Chicago Mercantile Exchange Proposed Primary Market Maker Rule Amendments

COMMODITY FUTURES TRADING COMMISSION

Chicago Mercantile Exchange Proposed Primary Market Maker Rule

Amendments

AGENCY: Commodity Futures Trading Commission.

ACTION: Notice of proposed rule amendments of the Chicago Mercantile

Exchange to establish a primary market maker system.

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SUMMARY: The Chicago Mercantile Exchange (``CME'' or ``Exchange'') has

submitted proposed rule amendments and other materials which would

establish a primary market maker system for certain CME futures and

options contracts.1 Acting pursuant to the authority delegated by

Commission Regulation 140.96, the Division of Trading and Markets has

determined to publish the CME proposal for public comment. The Division

believes that publication of the CME proposal is in the public interest

and will assist the Commission in considering the views of interested

persons.

\1\The CME proposal includes new Rule 556; amendments to

existing Rules 531, 533, and 539; and amendments to existing

interpretations and special notices under Rules 533 and 549.

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DATES: Comments must be received on or before January 13, 1995.

FOR FURTHER INFORMATION CONTACT: Clarence Sanders, Attorney, Division

of Trading and Markets, Commodity Futures Trading Commission, 2033 K

Street NW, Washington, DC 20581. Telephone: (202) 254-8955.

SUPPLEMENTARY INFORMATION:

I. Description of Proposed Rule Amendments

By a letter dated September 14, 1994, the CME submitted proposed

rule amendments pursuant to Section 5a(a)(12)(A) of the Commodity

Exchange Act (``Act'') and Commission Regulation 1.41(b). The proposed

amendments would establish a primary market maker (``PMM'') system for

certain CME futures and options contracts.

Under the CME proposal, application of the PMM system would be

limited to new or low volume contracts. Initially, the CME would

implement the PMM system on a pilot basis for new contracts based on

equity securities. After completion of the pilot period, the PMM system

could be extended to other new or low volume contracts.

Eligibility for appointment as a PMM would be limited to members of

the CME. A member's appointment, and the related rights and duties of

an appointee, would be confined to one or more designated contracts.

Applicants for appointment would be required to have the greater of net

capital of $250,000 or an amount sufficient to assume a position of

twenty trading units in the designated contract(s). An appointee would

be required (i) to maintain a two-sided market in the form of current

bid and ask price quotations at a maximum spread difference and (ii) to

satisfy bids or offers up to a specified quantity of contracts at the

appointee's current bid and ask prices.

A PMM also would serve as a floor broker and custodian of an order

book for customer limit orders. As custodian of the limit order book

(LOB), the PMM would be required to accept customer limit orders,

maintain those orders in the LOB, and effect their proper execution.

The PMM would be required to display bid and ask quotations of orders

placed in the LOB and to publicly disseminate market quotations. In so

doing, the PMM would be required to provide equal access to LOB depth

and size upon the request of a CME member. Although such disclosure is

required under the proposal, the CME has not indicated how this

information would be provided.

Customer orders placed with the PMM for inclusion in the LOB would

have priority over, and would be executed in advance of, other

competing orders. In executing transactions for his own account as

market maker, a PMM would be required to accord priority to those

customer orders or other member orders the PMM represents as a floor

broker or as custodian of the LOB.

A PMM would have a right of participation in orders executed at his

disseminated bid and ask quotations. The right of participation would

take the form of a priority over competing bids or offers at prices

equaling the PMM's bid or ask quotation. Although not expressly

included in the proposal, it appears that the PMM would be able to

exercise its market maker priority regardless of whether another member

first bid or offered for its own account at a price.

The magnitude of a PMM's right of participation would vary with the

level of trading in a designated contract. For a designated contract

with average daily volume of 2500 contracts or less, the PMM would have

a right to participate in 40 percent of the contracts transacted at the

PMM's bid or ask quotation. For a designated contract with average

daily volume of 2501 to 5000 contracts, the PMM's right of

participation would decline to 30 percent. For a designated contract

with average daily volume in excess of 5000 contracts, the PMM would

not have any right of participation.

Given that a PMM would function as a market maker and at the same

time conduct brokerage transactions, the proposal would permit the PMM

to facilitate the execution of customer orders by serving as a

counterparty on such orders.\2\ In this respect, the proposal includes

procedures permitting the execution of ``facilitation orders.'' Under

the proposal, facilitation orders would be defined as orders for the

account of the PMM or orders solicited by the PMM from members of the

trading crowd that are executed as a cross transaction with a customer

order.\3\

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\2\As part of the proposal, the existing CME rule prohibiting

trading against customer orders would be amended to permit the PMM

to engage in such transactions pursuant to the terms of the PMM

program.

