Revised Procedures for Commission Review and Approval of Applications for Contract Market Designation and of Related Contract Terms and Conditions

COMMODITY FUTURES TRADING COMMISSION

17 CFR Part 5

Revised Procedures for Commission Review and Approval of

Applications for Contract Market Designation and of Related Contract

Terms and Conditions

AGENCY: Commodity Futures Trading Commission.

ACTION: Proposed rulemaking.

-----------------------------------------------------------------------

SUMMARY: In 1997, the Commodity Futures Trading Commission (Commission)

promulgated a new fast-track procedure for the review and approval of

applications for contract market designation in either ten or forty-

five days. In response to continued expressions of industry concern

that the ability to list new contracts for trading without delay is

vital to the exchanges' continued competitiveness, the Commission is

proposing a two-year pilot program to permit the listing of contracts

for trading prior to Commission approval.

The proposed procedure would preserve the public interest in

Commission review and approval of new contracts by providing that no

more than one year's trading months may be listed at any time prior to

approval. Any problems with a new contract could be rectified within

that initial listing period. As proposed, exchanges would retain the

choice to proceed under the current procedures for prior approval of

new contracts, including fast-track application review.

The proposed listing of new contracts prior to designation does not

affect the general requirement that proposed exchange rules and changes

to existing exchange rules must be reviewed and approved by the

Commission prior to implementation. Exchange rule changes, including

both changes to contract terms and conditions and to rules of broad

application that are not contract terms or conditions, can and do have

an impact on open positions. They may affect the economic utility of

contracts. Moreover, exchange rule changes may be the subject of

divergent interests or, potentially, conflicts of interest at an

exchange or raise broad public policy issues, all of which require that

exchange rule changes be addressed through the Commission's statutory

process of prior review and approval.

DATES: Comments must be received August 26, 1999.

ADDRESSES: Comments should be mailed to the Commodity Futures Trading

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

DC 20581. Office of the Secretariat; transmitted by facsimile at (202)

418-5521; or transmitted electronically at [[email protected]].

FOR FURTHER INFORMATION CONTACT: Paul M. Architzel, Chief Counsel,

Division of Economic Analysis, Commodity Futures Trading Commission,

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

(202) 418-5260, or electronically, [PA[email protected]].

SUPPLEMENTARY INFORMATION:

I. Need for Additional Flexibility in Listing New Contracts

The Commission thoroughly analyzed the nature of global competition

in the futures industry in a major 1994 study mandated by Congress as

part of the 1992 amendments to the Act.\1\ That study analyzed the

growth of futures trading in non-U.S. markets and the relative decline

in the global market share of U.S. exchanges. Although much has changed

since 1994 in the global competitiveness of the futures industry,

including in particular the continued evolution and development of new

electronic trading platforms, many of the 1994 study's major

conclusions remain valid today. The 1994 study concluded that U.S.

exchanges remain leaders in innovation and generally have reached the

global market first with new products.\2\ Foreign exchanges, by and

large, have grown by developing products tailored to their home markets

and by trading those products at the same time of day as the underlying

foreign cash market.\3\ The study found no evidence that disparities in

the regulatory frameworks of various jurisdictions, including

particularly disparities in procedures for listing new contracts, were

a major factor explaining the success of various exchanges in the

global market.\4\

---------------------------------------------------------------------------

\1\ A study of the Global Competitiveness of U.S. Futures

Markets, Commodity Futures Trading Commission, (April 1994)(``1994

study'').

\2\ The Commission has been supportive, in general, of

initiatives of U.S. exchanges to become more competitive both in

terms of new products and trading systems. For example, the

Commission has encouraged and supported industry-wide innovation and

modernization in trading systems, sponsoring a round-table on

October 16, 1996, to highlight issues relating to electronic order

routing and trading systems. It has also amended many rules to

respond to industry requests and on its own initiative to support

the competitiveness of U.S. exchanges. Specifically, the Commission

has promulgated rules to streamline applications for contract market

designation, 64 FR 29217 (June 1, 1999); to permit bunched orders

for sophisticated customers to be allocated after their execution,

63 FR 45699 (August 27, 1998); to permit futures-style margining of

commodity options, 63 FR 32726 (June 16, 1998); to eliminate the

requirement that futures commission merchants and introducing

brokers deliver the specified risk disclosure document when opening

accounts for sophisticated customers, 63 FR 8566 (February 20,

1998); to eliminate the short option value charge against a future

commission merchant's net capital, 63 FR 32725 (June 16, 1998); to

expand the use of acceptable electronic storage media for required

records, 64 FR 28735 (May 27, 1999); to permit the use of a two-part

disclosure document, 63 FR 58300 (October 30, 1998); to permit the

trading of ``exchange of futures for swaps'' on the New York

Mercantile Exchange, 63 FR 3708 (January 26, 1998); and to increase

speculative position limits, 64 FR 24038 (May 5, 1999).

