market trading rules set forth in this section.
(g) Trades entered into in compliance with the section 4(c)
contract market trading rules in effect shall not be in violation of
Sections 4b(a)(iv), 4b(b) or 4c(a) of the Act based solely on having
been executed noncompetitively. Failure to comply with such contract
market rules shall render the conduct involved subject to Commission
action for noncompetitive trading under Sections 4b and 4c(a) of the
Act and Secs. 1.38, 1.39, and, if applicable, Secs. 155.2, 155.3, and
155.4 of this chapter in addition to any other applicable provisions of
the Act and rules of this chapter.
Sec. 36.4 Listing of section 4(c) contract market transactions.
(a) A board of trade which has been initially designated as a
contract market and has otherwise met the requirements of Sections 5
and 5a of the Act (other than Section 5a(a)(12)(A)) seeking to permit
trading in a section 4(c) contract market transaction shall furnish to
the Commission at least ten days prior to its proposed effective date,
the rules setting forth the terms and conditions of the proposed
section 4(c) contract market transaction.
(b) The board of trade shall furnish one copy of the information
set forth in paragraph (a) of this section to the Commission at its
Washington, D.C. headquarters. One copy shall also be transmitted by
the board of trade to the regional office of the Commission having
local jurisdiction over the board of trade. Each submission shall be
labeled as being submitted pursuant to this Part.
(c) A board of trade which has been initially designated as a
contract market and has otherwise met the requirements of Sections 5
and 5a of the Act (other than Section 5a(a)(12)(A)) and which meets the
requirements of Sec. 36.2 of this part shall be deemed to be designated
as a contract market in section 4(c) contract market transactions, the
rules submitted shall be deemed to be approved, and section 4(c)
contract market transactions may be traded or executed thereon ten days
after receipt of the submission pursuant to this section unless, within
the ten-day period, the Commission or its delegee notifies the board of
trade in writing that the proposed transactions do not meet the
requirements of Sec. 36.2 of this part. Upon such notification by the
Commission or its delegee, the submission will be subject to the usual
procedures for rule approval under Section 5a(a)(12)(A) of the Act and
Sec. 1.41(b) of this chapter.
(d) Any modification to the rules setting forth the terms and
conditions of a section 4(c) contract market transaction shall be
submitted to the Commission pursuant to the procedure set forth in this
section.
Sec. 36.5 Reporting requirements.
(a) The reporting requirements set forth in this section shall
govern section 4(c) market transactions in lieu of the requirements of
parts 16, 17, 18, and 19 of this chapter.
(b) The provisions of Sec. 15.05 and part 21 of this chapter shall
apply to section 4(c) contract market transactions as though they were
set forth herein and included specific references to eligible
participants.
(c) Reports by contract markets to the Commission. Each contract
market shall submit to the Commission in accordance with paragraph (d)
of this section the following information with respect to section 4(c)
market transactions by commodity or type of contract as specified by
the Commission:
(1) For each commodity or type of contract,
(i) The total gross open contracts at the end of the day covered by
the report,
(ii) Total transactions, by type of transaction, as specified by
the Commission, which occurred during the day covered by the report,
and
(iii) Prices, as specified by the Commission.
(2) For each clearing member by proprietary and customer account,
(i) The total of all long open contracts and the total of all short
open contracts carried at the end of the day covered by the report, and
(ii) The quantity of contracts transacted during the day covered by
the report, by type of transaction, as specified by the Commission.
(3) Large trader reports.
(i) Reportable positions. Reportable long and short positions of
traders as defined by contract market rules and approved by the
Commission, separately for each futures commission merchant or member
of the contract market.
(ii) Identification information. For each reportable position, the
information specified in Sec. 17.01(b)(1) through (b)(8) of this
chapter.
(d) Form and manner of reporting; time and place of filing reports.
Unless otherwise approved by the Commission or its designee, each
contract market operating pursuant to this part shall submit the
information required by paragraph (c) of this section as follows:
(1) Using a format and coding structure approved in writing by the
Commission or its designee on compatible data processing media as
defined in part 15 of this chapter;
(2) The information contained in paragraphs (c)(1) and (c)(2) of
this section must be filed daily when the data are first available, but
not later than 3:00 p.m. on the business day following the day to which
the information pertains. The information contained in paragraph (c)(3)
must be filed on call by the Commission or its designee, at such times
as specified in the call.
