Concept Release on the Placement of a Foreign Board of Trade's Computer Terminals in the United States
Federal RegisterJul 24, 1998
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COMMODITY FUTURES TRADING COMMISSION
17 CFR Part 30
Concept Release on the Placement of a Foreign Board of Trade's
Computer Terminals in the United States
AGENCY: Commodity Futures Trading Commission.
ACTION: Request for comment.
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SUMMARY: The Commodity Futures Trading Commission (``CFTC'' or
``Commission'') is publishing this release to solicit the views of the
public on how to address issues related to the placement by foreign
boards of trade of computer terminals in the U.S. that would be used
for the purpose of facilitating the trading of products available
through those boards of trade. The Commission's staff has received
requests for no-action positions and other inquiries regarding the
Commission's regulatory treatment with respect to foreign board of
trade computer terminals placed in the U.S. In general, these boards of
trade, their members or their members' affiliates have sought
confirmation from the Commission's staff that the placement and usage
of trading terminals in U.S. offices of foreign board of trade members
and/or their affiliates would not require the foreign board of trade to
be designated as a ``contract market'' under the Commodity Exchange Act
(``Act''). In light of a significant increase in these types of
requests, the Commission believes that it is appropriate to address the
subject by way of the notice and comment rulemaking process. The
Commission intends to propose rules and ultimately to adopt rules to
govern the treatment of foreign terminals in the U.S. Toward this end,
the Commission believes that it is appropriate first to issue this
concept release to solicit public comment regarding issues raised with
respect to foreign terminal placement and usage in the U.S.
DATE: Comments must be received on or before September 22, 1998.
ADDRESSES: Comments on the proposed rules should be sent to Jean A.
Webb, Secretary of the Commission, Commodity Futures Trading
Commission, 1155 21st Street, N.W., Washington, D.C. 20581. In
addition, comments may be sent by facsimile transmission to facsimile
number (202) 418-5521 or by electronic mail to [email protected].
Reference should be made to ``Foreign Board of Trade Terminals.''
FOR FURTHER INFORMATION CONTACT: I. Michael Greenberger, Director,
David M. Battan, Chief Counsel, Lawrence B. Patent, Associate Chief
Counsel, or Lawrence T. Eckert, Attorney Advisor, Division of Trading
and Markets, Commodity Futures Trading Commission, 1155 21st Street,
N.W., Washington, D.C. 20581. Telephone (202) 418-5450.
SUPPLEMENTARY INFORMATION:
I. Background
A. Prior Views of Certain Commission Staff Concerning Terminal
Placement in the U.S.
1. Prior Staff Views Related to Listing Products of Foreign
Boards of Trade on Globex
2. Prior Staff Views Concerning the Placement of Foreign Board
of Trade Terminals in the U.S.
B. Commission Approval of the Trading of Products of Foreign
Boards of Trade in the U.S. Pursuant to Trading Link Programs
C. Foreign Regulators' Treatment of U.S. Terminals in Their
Jurisdictions
D. Order Routing and Execution of U.S. Customer Orders on a
Foreign Board of Trade
II. Request for Comment
A. A Possible Approach for Foreign Terminal Placement and Use in
the U.S.
1. Petition Procedure
2. Conditions of an Order
3. Requests for Confirmation of Relief from Members and Their
Affiliates
B. Definitional Issues
1. Definition of Computer Terminal
2. Where May Computer Terminals Be Located in the U.S.?
3. Definition of an ``Affiliate'' of a Foreign Board of Trade
Member
C. Other Issues Concerning Foreign Board of Trade Terminal
Placement in the U.S.
1. Bona Fide Foreign Board of Trade
2. Order Execution and Order Routing Issues
3. Linkages Between Boards of Trade
III. Conclusion
I. Background
In general, under Section 4(a) of the Act,\1\ a futures contract
may be traded lawfully in the U.S. only if it is traded on or subject
to the rules of a board of trade that has been designated as a
``contract market'' under Section 5 of the Act,\2\ unless the contract
is traded on or subject to the rules of a board of trade, exchange or
market located outside the U.S.\3\ or is exempted from the Act. With
respect to the regulation of transactions involving foreign futures,\4\
Section 4(b) of the Act permits the Commission to regulate persons who
offer or sell futures, but prohibits the Commission from adopting any
rule or regulation that: (1) Would require Commission approval of any
foreign board of trade contract, rule, regulation or action; or (2)
governs any rule, contract term or action of a foreign board of
trade.\5\
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\1\ 7 U.S.C. 6(a) (1994).
\2\ 7 U.S.C. 7 (1994). Section 5 of the Act authorizes the
Commission to designate any board of trade as a contract market
provided that the board of trade complies with certain conditions
and requirements set forth in the Act.
\3\ Section 4(a) of the Act states in relevant part:
. . . [I]t shall be unlawful for any person to offer to enter
into, to enter into, execute, to confirm the execution of, or to
conduct any office or business anywhere in the U.S., its territories
or possessions, for the purpose of soliciting, or accepting any
order for, or otherwise dealing in, any transaction in, or in
connection with, a contract for the purchase or sale of a commodity
for future delivery (other than a contract which is made on or
subject to the rules of a board of trade, exchange, or market
located outside the U.S., its territories or possessions) unless--
(1) such transaction is conducted on or subject to the rules of
a board of trade which has been designated by the Commission as a
``contract market'' for such commodity; [and]
(2) such contract is executed or consummated by or through a
member of such contract market[.]
\4\ The Commission has defined the terms ``foreign futures'' and
``foreign options'' in Rules 30.1 (a) and (b). Commission rules
cited herein can be found at 17 CFR Ch. I (1998).
\5\ Section 4(b) of the Act states in pertinent part:
The Commission may adopt rules and regulations proscribing fraud
and requiring minimum financial standards, the disclosure of risk,
the filing of reports, the keeping of books and records, the
safeguarding of customers' funds, and the registration with the
Commission by any person located in the U.S., its territories or
possessions, who engages in the offer or sale of any contract of
sale of a commodity for future delivery that is made or to be made
on or subject to the rules of a board of trade, exchange or market
located outside the United States, its territories or possessions. .
. . No rule or regulation may be adopted by the Commission under
this subsection that (1) requires Commission approval of any
contract, rule, regulation, or action of any foreign board of trade,
exchange or market, or (2) governs in any way any rule or contract
term or action of any foreign board of trade, exchange or market.
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[[Page 39780]]
Significant developments in technology in recent years have now
made automated trading methods an attractive addition or alternative to
traditional open outcry for trading of commodity futures and option
products on or subject to the rules of foreign and domestic boards of
trade. Automated trading systems make it possible to execute trades on
computer terminals within the U.S., no matter where the central
computer is located, thus providing U.S. customers with a potential
additional means of access to foreign products. Additionally, systems
have been developed that enable customer orders to be submitted
electronically to an FCM and then routed for execution on a foreign
board of trade with little or no human intervention by a member of the
foreign board of trade. These technological advances raise myriad
issues concerning the use of these technologies. In this regard, a
variety of issues has arisen concerning the degree to which a foreign
board of trade's cross-border trading activities in the U.S. are
subject to Commission regulation. Specifically, at what point does a
foreign board of trade's presence within the U.S. become
indistinguishable from that of a U.S. board of trade? Put another way,
when should a board of trade be deemed to be a U.S. board of trade that
is required to be designated as a contract market under Section 5 of
the Act in order to offer its products lawfully within the U.S.? Should
the Commission permit foreign boards of trade to place dedicated
computer terminals in the U.S., or permit foreign boards of trade or
their parties to provide persons in the U.S. with computer software
that provides electronic access to a foreign board of trade, without
the foreign board of trade first being designated as a U.S. contract
market? \6\ To the extent that ``terminals'' of foreign boards of trade
are allowed to be placed in the U.S. for trading without the foreign
board of trade being designated as a contract market, what conditions
should apply? And finally, with respect to the interface with foreign
board of trade terminals, to what extent should customer use of
automated order routing and execution systems be permitted and what
safeguards, restrictions and conditions should apply to their use?
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\6\ A discussion concerning how to define ``computer terminal''
or some similar term is found at Section II.B.1, below, and makes
clear that the Commission would intend this term (and this release)
to cover not only dedicated proprietary terminals, but also certain
other technologies that are used in a similar manner.