Moreover, the Commission has been very supportive of industry

efforts over the years to introduce innovative futures and option

contracts. These include such innovative concepts as the

reintroduction of exchange-traded options, the introduction of

flexible options, the first cash-settled futures contracts, the

first futures contracts on stock indexes and the first futures and

option contracts on natural gas, electricity crop yields, pollution

permits, and bankruptcy rates.

\3\ For example, many foreign exchanges trade interest-rate

contracts based upon the sovereign debt of the nation in which they

are located.

\4\ Moreover, the trend among foreign authorities has been to

strengthen their regulatory regimes. The Commission has been a

world-leader in promoting the strengthening of regulatory oversigh

as futures trading becomes more global in nature. This process has

accelerated in light of developments in connection with the Barings,

Plc. and Sumitomo Corp. situations. See, Windsor Declaration issued

May 17, 1995, and London Communique on Supervision of Commodity

Futures Markets (November 26, 1996).

---------------------------------------------------------------------------

The Commission also concluded in its study that, ``the U.S.

regulatory system must be responsive to changes in the marketplace if

U.S. markets are to remain competitively robust. Consistent

[[Page 40529]]

with that view * * * the CFTC has historically attempted to facilitate

U.S. exchange innovation and reduce the costs of regulation within its

mandate * * *'' \5\ One means taken by the Commission in recent years

to lower the cost of regulation has been to reduce significantly the

time normally required for Commission review and approval of new

contracts, particularly since implementing new fast-track procedures in

1997. Generally, the 10- or 45-day review periods provided under the

fast-track procedure are readily compatible with the normal gestation

period for new contracts.\6\

---------------------------------------------------------------------------

\5\ 1994 study at p. 139.

\6\ U.S. exchanges' initial launch date for new contracts is

often well after designation, and many contracts are not listed

until months or even years later. In this regard, of the 201 new

contracts that were approved during the period 1996 through 1998,

about one-fourth (46) have not yet been listed for trading. The

average period after designation when the other 155 contracts were

listed was about three months (87 days). Only 29 contracts in all

were listed for trading within 10 days after Commission approval.

---------------------------------------------------------------------------

The Commission is proposing a pilot program to provide U.S.

exchanges with substantial, additional flexibility in the listing of

new contracts. Representatives of U.S. exchanges have testified that

the ability to list contracts more quickly than currently possible is

necessary for them to meet competitive challenges by foreign

exchanges.\7\ The proposed rule would enable designated exchanges

generally to list for trading new contracts without any waiting period,

directly responding to the exchanges' stated need to be able to respond

immediately to competitive challenges.\8\

---------------------------------------------------------------------------

\7\ During hearings before the Subcommittee on Risk Management

and Specialty Crops of the House Committee on Agriculture,

representatives of four U.S. futures exchanges testified that the

current regulatory structure is overly burdensome and that statutory

changes are necessary to achieve ``parity'' with foreign exchanges

and to better enable U.S. exchanges to compete in the growing global

marketplace. CTFC Reauthorization: Hearings Before the Subcommittee

on Risk Management and Specialty Crops of the House Committee on

Agriculture, 106th Cong., 1st Sess. (1999) See, statements of the

Chicago Board of Trade, the Board of Trade of the City of New York,

the Chicago Mercantile Exchange, and the New York Mercantile

Exchange.

In particular, the U.S. exchanges urged Congress to eliminate

the requirement that the Commission review and approve new contracts

before they begin trading and amendments to exchange rules before

they can be implemented. For example, Daniel Rappaport, Chairman of

the Board of Directors of NYMEX testified that, ``detailed CFTC

review and approval of the specific terms and conditions of the

contract has not been necessary, provides marginal, if any value,

and adds cost, uncertainty, and delay to the roll-out of new

contracts.''

\8\ However, contracts subject to the accord provision of

section 2(a)(1)(B) of the Act would not be eligible for this relief

consistent with the provisions of section 4(c) of the Act.

