New York Mercantile Exchange Proposed Specialist Market Maker Program

COMMODITY FUTURES TRADING COMMISSION

New York Mercantile Exchange Proposed Specialist Market Maker

Program

AGENCY: Commodity Futures Trading Commission.

ACTION: Notice of proposed new rule and rule amendments of the New York

Mercantile Exchange to establish a Specialist Market Maker program.

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SUMMARY: The New York Mercantile Exchange (``NYMEX'' or ``Exchange'')

has submitted a proposed new rule and rule amendments that would

establish a Specialist Market Maker (``SMM'') program for certain new

or low-volume futures contracts. The Exchange would appoint one SMM for

each contract market that it determined would benefit from the SMM

program. The SMM would be required to maintain a continuous physical

presence on the floor of the Exchange throughout the regular trading

session of the contract and to maintain a two-sided market in the

contract for which he or she had been appointed. The SMM also would be

required to maintain a limit order book of member and non-member (i.e.,

customer) limit orders. In return for these services, the SMM would be

paid a contract development fee and receive various priorities with

respect to certain transactions executed in the trading ring for the

appointed contract.

Acting pursuant to the authority delegated by Commission Regulation

140.96, the Division of Trading and Markets (``Division'') has

determined to publish the NYMEX proposal for public comment. The

Division believes that publication of the proposal is in the public

interest and will assist the Commission in considering the views of

interested persons.

DATE: Comments must be received on or before June 15, 1998.

FOR FURTHER INFORMATION CONTACT:

Thomas Smith, Attorney, Division of Trading and Markets, Commodity

Futures Trading Commission, Three Lafayette Centre, 1155 21st Street,

NW., Washington, DC 20581. Telephone: (202) 418-5495; or electronic

mail: [email protected].

SUPPLEMENTARY INFORMATION:

I. Description of Proposed SMM Program

A. Introduction

By letter dated April 16, 1998, NYMEX submitted proposed new Rule

6.45 (``Specialist Market Maker Program'') and proposed amendments to

Rule 6.43A (``Broker Registration Requirements'') pursuant to Section

5a(a)(12)(A) of the Commodity Exchange Act (``Act'') and Commission

Regulation 1.41(c). The proposed new rule and rule amendments would

establish an SMM program for certain new or low-volume futures

contracts. The SMM program is intended to provide liquidity for new or

illiquid markets and would be terminated once the contract obtained a

predetermined trading volume. The SMM program is patterned after a

market maker program at the Chicago Mercantile Exchange that was

previously approved by the Commission on April 20, 1995.

NYMEX intends to implement the SMM program in the Cinergy

Electricity and Entergy Electricity futures contracts, which were

approved by the Commission for trading on March 23, 1998. NYMEX

anticipates listing the two new electricity futures contracts for

trading within the next few months. The SMM program may be extended to

other new or low-volume futures contracts at a later date.

B. SMM Eligibility Criteria

Applications for SMM positions would be accepted from members and

member firms. Applications also would be accepted from individuals and

firms that were not members or member firms. Appointment as an SMM

could not occur however, until the individual or firm had been approved

by the NYMEX Board of Directors as a member or member firm.

NYMEX would establish a new Exchange Committee, the Specialist

Review Committee (``SRC''). The SRC would assess each SMM applicant's

financial resources, operational capabilities, trading experience,

regulatory history, and ability and willingness to promote NYMEX as a

marketplace and would report its findings to the Board of Directors.

Prospective SMM applicants also would need to demonstrate that they

have the ability to provide multiple qualified personnel with the

capability to perform the defined SMM obligations and have working

capital in excess of $500,000. The Board of Directors would make the

final decision as to which applicants to appoint as SMMs.

Only one SMM would be appointed for each contract market eligible

for the SMM program. The Board of Directors, however, may appoint a

member or member firm as an SMM for more than one contract market.

For any market for which an SMM has been appointed, the Exchange

would issue an SMM trading permit to the SMM. The permit would allow

the member or member firm to perform the SMM functions without

incurring the cost of dedicating a membership for use in that

designated futures contract. Thus, for example, if a member firm with

two full NYMEX memberships were appointed an SMM in a new contract, the

member firm would be permitted to act as the SMM for the new

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market while also retaining the trading privileges associated with the

two full memberships.