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As described below, certain Commission staff have addressed some
inquiries concerning electronic access to foreign boards of trade from
within the U.S. by way of no-action letters. These staff letters do not
constitute Commission action and do not establish any precedent. They
merely convey the views of certain staff members that they will not
urge the Commission to take enforcement action for violation of the Act
or Commission regulations by the requestor of the letter if certain
conditions are met. The Commission is free to act contrary to the views
expressed by staff in such letters. The Commission now finds it
appropriate to review the views set forth by certain Commission staff
in these letters and to seek public comment on the proper approach for
oversight going forward. The Commission desires to act as quickly as
practicable in this regard and, accordingly, intends to adhere strictly
to the 60-day comment period provided for in this release.
A. Prior Views of Certain Commission Staff Concerning Terminal
Placement in the U.S.
1. Prior Staff Views Related to Listing Products of Foreign Boards of
Trade on Globex
The first two letters issued by Commission staff that addressed
issues concerning automated trading in the U.S. by foreign boards of
trade involved trading through the Chicago Mercantile Exchange
(``CME'') Globex system (``Globex'').\7\ The first letter was a
response to a request from the CME for an opinion regarding whether
trading contracts of a foreign board of trade through Globex computer
terminals in the U.S. required the foreign board of trade to obtain
contract market designation pursuant to Section 5 of the Act (``CME
Letter'').\8\ In the CME Letter, the Commission's Division of Trading
and Markets (``Division'') noted that, consistent with Section 4(b) of
the Act, the Commission has not issued rules governing the terms and
conditions of contracts traded on foreign boards of trade or the rules
or actions of foreign boards of trade. The Division provided its view
that trading of contracts of foreign boards of trade through Globex
terminals in the U.S. should not cause the Commission to deem any
foreign board of trade for which products are listed through that
system to be a domestic board of trade. The Division noted, however,
that it would review the particulars of any proposal to trade the
contracts of a foreign board of trade through Globex in light of the
Commission's obligations under the Act to maintain the integrity of
U.S. markets and to provide for the protection of U.S. customers.\9\
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\7\ Globex is an automated order entry and matching system for
futures and options on futures. See note 25, infra, and accompanying
text.
\8\ See Letter from Andrea M. Corcoran, Director, Division of
Trading and Markets, to Carl Royal, Vice President and General
Counsel, CME (May 26, 1989).
\9\ In a later no-action position, the Division also granted the
CME and Chicago Board of Trade (``CBT'') so-called ``pass the book''
relief, which allows CME and CBT member firms the flexibility to
provide continuous access to Globex trading without the need for
members to staff their offices 24 hours a day. The letter permits
CME and CBT member firms to conduct Globex-related U.S. customer
business through the offices of a foreign affiliate without
requiring the foreign affiliate to register separately with the
Commission as a futures commission merchant (``FCM''). Thus, CME
contracts may be traded on Globex terminals located in non-U.S.
offices of foreign affiliates of FCM-registered CME members, and
U.S. customers may place orders for such contracts on Globex by
contacting the FCMs' affiliates during hours that the CME floor is
closed. The term ``passing the book'' is used to describe the
process by which a customer order that is placed outside of regular
U.S. business hours is transferred for entry into a Globex terminal
located in a non-U.S. office of a foreign affiliate of an exchange
member firm. CFTC Interpretative Letter No. 92-11, [1990-1992
Transfer Binder] Comm. Fut. L. Rep. (CCH) para.25,325 (June 25,
1992), superseded in part by CFTC Interpretative Letter No. 93-83,
[1992-1994 Transfer Binder] Comm. Fut. L. Rep. (CCH) para.25,849
(Aug. 9, 1993).
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The Division issued a second letter on related issues to the Marche
a Terme International de France (``MATIF'') in response to MATIF's
request that the Commission confirm that it would not assert
jurisdiction over MATIF or MATIF contracts traded on Globex (``MATIF
Letter'').\10\ In its response, the Division, among other things,
reiterated its view that the mere trading of foreign board of trade
products through Globex terminals in the U.S. should not cause any
foreign board of trade for which products are listed through the Globex
system to be deemed a domestic board of trade.\11\
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\10\ See Letter from Andrea M. Corcoran, Director, Division of
Trading and Markets, to Gerard Pfauwadel, President, MATIF (May 7,
1990).
\11\ The Commission later approved a formal cross-exchange
access program between CME and MATIF. The Commission's approval of
the CME/MATIF cross-exchange access program and other ``trading
link'' programs is discussed in Section I.B., below.
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[[Page 39781]]
2. Prior Staff Views Concerning the Placement of Foreign Board of Trade
Terminals in the U.S.
The Deutsche Terminborse (``DTB'') \12\ was the first foreign board
of trade to seek and receive a staff no-action letter for U.S.
placement of computer terminals for execution of trades on its market.
The DTB sought a no-action position from Commission staff regarding
placement of DTB computer terminals in the U.S. officers of its members
for their principal trading purposes \13\ and, where the DTB member is
also an FCM registered under the Act, on behalf of U.S. customers as
well, without obtaining designation as a contract market. After
analyzing, among other things, the German regulatory structure and
DTB's order processing network, clearing process and trading system
integrity and architecture, the Division issued a no-action letter
subject to the following conditions imposed upon DTB and their U.S.-
located members who seek to place terminals in their offices.\14\
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\12\ On June 18, 1998, DTB changed its name to Eurex Deutschland
as a step toward a planned merger later this year with the Swiss
Options and Financial Futures Exchange (``SOFFEX''). For the sake of
historical accuracy and simplicity we will continue to refer to the
DTB in this release.
The DTB is headquartered in Frankfurt, Germany, and is a fully
automated international futures and option exchange on which all
trades are executed and cleared electronically. Trading is conducted
solely via computer terminals. The market participants' computers
and terminals are linked to the DTB computer center by means of a
wide-ranging telecommunications network. As noted above, DTB and
SOFFEX plan to merge to create Eurex AG. Further, CBT, DTB and
SOFFEX have signed a letter of intent to form an electronic trading
link between CBT and Eurex with the eventual goal of providing users
of Eurex and Project A (the CBT's adjunct electronic trading system,
discussed in Section I.C.below) with access to both markets from a
single screen.
\13\ A ``principal'' trade under DTB rules is limited to a trade
made by a DTB member for its own account. DTB's definition of
``principal'' is narrower than the definition of ``proprietary'' in
Commission Rule 1.3(y). A proprietary trade under Commission rules
would include not only trades of board of trade members for their
own accounts, but also those made by certain members' affiliates and
insiders for the their respective accounts.
\14\ See CFTC Interpretative Letter No. 96-28, [1994-1996
Transfer Binder] Comm. Fut. L. Rep. (CCH) para.26,669 (Feb. 29,
1996). The Division's letter did not alter DTB's obligations to: (a)
request a no-action position from the Commission prior to engaging
in the offer or sale of any foreign stock index futures in the U.S.;
or (b) have any foreign debt obligation first designated as an
``exempt security'' by the Securities and Exchange Commission
(``SEC'') before engaging in the offer of sale of any futures
contract or option thereon in the U.S. Section 2(a)(1)(B)(v) of the
Act states generally that no person shall offer or enter into a
contract of sale for future delivery of any security except an
``exempt security'' under Section 3 of the Securities Act of 1933 or
Section 3(a)(12) of the Securities Exchange Act of 1934.