---------------------------------------------------------------------------

The proposed rule would not, however, eliminate the requirement

that contracts be designated by the Commission. Rather, it would permit

the Commission's review of new contracts to proceed after a new

contract's initial listing. The Commission would continue to designate

such contracts after they have been listed upon finding that they meet

the requirements of the Commodity Exchange Act, 7 U.S.C. 1 et seq.

(Act), and the rules thereunder. This would preserve a speedy, sure and

efficient method for the Commission to review new contracts and the

public's opportunity to comment on them. The proposed pilot program

would not apply to changes to existing contracts. As discussed in more

detail below, changes to existing contracts frequently raise issues

relating to the value of existing positions and there is often

significant interest by the public in commenting on proposed changes to

such contracts.

The Commission is proposing this two-year pilot program under the

Act's section 4(c) exemptive provision which, together with the other

provisions of the Act, provides the Commission with far-ranging

regulatory flexibility. The pilot program will provide an opportunity

to identify any adverse consequences resulting from the predesignation

listing of new contracts. As proposed, the approval requirement will

continue to fulfill the important functions of providing a forum to

resolve questions relating to the legality of contracts, a means to

consider and respond to concerns raised by other regulators, a

mechanism for government-to-government coordination when appropriate

and the opportunity to subject contracts to impartial, expert scrutiny

and to correct various problems early on. Finally, as proposed,

exchanges will retain the option to seek prior Commission approval

before listing new contracts.

II. History and Purpose of Statutory Requirement that Contracts Be

Designated Before Trading and Exemptive Authority

Section 4(a) of the Act provides that, unless exempted by the

Commission, futures contracts legally can be traded only on or subject

to the rules of a contract market designated by the Commission.\9\

Section 4(c)(1) authorizes the Commission, by rule, regulation, or

order, to exempt any contract between ``appropriate persons'' from that

or any other of the Act's requirements, with the exception of the

accord provisions of section 2(a)(1)(B). Before granting such an

exemption, the Commission must determine that its action would be

consistent with the public interest and would not have a material

adverse effect on the ability of the Commission to discharge its

regulatory responsibilities or of any contract market to discharge its

self-regulatory responsibilities under the Act.\10\

---------------------------------------------------------------------------

\9\ Section 4(a) of the Act provides that: ``Unless exempted by

the Commission pursuant to subsection (c), it shall be unlawful for

any person to offer to enter into, to enter into, to execute, to

confirm the execution of * * * a contract for the purchase or sale

of a commodity for future delivery * * * 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 * * *'' 7 U.S.C. 6(a).

\10\ The Futures Trading Practice Act of 1992, P.L. No. 102-546,

added a new subsections (c) and (d) to section 4 of the Act.

Specifically, section 4(c), 7 U.S.C. 6(c), provides that:

(1) In order to promote responsible economic or financial

innovation and fair competition, the Commission by rule, regulation,

or order, after notice and opportunity for hearing, may (on its own

initiative or on application of any person, including any board of

trade designated as a contract market for transactions for future

delivery in any commodity under section 5 of this Act) exempt any

agreement, contract, or transaction (or class thereof) that is

otherwise subject to subsection (a) (including any person or class

of persons offering, entering into, rendering advice or rendering

other services with respect to, the agreement, contract, or

transaction), either unconditionally or on stated terms or

conditions or for stated periods and either retroactively or

prospectively, or both, from any of the requirements of subsection

(a), or from any other provision of this Act (except section

2(a)(1)(B)), if the Commission determines that the exemption would

be consistent with the public interest.

(2) The Commission shall not grant any exemption under paragraph

(1) from any of the requirements of subsection (a) unless the

Commission determines that--

(A) The requirement should not be applied to the agreement,

contract, or transaction for which the exemption is sought and that

the exemption would be consistent with the public interest and the

purposes of this Act; and

(B) the agreement, contract, or transaction--

(i) will be entered into solely between appropriate persons; and

(ii) will not have a material adverse effect on the ability of

the Commission or any contract market to discharge its regulatory or

self-regulatory duties under this Act.