C. Duties of the SMM

The SMM's rights and obligations would be set forth in a written

agreement (the ``SMM Agreement'').\1\ The SMM Agreement would require

the SMM to provide a continuous physical presence on the floor of the

Exchange throughout the regular trading session in order to maintain an

orderly market in the appointed futures contract. During the trading

session of the appointed market, the SMM would continuously provide bid

and offer quotes for outright futures trades and price differentials

for spread transactions for the contract delivery months set forth in

the SMM Agreement.

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\1\ The SMM Agreement would be negotiated by the SMM and SRC and

would be subject to the approval of the NYMEX Board of Directors.

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The SMM Agreement would establish a maximum bid/offer quote spread

and maximum price differential for certain contract delivery months.\2\

At a given bid or offer, the SMM would be obligated to satisfy all bids

and offers in the ring at the same price up to a predefined maximum

number of contracts for any one trade.\3\ In complying with this

obligation for a particular price, the SMM could fill a bid or offer,

as applicable, with one or more limit orders maintained in a limit

order book at that price (the limit order book is discussed further

below), with a trade for the SMM's proprietary account, or with a

combination of limit orders and trading for his or her proprietary

account.

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\2\ The duration of the SMM's term would be set forth in the SMM

Agreement.

\3\ The maximum number of contracts that the SMM would be

obligated to fill at any one price would be set forth in the SMM

Agreement.

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NYMEX anticipates that a maximum bid/offer quote spread and maximum

price differential would be set only for the ``near'' months (e.g., for

one to three months out from the front-month contract) and the most

active spread transactions. In addition, the SMM Agreement may provide

for a maximum bid/offer quote spread and price differential during

usual market conditions and a larger maximum bid/offer quote spread and

price differential during periods of extreme volatility, extreme

trading volume, or market emergencies. The SMM Agreement would define

these ``unusual'' market conditions for the purposes of the SMM

program.

The SMM also would be required to maintain an order book of limit

orders (``OB'') in the markets for which he or she has been appointed

an SMM. The limit orders could be for outright futures trades or spread

transactions. The term ``Order Book Official'' (``OBO'') would be used

to refer to the SMM whenever the SMM was acting in the capacity of

managing the OB.

A customer may elect to have a limit order given to the SMM for

inclusion in the OB. NYMEX members also may place limit orders for

their proprietary accounts with the SMM for inclusion in the OB. The

OBO would be obligated to accept all limit orders presented for

inclusion in the OB. Customers also may request that non-limit orders

be given to the OBO for execution. The OBO would not be obligated to

accept non-limit orders.

Upon a request from a member or clerk on the trading floor, the OBO

would be required to disclose the prices, quantities and contract

delivery months for the limit orders held in the OB. The promptness of

the OBO's response would depend upon market conditions.

All orders presented to the OBO would have to be in writing. Orders

entered into the OB would be executed on a price-priority and time-

priority basis. The Exchange would provide the OBO with a time-stamp

clock in the trading ring, and the OBO would be required to time-stamp

each limit order that he or she received.

The proposal also would provide that the SMM may, at his or her

discretion, respond to a request for a bid or offer as part of a large-

order execution procedure. The SMM would be permitted to survey the

ring to determine if other floor members were interested in

participating in responding to the request.\4\

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\4\ NYMEX current does not have a rule governing large-order

executions. The Exchange has stated that it would submit a proposed

large-order execution rule to the Commission pursuant to Section

5a(a)(12)(A) of the Act and Commission Regulation 1.41(c) prior to

its implementation.

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D. Transaction Priorities

The SMM program would provide certain trading priorities to the OBO

and to the SMM. With respect to the execution of limit orders in the

OB, the OBO would have a 100% priority right over other proprietary

traders and floor brokers in the ring for trades that take place at the

OBO's bid or offer. For example, if the OB contained limit orders to

buy a total of 10 contracts at a price of 40, the OBO would have a

right to participate in any transactions executed at a price of 40 in

the trading ring until all 10 of the limit orders in the OB were

executed. With respect to this priority, no distinction would be made

between members and customer limit orders in the OB.

In connection with the SMM's proprietary account, the SMM would

have priority rights with respect to trades executed (1) against the

OB; (2) in the ring and within the SMM's bid/offer spread; and (3) as a

cross-trade against the OB. The SMM, however, would not be obligated to

exercise his or her priority rights. The extent of each of these

priorities is specified below.