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1. DTB terminals will be located only in the U.S. offices of DTB
members;
2. Only DTB members that also are U.S.-registered FCMs may trade
for customers--non-FCM DTB members are limited to principal-only
trading;
3. DTB members will (a) provide the Commission and the National
Futures Association (``NFA'') with access to their books and records
and the premises where DTB terminals are installed, and (b) consent to
U.S. jurisdiction with respect to compliance with relief provided in
the no-action letter;
4. All DTB members that will operate pursuant to the relief granted
will be identified to the Commission and NFA;
5. Upon request, DTB (a) will provide the Commission with
information received from its members regarding the location of DTB
terminals in the U.S. and (b) will update the information on a periodic
basis;
6. DTB will continue to comply with the International Organization
of Securities Commissions (``IOSCO'') ``Principles for Oversight of
Screen-Based Trading Systems for Derivative Products'';\15\
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\15\ The Commission has adopted principles formulated by a
working group of IOSCO for the regulatory review of automated
trading systems. These principles address the following topics:
1. Compliance with applicable legal standards, regulatory
policies, and/or market custom or practice where relevant;
2. The equitable availability of accurate and timely trade and
quotation information;
3. The order execution algorithm used by the system;
4. Technical operation of the system that is equitable to all
market participants;
5. Periodic objective risk assessment of the system and system
interfaces;
6. Procedures to ensure the competence, integrity, and authority
of system users and to ensure fair access to the system;
7. Consideration of any additional risk management exposures
pertinent to the system;
8. Mechanisms in place to ensure that the information necessary
to conduct adequate surveillance of the system for supervisory and
enforcement purposes is available;
9. Adequacy of risk disclosure, including system liability; and
10. Procedures to ensure that the system sponsor, providers, and
users are aware of and will be responsive to relevant regulatory
authorities.
See Policy Statement Concerning the Oversight of Screen-Based
Trading Systems, 55 FR 48670 (Nov. 21, 1990), in which the
Commission adopted the principles set forth in the IOSCO report
entitled ``Screen-Based Trading Systems for Derivative Products''
(June 1990).
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7. DTB will submit on at least a quarterly basis information
reflecting the volume of trades from U.S.-based computer terminals
compared to DTB's overall trading volume; and
8. DTB will provide the Division with prompt notice of all material
changes to any DTB rules or German laws that may impact the provided
relief.
In analyzing DTB's no-action request, the Division reiterated the
positions set forth in the Globex letters discussed above. The Division
concluded that no public interest would be affected adversely by DTB
members having access to DTB terminals in the U.S. because (1) no
customer trading would be permitted from U.S.-based terminals unless
the DTB member firm is registered as an FCM and (2) the Commission's
ability to inspect relevant books and records and the premises where
DTB terminals are installed, in combination with information-sharing
assurances received from the German Federal Securities Supervisory
Office (``BAWe''),\16\ provided an adequate basis for supervision of
such trading. The Division noted that the DTB and/or the relevant
German state or federal regulatory authorities have rules, systems, and
compliance mechanisms in place that address, among other things, the
processing of orders, including prioritization and execution (i.e.,
DTB's order execution algorithm), and the timely availability of
information necessary to conduct adequate surveillance of the DTB
system for supervisory and enforce purposes.\17\ Further, DTB members
located in the U.S. are permitted to enter trades for, and access
trading screens of, only those contracts permissible for trading by
U.S. persons.\18\ Finally, the Division also emphasized the importance
of DTB's agreement to provide information to the Commission concerning
the location of terminals in the U.S. and the volume of trades
originating from the U.S.
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\16\ The BAWe carries out oversight of the German securities and
futures markets pursuant to the German Securities Trading law and is
the central authority in Germany for cooperation with the Commission
in questions of futures trading oversight and in matters that are
subject to the oversight of the German Federal States.
\17\ In this regard, DTB terminals located in the U.S. have a
systems capability to ``time stamp'' the execution of customer
orders so that an electronic ``audit trail'' is maintained.
\18\ See note 14, supra.
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The no-action position taken in the DTB letter was based upon,
among other things, the premise that the DTB is a ``bona fide foreign
board of trade'' whose main business activities take place in Germany.
By conditioning its letter on the DTB providing the Division with
quarterly updates of DTB's U.S.-originated trading volume, the Division
intended to leave open the possibility that at some point DTB's
activities in the U.S. might rise to a level that would necessitate
greater Commission regulation.
The initial DTB no-action letter was modified in a no-action letter
to the DTB dated, May 9, 1997, in which the Division agreed not to
recommend Commission enforcement action if DTB terminals
[[Page 39782]]
were placed in DTB member firm booths at the CME, subject to compliance
with the terms and conditions of the original DTB letter.\19\ Under the
May 1997 letter, no enforcement action would be recommended if DTB
terminals are placed only at booths of firms that are both CME and DTB
members; only DTB contracts authorized or permissible for trading by
U.S. persons are eligible to be traded from the terminals; no CME
contracts are traded via the terminals; and CME has no involvement in
clearance or settlement of the contracts. Currently, there are no
terminals in DTB member firm booths at the CME.
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\19\See Letter from Andrea M. Corcoran, Director, Division of
Trading and Markets, to Volker Potthoff, Senior Vice President and
Dr. Ekkehard Jaskulla, Deutsche Borse AG (May 9, 1997).
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Pursuant to the DTB no-action letters, if a DTB member located in
the U.S. wishes to install a DTB terminal in its office, the DTB itself
must make a written filing to the NFA on behalf of that member. The DTB
makes this filing after a DTB member applies to the DTB to place a DTB
terminal in the U.S. The filing identifies the member that intends to
operate a DTB terminal in the U.S. and includes: (1) A Declaration
signed by the member whereby the member declares that it acknowledges
(a) the terms and conditions of the division's no-action letter and
that it will comply therewith and (b) its obligation to inform DTB in
writing of any changes regarding its DTB membership or the placement of
DTB terminals in the U.S.; and (2) an Acknowledgment of Jurisdiction
signed by the member whereby the member acknowledges that (a) for
purposes of the DTB no-action letter it is subject to the Act and the
Commission's regulations thereunder, (b) it will provide upon request
prompt access to original books and records and the premises where DTB
terminals are installed in the U.S., and (c) the person signing the
Acknowledgment on behalf of the member is duly authorized to do so.
Under the terms of the Division's no-action letter, the DTB member may
begin trading on its U.S.-based DTB terminal five business days after
the DTB member is identified to the NFA unless NFA or the Division
informs DTB otherwise. The DTB does not inform the member of the
approval of its application until the five-day period has passed.
B. Commission Approval of the Trading of Products of Foreign Boards of
Trade in the U.S. Pursuant to Trading Link Programs
As noted above, the Division issued the MATIF Letter which, among
other things, enunciated the Division's view that the trading of MATIF
products through Globex terminals in the U.S. should not cause MATIF to
be deemed a domestic board of trade. After the issuance of the MATIF
Letter, the Commission approved a formal cross-exchange access program
between CME and MATIF previously submitted by CME, which allows CME and
MATIF members to enter orders through Globex terminals located in the
U.S. and France, respectively, to buy and sell each other's
products.\20\ Under the program, the rules of the exchange whose
products are traded apply to the members of the other exchange when
they trade those products. Accordingly, CME members trading MATIF
contracts through Globex terminals located in the U.S. are subject to
MATIF's Globex trading rules, while MATIF members trading CME contracts
through Globex terminals located in France are subject to CME's Globex
trading rules.
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\20\ The Commission took this action pursuant to the regulatory
authority provided under Section 5a(12), now Section 5a(a)(12)(A),
of the Act. See Letter from Jean A. Webb, Secretary of the
Commission, to Eileen T. Flaherty, Associate General Counsel, CME
(Sep. 25, 1992).
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In approving the CME-MATIF proposal, the Commission evaluated
MATIF's Globex trading rules, CME and MATIF rules regarding member
eligibility to participate in the cross-exchange program, how each
exchange would monitor its members in trading the other exchange's
contracts, and the market surveillance and financial and sales practice
rules that would apply in each instance.\21\ The Commission noted and
relied on the fact that MATIF'S Globex trading rules governing trading
of MATIF contracts are generally the same as the CME's Globex trading
rules. Accordingly, all market participants trading MATIF contracts
through Globex are subject to the same trading rules whether they are
CME members or MATIF members.
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\21\ The responsibility for enforcing each exchange's Globex
trading rules is shared between the two exchanges. Surveillance for
compliance with these rules by those trading over the Globex
terminals is the responsibility of the exchange whose contracts are
traded. Each exchange continues to carry out its own market
surveillance activities for all its contracts traded on a terminal,
and each exchange's members continue to be subject to their
respective exchange's financial and sales practice requirements.