\3\As part of the proposal, the existing CME rules that prohibit

pre-arranged trades and regulate the crossing of orders for

different customers by the same floor broker would be revised to

permit the PMM to engage in such transactions pursuant to the terms

of the PMM program.

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Procedures for the execution of facilitation orders would require

the PMM to first request bids or offers for the execution of such

customer orders from other market participants. The PMM would then be

required on behalf of the customer order to bid at a price above the

highest market bid or to offer at a price below the lowest market

offer, to identify to the trading crowd that the customer order is

being bid or offered subject to facilitation, and to disclose all terms

and conditions of such order. After all other market participants were

given an opportunity to meet the PMM's bid or offer made on behalf of

the customer order, the PMM would be permitted to cross all or any

remaining part of the customer order against the facilitation order by

announcing in open outcry the quantity and price of the order being

crossed. Once the PMM made this announcement, the customer order would

have precedence over any other bid or offer in the trading crowd for

execution against the facilitation order. The facilitation order would

have priority for execution against the customer order subject to LOB

priorities.\4\

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\4\The Commission notes that these procedures for facilitation

orders appear to be materially different than those called for by

Commission Regulation 1.39 and current CME rules. Specifically,

Regulation 1.39 requires the presence of an Exchange official and

CME rules require that crossed orders be pre-announced three times.

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A newly appointed PMM would serve continuously until trading

activity in the designated contract reached a level of 5000 contracts

per day. Thereafter, the term of a PMM appointment would continue to

run for an additional five years, during which time the PMM would

continue to serve as custodian of the LOB. A PMM appointment could be

transferred only with the approval of the Board of Directors of the

CME.

Except for the right of participation conferred on a PMM appointee,

the PMM system would not limit the trading activities of other floor

members in designated contracts. Other floor members would have access

to designated contracts for purposes of conducting proprietary and

brokerage transactions. With respect to brokerage transactions, other

floor members would be permitted to accept for execution both market

and limit orders of customers. Notwithstanding that the proposal would

establish a LOB under the custodianship of a PMM appointee, and provide

orders placed therein with a trade priority, the PMM system would not

prohibit other floor members from accepting customers' limit orders for

execution.

The proposal would prohibit any affiliate of a PMM from purchasing

or selling any contract to which such PMM was appointed except to

reduce or liquidate an existing position pursuant to notice to the CME.

However, the proposal would permit the CME to grant an exemption from

this prohibition subject to CME approval of procedures restricting the

flow of material non-public information between the PMM and the

affiliated person(s). The proposal also would revise an existing CME

interpretation prohibiting ``frontrunning'' in connection with the CME

Large Order Execution (``LOX'') program. The CME interpretation

applicable to the LOX program would be revised to include orders

executed under the PMM program.

II. Request for Comments

The Commission requests comments on any aspect of the CME's

proposed rule amendments that members of the public believe may raise

issues under the Act or Commission regulations. In particular, the

Commission requests comments regarding the suitability of the order

disclosure provisions, the impact on competitive trading conditions,

the priority afforded orders held in the LOB but not obtained by orders

held by floor brokers, whether there would be adequate protection of

customer trade executions, the implications for customer protection

under the proposed facilitation procedures as compared to current order

crossing procedures, and whether any other conditions or requirements

should be imposed on the proposal.

Copies of the proposed rule amendments and related materials are

available for inspection at the Office of the Secretariat, Commodity

Futures Trading Commission, 2033 K Street NW, Washington, DC 20581.

Copies also may be obtained through the Office of the Secretariat at

the above address or by telephoning (202) 254-6314. Some materials may

be subject to confidential treatment pursuant to 17 CFR 145.5 or 145.9.

Any person interested in submitting written data, views, or

arguments on the proposed rule amendments should send such comments to

Jean A. Webb, Secretary, Commodity Futures Trading Commission, 2033 K

Street NW, Washington, DC 20581, by the specified date.

Issued in Washington, DC, on December 8, 1994.

Alan L. Seifert,

Deputy Director.

[FR Doc. 94-30691 Filed 12-13-94; 8:45 am]

BILLING CODE 6351-01-P