(3) Except for dial-up transmissions, at the regional office of the
Commission having local jurisdiction with respect to such contract
market.
(e) Reports by contract markets to the public. Each contract market
operating pursuant to this part shall publish for each business day the
following information for section 4(c) contract market transactions by
commodity or type of contract as specified by the Commission:
(1) The total gross open contracts;
(2) The total number of transactions by transaction type as
specified by the Commission; and
(3) Prices, as specified by the Commission.
(f) Reports and maintenance of books and records by traders. Every
trader who owns, holds, or controls, or has held, owned, or controlled
a reportable position, as defined by contract market rules, in
contracts traded as section 4(c) market transactions shall:
(1) Keep books and records showing all details concerning all
positions and transactions with respect to section 4(c) market
transactions, all positions and transactions in any options traded
thereon, and all positions and transactions in the underlying
commodity, its products, and by-products and, in addition, commercial
activities that the trader hedges in the underlying commodity, and
shall upon request furnish to the Commission or the U.S. Department of
Justice any pertinent information concerning such positions,
transactions, or activities.
(2) File within one business day after a special call upon such
trader by the Commission or its designee the following:
(i) Reports showing positions and transactions on such contract
markets for the period of time that the trader held or controlled a
reportable position, and in a form and manner as instructed in the
call; and
(ii) The information specified in Sec. 18.04 of this chapter as
though it pertains to section 4(c) market transactions.
Sec. 36.6 Special procedures relating to temporary licensing,
registration, and listing of principals.
Notwithstanding any other provision of law, any person associated
with a futures commission merchant or an introducing broker shall be
granted a temporary license to act in the capacity of an associated
person of such sponsor or listed as a principal of such futures
commission merchant or introducing broker if such person certifies that
he is licensed, or otherwise authorized to do business and in good
standing with another federal financial regulatory authority, or a
foreign financial regulatory authority with which the Commission has
comparability arrangements under part 30 of this chapter, is not
subject to a statutory disqualification from registration under Section
8a(2) of the Act and restricts his activities to section 4(c) market
transactions, and if such person and his sponsor comply with special
temporary license, registration, or principal listing procedures
applicable to persons involved solely with such transactions that have
been adopted by the National Futures Association and approved by the
Commission.
Sec. 36.7 Risk disclosure.
(a) A futures commission merchant or, in the case of an introduced
account, an introducing broker, may open an account for a customer with
respect to an instrument governed by this part without furnishing such
customer the disclosure statements required under Secs. 1.55, 1.65,
33.7, and 190.10 of this chapter: Provided, however, that the futures
commission merchant or, in the case of an introduced account, the
introducing broker, does furnish the customer, prior to the customer's
entry into the first section 4(c) contract market transaction with
respect to a particular instrument, with disclosure appropriate to the
particular instrument and the customer.
(b) This section does not relieve a futures commission merchant or
introducing broker from any other disclosure obligation it may have
under applicable law.
Sec. 36.8 Suspension or revocation of section 4(c) contract market
transaction exemption.
The Commission may, after notice and opportunity for a hearing,
suspend or revoke the exemption of any section 4(c) contract market
transaction if the Commission determines that the exemption is no
longer consistent with the public interest and the purposes of the Act.
Sec. 36.9 Fraud and manipulation in connection with section 4(c)
contract market transactions.
(a) Fraud. The requirements of sections 4b(a) and 4o of the Act and
Sec. 33.10 of this chapter shall apply to section 4(c) contract market
transactions. In addition, 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 other
person;
(2) To make or cause to be made to any other person any false
report or statement thereof or cause to be entered for any person any
false record thereof;
(3) To deceive or attempt to deceive any other person by any means
whatsoever.
(b) Manipulation. The requirements of sections 6(c), 6(d), and 9(a)
of the Act and Sec. 33.9(d) of this chapter shall apply to section 4(c)
contract market transactions.
Issued in Washington, D.C. on October 24, 1994, by the
Commission.
Jean A. Webb,
Secretary of the Commission.
[FR Doc. 94-26726 Filed 10-27-94; 8:45 am]
BILLING CODE 6351-01-P
This is a copy of a public record, reproduced as it was published. It is not legal advice, and it may not be the version a court would rely on. Check the official source before you cite it.