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Pursuant to its regulatory authority, the Commission also approved
last year a reciprocal trading link between the CBT and the London
International Financial Futures and Options Exchange (``LIFFE'').\22\
The parties to this linkage have determined not to operate the linkage
at this time, but the Commission's evaluation of the proposal remains
illustrative of the Commission's standards and requirements for link
arrangements which allow products of foreign boards of trade to be
traded in the U.S. Under the CBT-LIFFE trading link, each exchange can
list the other's major financial futures and option contracts for
trading on its floor by open outcry during regular trading hours. In
evaluating this trading link, the Commission compared the trading rules
and member eligibility rules of LIFFE with those of the CBT and
analyzed the manner in which surveillance and investigations related to
contracts traded over the link could be implemented effectively at each
board of trade. The Commission approved this trading link under the
condition, inter alia, that LIFFE-designated contracts traded on CBT be
subject to CBT rules.
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\22\See Letter and Order from Jean A. Webb, Secretary of the
Commission, to Paul J. Draths (May 6, 1997).
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The Commission also has approved other trading arrangements
commonly referred to as trading links whereby products of U.S.
designated contract markets can be traded through automated trading
system terminals located in foreign jurisdictions.\23\ These
arrangements do not, however, allow the trading of the foreign
exchanges' products in the U.S.\24\
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\23\ In 1995, the New York Mercantile Exchange (``NYMEX'')
established a linked access arrangement with the Sydney Futures
Exchange (``SFE'') and linked SFE terminals located in Sydney to the
NYMEX ACCESS trading system. In 1997, a linked access arrangement
between NYMEX and the Hong Kong Futures Exchange (``HKFE'')
permitted HKFE members to trade NYMEX contracts on NYMEX ACCESS
terminals located in Honk Kong.
\24\ These arrangements are referred to in Section I.C., below,
which discusses foreign regulators' treatment of U.S. terminals
placed in their jurisdictions. See note 27, infra.
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C. Foreign Regulators' Treatment of U.S. Terminals in Their
Jurisdictions
Several U.S. futures exchanges have developed automated trading
systems for exchange members and their customers to trade in certain of
the exchanges's futures and options contracts after regular trading
hours. The CME's Globex system, for example, is an electronic trade
execution system developed by the CME and Reuters for trading CME
contracts, generally outside regular business hours.\25\ Globex brings
[[Page 39783]]
buy and sell orders together by linking individual terminals to a
central computer where orders are processed. NYMEX and the CBT also
have developed automated trading systems, known as NYMEX ACCESS and
Project A, respectively.\26\
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\25\ Although the Globex system originally was intended as an
after-hours system for trading products otherwise traded on the
floor of the CME, the CME now trades E-mini Standard and Poor's 500
contracts both on Globex and on the floor of the CME, depending upon
the size of the order, during regular trading hours. The CME
recently announced that it intends to launch a new electronic
trading system, ``GLOBEX2,'' in September 1998 in a joint venture
with MATIF. GLOBEX2 will use a new system architecture that will
replace that currently used by the Globex system.
\26\ Certain CBT contracts initially were listed for trading on
Globex. However, CBT later withdrew from participation in the Globex
system to develop its own automated trading system, Project A.
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CME, NYMEX A and CBT each have computer terminals located in
certain foreign countries on which trading for foreign firms and
customers is conducted.\27\ CME Globex terminals are located abroad in
the offices of both CME members and offshore affiliates of those
members. Similarly, NYMEX ACCESS terminals are located in offices of
NYMEX members and affiliates thereof. The CBT Project A terminals in
the U.K. are located in branch offices of CBT members and in the
offices of affiliates of CBT members. CBT, NYMEX and CME permit users
of their terminals in foreign countries to trade for both proprietary
and customer accounts.
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\27\ As of the beginning of 1998, the CME had placed Globex
terminals in the U.K., Hong Kong, Japan, France and Bermuda, NYMEX
ACCESS terminals were located in Australia, Hong Kong and the U.K.,
and CBT's Project A terminals were located in the U.K.
In certain cases, a board of trade in the foreign jurisdiction
in which U.S. terminals are located has formal business agreements
or arrangements with the U.S. exchange that has placed terminals in
that country. For example, agreements exist between NYMEX and the
SFE and the HKFE, respectively, which permit SFE and HKFE members to
trade products on NYMEX ACCESS. Likewise, there is an agreement in
effect between the CME and MATIF that permits, under certain
circumstances, each exchange to trade the contracts of the other
through Globex. As discussed above, the Commission has approved the
necessary CME and NYMEX rule changes enabling these agreements and
has permitted the trading arrangements proposed by these exchanges,
subject to certain conditions. See Letters from Jean A. Webb,
Secretary of the Commission, to Ronald S. Oppenheimer, Esq.,
Executive Vice President and General Counsel, NYMEX (June 5, 1997);
Letter from Jean A. Webb, Secretary of the Commission, to Ronald S.
Oppenheimer, Esq., Executive Vice President and General Counsel,
NYMEX (Sep. 1, 1995); Letter from Jean A. Webb, Secretary of the
Commission, to Eileen T. Flaherty, Associate General Counsel, CME
(Sep. 25, 1992).
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Foreign jurisdictions vary in their approaches to reviewing
requests by U.S. boards of trade to place computer terminals in their
countries. A non-U.K. board of trade that wishes to place computer
terminals in the U.K., for example, must first become a ``recognised
overseas investment exchange'' (``ROIE'') under Section 40 of the
Financial Services Act (``FSA'').\28\ Under the FSA, an application by
a non-U.K. board of trade for treatment as an ROIE is reviewed to
ensure, among other things, that: (1) Investors in the U.K. are
afforded protections at least equivalent to those provided by the FSA
for customers trading on or subject to the rules of U.K. boards of
trade; (2) the applicant is willing to cooperate by sharing information
with U.K. regulators; and (3) adequate arrangements exist for
information sharing between the applicant's regulator and U.K.
regulators. The FSA also provides that, in determining whether it is
appropriate to ``make a recognition order,'' a relevant consideration
is the extent to which persons in the U.K. and the country of the
applicant have access to each other's financial markets.
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\28\ CME, NYMEX and CBT were designated as ROIEs prior to
placing computer terminals in the U.K.
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The procedures for approval of U.S board of trade terminal
placement appear somewhat less formal in other foreign countries,
although each jurisdiction appears to require some form of review by
the jurisdiction's regulatory authorities prior to allowing a U.S.
board of trade to place computer terminals in its country. Australia
and Hong Kong, for example, appear to require foreign boards of trade
to be approved through an exemption process.\29\ In France, the
placement of terminals must be recognized by the Ministry of Finance.
Prior to installing terminals, the Commission des Operations de Bourse
(``COB'') must be informed of the dates that screens will be installed
and the location of their intended installation. Additionally, a
foreign firm operating a terminal must comply with French rules
governing disclosure and solicitation of the public. In Japan, approval
by the Ministry of Finance is necessary before trading may take place
through ``foreign screen-based systems.''\30\
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\29\ On August 30, 1995, the Australian Federal Attorney General
signed a Declaration exempting NYMEX ACCESS from regulation under
the Australian Corporations Law, subject to certain conditions
pertaining primarily to information sharing between the SFE an NYMEX
and disciplinary procedures for breaches of NYMEX ACCESS trading
rules. With respect to the placement of Globex and NYMEX ACCESS
terminals in Hong Kong, the Hong Kong Securities and Futures
Commission requested that it be kept informed with respect to
operations of terminals with Hong Kong dealers and requested
information-sharing arrangements with the CME and NYMEX.
\30\ The Japanese Ministry of Finance informed the CME of its
approval with respect to the placement of Globex terminals in Japan
by letter to the CME on February 8, 1993.
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D. Order Routing and Execution of U.S. Customers Order on a Foreign
Board of Trade
In developing the Commission's policy with respect to the treatment
of foreign board of trade computer terminals in the U.S., it is helpful
to review the basic methods by which a U.S. customer traditionally
placed orders for products offered on a foreign board of trade where
computer terminals of that exchange were not located within the U.S.
U.S. customers traditionally have transacted business on a foreign
board of trade by way of: (1) Communicating through a U.S.-registered
FCM or IB; or (2) communicating with a foreign firm that has received
an exemption from registration under Part 30 of the Commission
rules.\31\ U.S. customers traditionally have placed orders via the
telephone. In the case of a communication from a U.S. customer to a
U.S.-registered FCM or IB, the FCM or IB generally would relay the
customer's order for execution to a foreign member of the foreign board
of trade by telephone or other means (e.g. facsimile transmission). The
trade would be carried on the books of the foreign firm on an omnibus
basis.\32\ If the U.S. customer communicated directly with a foreign
firm with a Part 30 exemption, the foreign firm simply would execute
the customer's trade either electronically or on the floor of an
exchange, as appropriate. With advances in available technology, many
intermediaries are implementing automated order routing systems that
allow customers electronically to submit their orders and that are
intended to pass these orders to a board of trade with minimal, if any,
human intervention. Issues concerning such automated systems are
discussed in Section II. C. 2., below.