The SMM would have a 10% priority right with respect to any

transaction executed opposite the OB. For example, if a floor broker

executed a trade opposite the OB for 20 contracts at a price of 39, the

SMM may exercise his or her priority right and ``take'' 2 of the

contracts at a price of 39 from the floor broker.

The SMM would have a 40% priority right with respect to trades

executed in the trading ring that do not involve the OB and are within

the SMM's bid/offer spread. For example if the SMM's spread is bid 40

and offer 50, and two floor brokers execute a trade for 20 contracts at

a price of 40, the SMM may exercise his or her right to buy 8 of the

contracts from the selling floor broker.

The SMM may trade for his or her proprietary account against the

OB, provided that the SMM follows the cross-trade procedures set forth

in NYMEX Rule 6.40, including announcing the price and quantity of the

contracts to be purchased and sold to the trading ring three times and

executing the transaction in the presence of an Exchange employee

designated to observe such transactions. If one or more floor members

respond to the SMM's bid and offer, the SMM may exercise a right of

priority to a maximum of 40% of the transaction. For example, if the OB

contained limit orders to buy a total of 10 contracts at a price of 30,

the SMM may elect to trade opposite the OB by announcing three times

the bid and offer for 10 contracts at a price of 30 to the other floor

members in the trading ring. If other floor members respond to the

announcement by offering to sell 10 contracts at 30, the SMM may elect

to exercise his or her priority and trade against four of the contracts

in the OB. The remaining six contracts would go to the other floor

members in the trading ring who wished to participate in the

transaction.\5\

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\5\ The proposal would require a member or member firm using the

SMM facility for the execution of customer limit orders to disclose

in writing to the customer that the SMM may trade against such

orders and that the customer may choose not to place a limit order

with the SMM.

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[[Page 27060]]

The SMM's priorities would extend to floor members executing trades

for proprietary accounts and floor brokers executing customer orders.

Therefore, the SMM's priority may preempt the execution of customer

orders.

E. Contract Development Fee

The SMM would receive a contract development fee (``CDF'') as an

incentive to perform the SMM function. The terms and duration of the

CDF would be set forth in the SMM Agreement, and would be based upon

the level of customer trading volume in the designated contract. Unless

otherwise provided in the SMM Agreement, the SMM would receive $8,000

per month if monthly customer trading volume was less than 3,500

contracts. Once monthly customer trading volume exceeded 3,500

contracts, the SMM would receive $8,000 plus a per contract fee for

each transaction in excess of 3,500 that involved a customer order.

F. Specialist Floor Brokers

The proposal would permit the SMM to contract with one or more

floor brokers (``Specialist Floor Brokers'' or ``SFB'') to perform all

or part of the SMM function. For example, the SMM may contract with the

SFB to manage the OB and to perform all of the OBO obligations,

including the OB's priority with respect to trading against the OB.

The proposal would give significant latitude to the SMM to contract

with an SFB. However, any contract between an SMM and an SFB would be

subject to the review and approval of the SRC. The proposal also would

provide that the SMM would be principally liable to the Exchange for

the execution of all SMM obligations and duties.

II. Request for Comments

The Commission requests comments from interested persons concerning

any aspect of NYMEX's proposed SMM program that the commenters believe

raise issues under the Act or Commission Regulations. In particular,

the Commission requests comments regarding the appropriateness of: (1)

Permitting members to place limit orders for their own accounts in the

OB; (2)permitting member limit orders to be executed ahead of customer

limit orders that are at the same price, but received by the OBO at a

later time; (3) granting the SMMs trading priorities, including the

priority to trade against the OB; and (4) permitting the SMM's trading

priority to preempt the execution of customer orders in the trading

ring.

Copies of the proposed new Rule 6.45 and the proposed amendments to

Rule 6.43A and related materials are available for inspection at the

Office of the Secretariat, Commodity Futures Trading Commission, Three

Lafayette Centre, 1155 21st Street, NW, Washington, DC 20581. Copies

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

address or by telephoning (202) 418-5100.

Any person interested in submitting written data, views, or

arguments on the proposed SMM program should send such comments, by the

specified date, to Jean A. Webb, Secretary, Commodity Futures Trading

Commission, Three Lafayette Centre, 1155 21st Street, NW, Washington,

DC 20581; transmitted by facsimile to (202) 418-5521; or transmitted

electronically to [email protected].

Issued in Washington, DC, on May 11, 1998.

Alan L. Seifert,

Deputy Director.

[FR Doc. 98-12970 Filed 5-14-98; 8:45 am]

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