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\31\ In general, under the Commission's Part 30 rules, foreign
brokerage firms may be exempted from the registration requirements
of the Act provided that the Commission determines that the firm is
subject to comparable rules and regulations in its home country. 17
CFR part 30.
\32\ If contact with U.S. customers is limited to carrying the
customer omnibus account of the U.S. FCM for execution on the
foreign exchange, the foreign firm would not be required to register
with the Commission as an FCM or receive an exemption under Part 30.
See CFTC Interpretative Letter No. 87-7 [1987-1990 Transfer Binder]
Comm. Fut. L. Rep. (CCH) para. 23,972 (Nov. 17, 1987).
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II Request for Comment
The Commission solicits comment from the public on the broad range
of issues related to providing electronic access to a foreign board of
trade from within the United States. The Commission notes that any
action taken
[[Page 39784]]
in this area must ensure the Commission's ability to carry out its
obligations under the Act to maintain the integrity of the U.S. markets
and to provide protection to U.S. customers. At the same time, the
Commission believes that its regulatory approach should not inhibit
cross-border trading by imposing unnecessary regulatory burdens.
As a means of raising relevant issues and facilitating a discussion
thereon, this concept release provides a framework that may form the
basis for a later rulemaking. For example, Division staff has explored
the possibility of a new rule that might be included among the
Commission's Part 30 rules (concerning foreign futures and options
transactions) and could implement a two-step procedure similar in some
respects to that currently in effect under Rule 30.10 with respect to
foreign firms that wish to obtain an exemption from compliance with the
Commission's part 30 regulations.\33\
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\33\ Commission Rule 30.10 is an exemptive provision that allows
the Commission to exempt foreign firms from the application of
certain CFTC rules and regulations (e.g., those governing
registration and financial requirements) based upon substituted
compliance by a firm with comparable regulatory requirements imposed
by the firm's home-country regulator. In considering a request from
a foreign regulatory or self-regulatory authority for Rule 30.10
comparability relief, the Commission considers, among other things:
(1) registration, authorization or other form of licensing, fitness
review, or qualification of persons through whom customer order are
solicited and accepted; (2) minimum financial requirements for those
persons that accept customer funds; (3) minimum sales practice
standards, including disclosure of risks and the risk of
transactions undertaken outside of the U.S.; (4) procedures for
auditing compliance with the requirements of the regulatory program,
including recordkeeping and reporting requirements; (5) protection
of customer funds from misapplication; and (6) the existence of
appropriate information-sharing arrangements. The Commission has
issued orders to permit certain foreign firms that have
comparability relief under Rule 30.10 to engage in limited marketing
activities of foreign futures and option products from locations
within the U.S. See orders of October 28, 1992 and August 4, 1994.
57 FR 49644 (Nov. 3, 1992) and 59 FR 42156 (Aug. 17, 1994),
respectively.
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Under the potential procedure envisioned by the Division, a foreign
board to trade initially would petition the Commission for an order to
place its computer terminals in the U.S. without being designated as a
U.S. contract market. If the Commission issued the requested order, a
member of the board of trade or an affiliate of a member would then be
permitted to request confirmation of relief under the order to allow
the member or affiliate to place and to operate a foreign board of
trade computer terminal in the U.S., subject to appropriate conditions
contained in the order. The remainder of the concept release describes
this potential approach more fully and raises a variety of issues
concerning foreign board of trade terminal placement and use in the
U.S. generally. The following discussion assumes that a foreign board
of trade wishes to place computer terminal in the U.S. without being
designated as a contract market. Any foreign board of trade, of course,
may apply for designation as a U.S. contract market and, upon the
Commission's approval of such designation, may offer its products in
the U.S. subject to rules for U.S. contract markets.
A. A Possible Approach for Foreign Terminal Placement and Use in the
U.S.
1. Petition Procedure
As noted above, under the possible approach envisioned by Division
staff, a foreign board of trade would be required to petition for an
order that would allow the foreign board of trade to place its computer
terminals in the U.S.\34\ In evaluating DTB's request for a no-action
position to allow it to place computer terminals in the U.S., the
Division reviewed, among other things the following information
provided by the DTB: (1) An overview of the DTB, including the
regulatory structure applicable to the operation of the DTB and
transactions thereon; (2) a description of the order processing network
utilized by the DTB; (3) a description of the DTB's clearing process;
(4) a description of the system integrity and architecture of the DTB
system, including security arrangements and procedures regarding system
failures; and (5) a description of the contracts which initially were
to be traded on the DTB through computer terminals located in the U.S.
and a discussion of the rules and regulations governing such
contracts.\35\ The Commission's petition procedure could set forth a
specific list of items, similar to the information reviewed as part of
the DTB's no-action request. The Commission could review all of the
information received from each petitioner and, based upon the totality
of the information received, make a determination as to whether an
order of exemption should be issued. Under such an approach no
particular piece of information would necessarily be dispositive. The
Commission could publish petitions in the Federal Register for public
comment.\36\ The Commission requests comment as to whether specific
tests should be used to evaluate each required item of information
rather than reviewing all of the information based upon a ``totality of
the circumstances.'' If so, what tests are appropriate for each
category of information discussed below?
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\34\ Given the type and scope of information concerning the
foreign board of trade and its operations that likely would be
required to be provided to the Commission in a petition, it would be
most appropriate for the foreign board of trade itself to submit
such a petition. However, the Commission requests comment as to
whether it would be feasible and appropriate to allow the petition
to be submitted on behalf of the foreign board of trade by a member
of the foreign board of trade or an affiliate thereof or by the
foreign board of trade's foreign regulatory authority.
\35\ Requirements with respect to the offer and sale of foreign
stock index futures and futures and option contracts on foreign debt
obligations would still be applicable if the Commission were to
adopt the procedure outlined herein. See also, note 14, supra.
\36\ The Commission could, upon the request of a petitioner,
limit the public availability of information if it determined that
such information constituted a trade secret or that public
disclosure would result in material competitive harm to the
petitioner.
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Six general categories of information might be requested.\37\ (1)
General information concerning the petitioner foreign board of trade
and its products; (2) information concerning the petitioner's rules and
regulations, the laws and regulations in effect in the petitioner's
home country, and the methods for monitoring compliance therewith; (3)
information related to the petitioner's technological system and
standards; (4) financial and accounting information pertaining to the
petitioner; (5) information concerning the ability of U.S. boards of
trade to place and operate computer terminals in the petitioner's home
country; and (6) information concerning the petitioner's intended U.S.
activities and presence. More specifically, the first category of
information discussed above (general information concerning the
petitioner and its products) could include information such as the
petitioner's main business address, its address in the U.S. for service
of process, a copy of the petitioner's organizational documents and a
list of the contracts that the petitioner desires to trade in the U.S.
through its terminals.
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\37\ Information requested would be required to be translated
into English where appropriate.
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The next category of information concerning the regulatory
requirements of the petitioner and its home regulatory authority might
include: (1) A copy of the petitioner's rules; (2) a list of the
persons responsible, and the supervisory arrangements in place, for
monitoring compliance with respect to those rules of the petitioner
that apply to activities conducted in the U.S.; and (3) a comprehensive
discussion of the regulatory structure in the petitioner's home
country. This last point might include information on the following:
(a) the regulatory authorities to which the petitioner is subject in
its home
[[Page 39785]]
country and the petitioner's status under the laws of the country; (b)
applicable requirements established by law or by regulatory and self-
regulatory authorities in the petitioner's home country regarding the
protection of customer funds (including in the event of insolvency),
recordkeeping, reporting, timing of transactions, allocation of orders,
ability to obtain the identity of customers, including rules concerning
entry of account numbers, and trade practice standards, including any
rules concerning prearranged trading, noncompetitive trading,
``frontrunning,'' trading ahead of customers, wash sales and bucketing
of transactions; (c) procedures employed by the regulatory and self-
regulatory authorities in the petitioner's home country to ensure
compliance with their rules, including a history of market failures and
defaults in the petitioner's home country; (d) information sharing
arrangements in effect among the relevant regulatory authorities and
the Commission, including information concerning any blocking statutes
or data protection laws in effect in the petitioner's home country
which might impair the Commission's ability to obtain information under
such an arrangement; and (e) a discussion of any disciplinary action
taken against the petitioner by its home country regulatory
authorities. For petitioners that have received an exemption under
Commission Rule 30.10 or petitioners from a jurisdiction where another
entity has received such an exemption, providing the information
discussed above concerning the petitioner's home country regulatory
requirements would likely prove duplicative in some respects. The
Commission requests comment generally on means by which the Commission
could prevent unnecessary duplication of information.
Information concerning technological systems and standards of the
petitioner might include a discussion of the order processing system,
its system integrity and architecture and its clearing and settlement
process. A discussion of the order processing system might include,
among other things, a complete discussion of the order execution
algorithm for each contract traded (to the extent the algorithm differs
by contract). The discussion of the system integrity and architecture
might include, for example, the location of computer servers (if
appropriate), information concerning the processing time for executed
transactions, security arrangements and procedures regarding system
failures that govern U.S.-placed computer terminals, including a
discussion of liability for market interruptions, and a discussion as
to whether these features and procedures differ (and, if so, how they
differ) from those used in the petitioner's home country or on
petitioner's computer terminals located in other countries, if any.
General financial information and trading volume data might include
the petitioner's most recent annual financial statements and the total
trading volume, on a contract-by-contract basis and in the aggregate,
for its most recent year and most recent quarter (or other period if
data is not maintained on an annual and quarterly basis). The
Commission requests comment generally as to what types of trading
volume information are maintained by foreign boards of trade and how
volume is calculated. More specifically, the Commission requests
comment as to whether foreign boards of trade maintain information such
that it would be feasible to provide the Commission with information
concerning, for each contract traded and in the aggregate, the
percentage of trading volume that originates from U.S. registered FCMs,
the percentage of trading volume that originates from U.S. customers,
and the percentage of trading volume that originates from each other
jurisdiction where trading activity occurs.
Each petitioner might be required to provide a statement from its
home country regulator as to any requirements or restrictions placed by
authorities in its home country on U.S. boards of trade with respect to
the placement and operation of computer terminals or the sale of
products in such country. If any such requirements or restrictions
exist, the statement might include a description of the restrictions or
regulations, be accompanied by copies of any relevant statutes or other
relevant legal materials, and include a description of the application
process, if any, required for a U.S. board of trade and their members
or affiliates of members to place its computer terminals and/or to sell
products in the petitioner's home country.
Information concerning the petitioner's U.S. activities might
include, for example, information concerning the location of any
office, delivery points or employees of the foreign board of trade
within the U.S. and any marketing, educational or other activities in
the U.S. in which the foreign board of trade engages. The Commission
requests comment regarding the appropriateness of each of these items
of information and encourages commenters to address what additional
information might prove valuable for the Commission to consider in
evaluating a petition from a foreign board of trade to place its
terminals in the U.S.
2. Conditions of an Order
Under Commission Rule 30.10, the Commission may, upon request,
grant a petition of a foreign firm for an exemption from certain Part
30 requirements ``subject to such terms and conditions as the
Commission may find appropriate.'' In developing a rule concerning
foreign board of trade terminal placement in the U.S., the Commission
could reserve for itself similar flexibility to issue orders to a
foreign board of trade subject to appropriate terms and conditions.
Moreover, the rule could set forth certain conditions that the
Commission would include, at a minimum, in each order allowing U.S.
terminal placement by a foreign board of trade. The Division staff has
urged that many of these conditions should be similar to those imposed
upon the DTB in the Division's no-action letter, discussed above. The
Commission requests comment on the following list of conditions that
might be included in a Commission order:
1. Computer terminals must be located only in the offices of
members of the foreign board of trade and their affiliates or in a
member's or affiliate's firm booth on the floor of a U.S. board of
trade;
2. Any member or affiliate thereof that executes trades under an
order must be registered as an FCM unless it trades solely for its
proprietary account; \38\
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\38\ ``Proprietary account'' as used herein has the same meaning
as that contained in Commission Rule 1.3(y).
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3. The foreign board of trade must notify the Commission in writing
immediately of any material changes in the information provided in its
petition to the Commission, in its rules, or in the laws or rules of
its home country;
4. The foreign board of trade must notify the Commission
immediately of any Known violations of the order, the Act, the
Commission's regulations, or any other futures regulatory scheme by the
board of trade or by a member of affiliate operating under a Commission
order;
5. The foreign board of trade, in order to ensure compliance with
the terms of the Commission's order, must conduct an on-site review of
the activities of each member or affiliate operating under the order at
least every two years or upon notice of a possible violation of the
order.\39\
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\39\ Comment is requested on whether to permit the foreign board
of trade to arrange for NFA or a U.S. self-regulatory organization
to conduct the required on-site review. The Commission also requests
comment as to whether the on-site review is appropriate and, if so,
whether it should be conducted more or less frequently than
biennially.
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[[Page 39786]]
6. Satisfactory information sharing arrangements must be in effect
among the appropriate regulatory authorities and the Commission;\40\
and
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\40\ The Commission requests comment concerning whether its
rules should specify particular elements that would be required to
be included in a ``satisfactory'' information sharing arrangement
and, if so, what elements are appropriate. Additionally, the
Commission requests comment as to who should be a party to such an
arrangement. Should the arrangement be only between the Commission
and the relevant home country regulator, or should the foreign board
of trade itself be a party to the arrangement?
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7. The foreign board of trade must provide the Commission with
quarterly reports indicating: (a) With respect to each contract traded
through U.S. computer terminals, (i) the total trade volume, and (ii)
the trade volume broken down by customer and proprietary trades; (b)
with respect to each contract traded through computer terminals in
other jurisdictions, the total trade volume by jurisdiction and in the
aggregate; and (c) with respect to all contracts traded on the board of
trade (whether traded in the U.S. or elsewhere), the total trading
volume for the period and by contract.\41\ If applicable, the foreign
board of trade also would be required to provide quarterly reports
indicating the stocks held as of the end of the quarter at any
warehouse maintained by in the U.S. for products that require physical
delivery;
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\41\ The Commission requests comment as to what information
foreign boards of trade currently maintain concerning trading volume
on a jurisdiction by jurisdiction basis and, in particular, whether
foreign boards of trade currently maintain information in a manner
that would enable them to provide the Commission with quarterly
reports indicating the percentage of its total volume that
originated from each foreign jurisdiction, whether from terminals or
otherwise.
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In addition to the conditions discussed above, the Commission could
retain the authority to condition, modify, suspend, terminate or
otherwise restrict an order that it issues, as applied to a specific
person operating thereunder or with respect to the order in its
entirety. The Commission could then take action, for example, if the
Commission determined that the foreign board of trade that received and
order, or an entity operating in the U.S. based on the order, ceased to
comply with a stated condition of the order or that continuation of the
order would be contrary to public policy or the public interest.
3. Request for Confirmation of Relief from Members and Their Affiliates
Under the possible approach the Division envisions, following the
issuance of an order, an entity that desired to operate a computer
terminal in the U.S. under the order would request confirmation of its
ability to do so by filing a confirmation request with NFA. Such a
procedure would be similar to the current procedure followed by DTB on
behalf of its members that wish to install DTB terminals in the U.S.
under the DTB's no-action letter.
Such a written confirmation request would be signed by a duly
authorized representative of the foreign board of trade member or
affiliate, and the member or affiliate would do the following: (1)
Certify that it is a member or an affiliate of a member in good
standing of a foreign board of trade that has received a Commission
order; (2) certify that it will take reasonable precautions to
safeguard access to computer terminals operated by it under the order;
(3) agree to comply with all applicable conditions of the order; (4)
provide the NFA with the address where computer terminals are to be
kept and the number of terminals to be placed in each location.\42\ (5)
acknowledge that is subject to the jurisdiction of the Commission and
the U.S. with respect to its activities related to the order; (6) agree
to keep books and records in accordance with the Act and the
Commission's regulations, if the member or affiliate is registered as
an FCM, or in accordance with Rule 1.3 if not registered;\43\ (7) agree
to provide the Commission with prompt access to the premises where
computer terminals are located;\44\ (8) indicate what type of business
it intends to operate in the U.S. and whether it will be trading for
its proprietary account, for customer accounts or both (and if the
person intends to engage in customer business, certify that it is or
will be registered as an FCM and acknowledge that it is subject to all
applicable Commission regulations); (9) provide a description of any
litigation, enforcement actions, disciplinary proceedings or other
civil, criminal or administrative proceedings, within the prior five
years, involving the requester or any principal of the requester (as
the term ``principal'' is defined in Commission Rule 3.1(a)), in which
there was an allegation of fraud, customer abuse, or violation of
applicable regulatory or board of trade requirements; (10) agree to
provide NFA and the Commission with immediate written notice of any
material changes in its structure, status or operations that might
impact the entity's activities under the order; (11) agree to provide
additional information as necessary; and (12) make any other
certifications that may be required by the order. The Commission
requests comment as to the appropriateness of these potential
requirements. Are any of these requirements unduly burdensome? Are
there any additional certifications, undertakings, or acknowledgments
that the Commission should consider including?
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\42\ Such information would be required to be updated when a
change occurs. The Commission requests comment as to whether ten
business days is a reasonable time period in which to update such
information.
\43\ In the case of an unregistered entity engaged only in
proprietary trading, the entity could keep either its original books
and records or a complete copy of its books and records in its U.S.
office. However, if copies were kept rather than originals, the
member or affiliate thereof would be required to: (1) state why it
is necessary or beneficial to keep the originals outside the U.S.;
(2) provide the address where they are kept; (3) agree to provide
the books and records in the U.S. within 72 hours of a request of a
Commission or NFA representative; and (4) certify that no foreign
laws would prevent the Commission's inspection of the books and
records.
\44\ If the member or affiliate is a registered FCM that
utilizes an automated order routing system for transmitting trades
submitted electronically from customers, the FCM could be required
to keep a list of the names and addresses of each customer who
utilizes this system and make such list available to the Commission
or a Commission representative upon request.
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Such a confirmation request could become effective automatically
ten business days after its receipt by NFA unless the requester was
notified otherwise. If contacted, the requester would have to receive
written notification from the Commission or NFA prior to placing any
terminals in the U.S.
B. Definitional Issues
As discussed above, the Division envisions a regulatory approach
that would provide a means for a foreign board of trade to petition the
Commission to place computer terminals in the U.S. for use by its
members and their affiliates. Initially, several definitional issues
are raised by such an approach. For example: (a) how should the term
``computer terminal'' be defined? (b) where in the U.S. may computer
terminals be placed; and (c) who is an ``affiliate'' of a foreign board
of trade member? These issues are discussed individually below, and the
Commission requests comment on them.
1. Definition of Computer Terminal
The Commission believes that the term ``computer terminal,'' or
some similar term should be defined broadly under any rule adopted
regarding foreign board of trade terminal placement in the U.S. to
anticipate, to the extent practicable, the evolution of electronic
trading systems. By defining such a term broadly to anticipate
[[Page 39787]]
changes in technology, the Commission would hope to ensure that a
person could not circumvent any rules adopted by the Commission simply
by contending that a particular device is not a computer terminal even
though the device performs essentially the same operation.
Historically, the term ``computer terminal'' was thought to be a
dedicated proprietary computer system that provided access to a board
of trade (e.g., a DTB computer terminal). This perception is rapidly
changing, however, as new technologies enter the marketplace. The
Commission anticipates that ``computer terminal'' or some similar term
would be defined for purposes of proposed rules in such a way as to
contemplate such changes, and would include not only proprietary
computer systems, but also any other device that currently is being
used or may be used in the future to provide access to a foreign board
of trade in the same manner and providing the same functionality as a
proprietary system. Such devices might take the form of specialized
computer software, a telephonic system, or Internet access to a foreign
board of trade through a personal computer, telephone or similar device
which is provided in a manner that makes Internet use the functional
equivalent of a proprietary terminal. The Commission requests comment
as to whether a mechanism that enables a customer order to be submitted
electronically to an FCM and subsequently to a foreign board of trade
without the necessity for human intervention at the FCM should be
considered a ``computer terminal'' under Commission rules.\45\
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\45\ See also, discussion of automated order routing and
execution issues in section II.C.2, below.
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As new technology evolves, new types of access to foreign markets
likely will develop. The Internet, which has seen tremendous growth in
recent years, provides one likely source for such development.\46\ The
Commission solicits comment on what types of ``computer'' or other
technological systems currently are in use or anticipated that could
provide access to a foreign board of trade. To what extent is Internet
access to foreign futures and options currently available? Is direct
Internet access (i.e., not conducted through an intermediary) currently
available to any foreign board of trade? To what extent is the Internet
currently being used for the placement of orders for futures and option
products with U.S. or foreign FCMs? How should the Commission define
``computer terminal'' so as to be sufficiently inclusive?
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\46\ In this regard, FutureCom, a U.S. exchange owned by the
Texas Beef Trading Co., Ltd., has applied to the Commission for
contract market designation. If its application is approved,
FutureCom would be the first U.S. Internet-based futures and option
exchange.
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2. Where May Computer Terminals Be Located in the U.S.?
The Division's approach would permit members of a foreign board of
trade and members' affiliates to place computer terminals in their U.S.
offices or in their firm booths on the floor of a U.S. board of trade.
The Division does not currently contemplate that proposed rules would
permit the installation of a foreign computer terminal that provides a
customer a direct link to a foreign board of trade's floor or computer
system without first flowing through a registered FCM that is a member
or affiliate thereof of the foreign board of trade. Neither does the
Division contemplate that the proposed rules would permit any customer
to utilize a foreign board of trade's computer terminal maintained by a
member of the foreign board of trade or its affiliate to achieve such
direct access. The Commission requests comment as to these positions of
the Division and as to what safeguards might be required to prevent
improper access to a foreign board of trade's computer terminals in the
U.S.
3. Definition of an ``Affiliate'' of a Foreign Board of Trade Member
The Division's approach would allow affiliates of members of a
foreign board of trade to operate foreign board to trade computer
terminals pursuant to a Commission Order. This position raises the
issue of who is a bona fide affiliate of a member. Arguably, only those
person who have a substantial ownership connection to a member should
be permitted to have access to a foreign board of trade's U.S.-located
terminals, this preventing customers from circumventing Commission
rules by becoming an ``affiliate'' in name only. An affiliated of a
foreign board of trade member for those purposes could be defined as:
(1) A person that owns 50 percent or more of a member (i.e, a foreign
board of trade member's parent company with an ownership interest in
the member of 50 percent or more); (2) a person owned 50 percent or
more by a member (i.e., a foreign board of trade member's 50 percent or
more owned subsidiary); (3) a person that is owned 50 percent or more
by a third person that also owns 50 percent or more of a member (i.e.,
a member's sister company where both the member and the sister company
are owned 50 percent or more by a third person); or (4) any person that
otherwise has control, is controlled by or is owned 50 percent or more
by a third person that has control of a member. The Commission requests
comments as to the appropriateness of this definition. Should the
Commission permit affiliates of foreign board of trade members to
operate computer terminals in the U.S. absent the foreign board of
trade's designation as a U.S. contract market? Is a 50 percent
threshold too high or too low?
The Commission is also concerned that foreign board of trade do not
create categories of membership without creating meaningful
distinctions between a member of a foreign board of trade and a
customer thereof. The Commission requests comment as to whether the
Commission should consider imposing any requirements that would enable
the Commission to ensure that a member of a foreign board of trade is a
bona fide member. If so, what types of requirements are appropriate?
C. Other Issues Concerning Foreign Board of Trade Terminal Placements
in the U.S.
1. Bona Fide Foreign Board of Trade
The Division in the DTB letter took the position that only a bona
fide foreign board of trade should be entitle to place and operate
computer terminals in the U.S. without being designated as a contract
market. At some level of U.S. activity, a board of trade can no longer
claim to be a board of trade located outside the U.S. and would be
required to be designated as contract market. The Division's approach
describe above would establish a number of requirements that are aimed
specifically at providing the Commission with initial and ongoing
information concerning a foreign board of trade's U.S. presence. For
example, as noted above, the Commission could receive in a petition
from a foreign board of trade information concerning: (1) Any physical
presence the board of trade has in the U.S.; and (2) any marketing,
education or other activities that are conducted by a foreign board of
trade in the U.S. or that otherwise are directed toward U.S. customers.
This information could be required to be updated in the event of a
material change. The Commission also could receive in a foreign board
of trade's petition certain information concerning the foreign board of
trade's recent trade volume originating from the U.S. and the current
quantity of stocks, if any, held in any U.S.-located warehouses. Such
information could be required to
[[Page 39788]]
be provided quarterly. Information about a foreign board of trade's
activities and presence in the U.S. is relevant in determining whether
a board of trade should be required to be designated as a U.S. contract
market. Likewise, the percentage of a foreign board of trade's volume
that originates from the U.S. also is relevant in determining such
questions. The Commission solicits public comment as to whether it
should define in its rules the level of U.S. activity requiring
contract market designation. If so, how should the level be defined?
Additionally, the Commission requests comment as to any U.S.
activities, other than those discussed above, that might be relevant to
a determination as to whether a board of trade that desires to place
its computer terminals in the U.S. is a bona fide foreign board of
trade.
The Division's potential approach describes above also assumes that
any foreign board of trade that would petition the Commission for an
order under such procedures would be a bona fide board of trade that is
subject to an established rulemaking structure. This view is in keeping
with Congressional intent with respect to what is meant by the term
``foreign board of trade'' under the Act. In this regard, the
legislative history concerning the 1982 amendments to the Act suggests
that, when Congress amended the Act in 1982, it intended that the
exclusion of futures contracts traded on ``a board of trade, exchange
or market located outside the United States'' form the off-exchange ban
in Section 4(a) of the Act, as well as the limitation on the
Commission's regulatory authority in Section 4(b), apply only to ``bona
fide foreign futures contracts'' traded in a regulated exchange
environment.\47\ Consistent with Congressional intent, the Commission
made clear when promulgating part 30 that the part 30 rules do not
permit the offer and sale in the U.S. of foreign futures or options
that are not executed on or subject to the rules of a foreign board of
trade.
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\47\ See S. Rep. 384, 97th Cong., 2d Sess. 45-47, 84-
85 (1982); H.R. Rep. No. 565, Part I, 97th Cong., 2d
Sess. 84-85 (1982).
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2. Order Execution and Order Routing Issues
Technological capabilities now exist that would enable a customer,
who is not a member of a foreign board of trade, to send orders to the
foreign board of trade through an automated order routing system that
is linked to the board of trade through a member. Through such a
system, customers could place orders on the foreign board of trade with
little, if any, human intervention by the member. Execution of the
customer's order could be accomplished either through the foreign board
of trade's system interface or on the floor of an exchange.
To date, the Commission has not opined on the appropriateness of an
FCM's use of an automated order routing system that would allow
customer orders that have been submitted electronically to the FCM to
be transmitted into a foreign board of trade computer system for
placing orders on the foreign board of trade.\48\ As discussed above,
the Division's approach does not contemplate that the Commission's
rules would permit customers to have access to ``computer terminals''
such that they would have the functionality of a proprietary terminal
and could place a trade directly on a foreign board of trade without
the use of an intermediary. The Commission requests comment on whether
its rules should permit the use of some type of automated process to be
employed by FCMs to allow customer orders that have been submitted
electronically to the FCM to be transmitted into a foreign board of
trade computer system. If so, what features would the system have to
include or lack so that it would not be deemed a computer terminal
under Commission rules? For example, should any automated order
transmission system allowing a customer to transmit orders to its FCM
require an employee of the FCM to review and to accept such orders and
to take some affirmative, non-automated action to transmit such order
to the foreign board of trade, or should fully automated intermediation
be permitted, in which a fully computerized process would substitute
for acceptance and transmission of orders by FCM employees? Should any
such system limit a customer's view of information to only a portion of
that otherwise available to a member of a foreign board of trade that
has a computer terminal? If so, what types of information should be
permissible to be viewed by the customer on such a system and what
information should be inaccessible? Should automated systems be
required to provide, at a minimum, credit and position limit checks?
The Commission requests comment as to other safeguards that should be
required if automated verification, acceptance and transmission of
customer orders to a foreign board of trade's computer system is
permitted.
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\48\ By letter to the CME dated August 14, 1997, the Division,
under authority delegated by the Commission in Rule 1.41a(a)(3),
informed the CME that its proposal to permit customers to transmit
Globex orders to FCMs via the Internet did not require Commission
approval under Section 5a(a)(12) of the Act. Under CME's proposal,
customers do not have direct access to Globex. Rather, the proposal
permits CME clearing members to accept customer orders via the
Internet. After receipt of a customer order, the order is
transmitted to Globex via the clearing member's order routing system
and CME's computer-to-computer interface (``CTCI''), which enables
clearing members to upload and download orders between the member's
order routing system and Globex. A CME clearing member may use CME's
CTCI only if (1) the member's order routing system contains
automated credit controls or position limits, or (2) customer orders
received by the member through its order routing system are subject
to manual review and processing by a clearing member employee prior
to being entered into a Globex terminal.
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If the Commission were to permit an FCM to use a fully automated
process to transmit electronically submitted customer orders to a
foreign board of trade, should the FCM's use of this process be
permitted only pursuant to the requirements of a Commission order to
the foreign board of trade? That is, should customer access through an
automated order routing system be provided: (1) only to a foreign board
of trade that had received an order from the Commission to place
computer terminals in the U.S. without being designated as a contract
market; and (2) only through an FCM that is a member or affiliate of a
member of such foreign board of trade and that had undergone the
appropriate confirmation process to operate computer terminals under
the foreign board of trade's order? Or should fully automated order
routing systems allowed to provide access to all foreign boards of
trade even if they have not received permission to place terminals in
the U.S.? How should foreign firms that operate pursuant to an
exemption under Commission Rule 30.10 be treated?
3. Linkages Between Boards of Trade
As electronic trading systems continue to evolve, some boards of
trade are finding it advantageous to enter into partnerships with other
boards of trade to make their products more widely available.\49\ These
partnerships raise issues regarding how a Commission rule should
accommodate situations where the products of one board of trade are
being made available through another board of trade's computer
terminals located in the U.S. or where two or more boards of trade
share the same electronic trading platform. The Division's approach,
described above, would apply not only with respect to a single foreign
board of trade, but also in circumstances where the products of
multiple foreign boards of trade are traded from a single system. In
such a
[[Page 39789]]
case, each foreign board of trade whose products would be made
available through U.S.-located computer terminals would be required to
comply with any requirements adopted by the Commission in its order.
For example, if two or more foreign boards of trade share the same
computer terminal platform and each wished to place computer terminals
in the U.S. for the use of its members (or members' affiliates), each
would be required to receive an order from the Commission and comply
with the requirements in that order under the approach described above.
The Division's approach would also arguably apply to a foreign board of
trade which trades through terminals shared with a U.S. exchange that
has been designated as a U.S. contract market.\50\ The Commission
requests comment as to whether different requirements should apply to a
foreign board of trade's products which are traded on the computer
terminals of a U.S. contract market. If so, how should such
requirements differ and why?
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\49\ See, e.g., note 12, supra.
\50\ The Commission anticipates that a foreign board of trade
that currently is trading its products through computer terminals in
the U.S. would be required to comply with any new rules eventually
adopted by the Commission, but would be provided a transition period
in which to come into compliance.
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III. Conclusion
The Commission believes that it is appropriate to develop rules
concerning placement of foreign board of trade terminals in the U.S. in
light of the growing interest among foreign boards of trade to do so.
The Commission hopes to develop an approach to address these issues
that will provide certainty to foreign exchanges that wish to place
their computer terminals in the U.S. for trading purposes and will be
consistent with the Commission's obligations under the Act to maintain
the integrity and competitiveness of the U.S. markets and to provide
protection to U.S. customers. To this end, the Commission requests
public comment on the issues and the Division's approach, as discussed
above.
Issued in Washington, D.C. on July 17, 1998 by the Commission.
Jean A. Webb,
Secretary of the Commission.
[FR Doc. 98-19723 Filed 7-23-98; 8:45 am]
BILLING CODE 6351-01-M
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.