---------------------------------------------------------------------------

The requirement that boards of trade meet specified conditions in

order to be designated as contract markets has been a fundamental tool

of federal regulation of commodity futures exchanges for the past

seventy-five years.\11\ Prior to the 1974 amendments to the Act,

however, the statutory scheme did not require the

[[Page 40530]]

Commodity Exchange Authority, the Commission's predecessor agency, to

approve in advance the trading of all new futures contracts,\12\ nor

did it require agency approval of exchange rules before they became

effective. Rather, exchange rules amending the terms and conditions of

futures contracts were subject only to disapproval after becoming

effective.\13\ The 1974 amendments to the Act reversed that approach,

requiring that new contracts be approved prior to trading. As part of

Congress' overall intent to strengthen federal regulatory oversight of

the futures industry, the 1974 amendments provided for a meaningful

government review of all new futures contracts before trading could

begin and of proposed amendments to the terms of conditions of existing

contracts.\14\

---------------------------------------------------------------------------

\11\ See, Futures Trading Act of 1921, Pub. L. No. 67-66, 42

Stat. 187 (1921). Designation as a contract market under the 1921

Act was contingent upon a board of trade's meeting specified

statutory criteria, including providing for the prevention of

manipulative activity. Although the constitutionality of this Act

was successfully challenged as an improper use of the Congressional

taxing power in Hill v. Wallace, 259 U.S. 44 (1922), all subsequent

legislation regulating the futures industry followed the template of

requiring exchanges to be designated as contract markets.

\12\ Prior to 1974, the Act defined ``commodity'' by specific

enumeration. Accordingly, new contracts that were not so enumerated

were unregulated. The definition of commodity periodically would be

updated to include additional commodities in which trading had

commenced on those exchanges which traded other regulated contracts.

For example, livestock and livestock products were added to the

Act's definition of ``commodity'' as part of the 1968 amendments to

the Act, after such contracts had already begun trading on the

Chicago Mercantile Exchange. Pub. L. No. 90-258 Sec. 1(a), 49 Stat.

1491 (1968). Other futures exchanges, including the Commodity

Exchange, Inc. and the former Coffee and Sugar, and the Cocoa

exchanges, operated wholly outside of the regulatory scheme.

\13\ See Pub. L. No. 90-258, Sec. 23, 82 Stat. 33 (1968).

\14\ See H.R. Rep. No. 93-975, 93d Cong., 2d Sess. at 78, 82

(1974).

---------------------------------------------------------------------------

Subsequently, Congress enhanced the opportunity for public

participation in the Commission's review of proposed exchange rule

amendments.\15\ In offering this amendment, Representative AuCoin

reasoned that, although many rule changes may be technical,

---------------------------------------------------------------------------

\15\ As part of the 1978 amendments to the Act, Congress added

the provision requiring a public comment period for proposed

exchange rules of major economic significance. That amendment to

section 5a(a)(12) of the Act was offered from the floor during

debate in the House of Representatives.

---------------------------------------------------------------------------

there are a number of proposed rule changes that are controversial

because of their expected impact on the way a particular commodity

is traded or on the broader effects that a change may bring about in

the production and distribution of that commodity.

124 Cong. Rec. H7312 (July 26, 1978).

The Commission, recognizing the validity of Representative AuCoin's

observation that various submissions may require differing levels of

public scrutiny, has been flexible in implementing its regulatory

mandate to review and approve new contracts and amendments to existing

contracts. The fast-track review procedures, in particular, broke new

ground in how the Commission reviews and approves applications for

contract market designation, proposed exchange rules and changes to

existing exchange rules. Since promulgating the fast-track designation

procedures, the Commission has approved 36 contracts under the 10-day

procedures, and 34 contracts under the 45-day procedures. Fast-track

designation procedures have provided the exchanges with a time certain

for Commission review, easing their planning for new contract

introduction. Fast-track procedures also confirmed, however, that in

many instances exchanges may prefer review procedures. Specifically, 43

proposed contracts that were otherwise eligible for fast-track review

have been submitted under regular review procedures, which under the

Act permits the Commission to take up to one year to review an

application for contract market designation.

The Commission's past procedural flexibility has made its review

more efficient while at the same time preserving the public interest in

Commission approval of new contracts and of contract amendments. Review

and approval of new contracts helps assure that futures markets are not

readily susceptible to manipulation so that they better can serve their

risk transfer and price discovery functions. The Commission, based upon

its past experience, has found that appropriate contract design is the

best deterrent to market manipulation, price distortion or market

congestion, and that contract approval assures that contracts meet

these widely-accepted design criteria.\16\ Although market incentives,

enlightened business judgment and the desire to protect reputation are

strong motivations which can lead to a high degree of self-regulation,

experience demonstrates that there have been instances when government

oversight and action serve to address particular instances where

business judgments by the exchange membership did not appear to offer

sufficient guidance to inform fully an SRO's regulatory judgment.\17\

---------------------------------------------------------------------------

\16\ See, e.g., Sec. 5a(a)(10) of the Act and the Commission's

proceeding to amend the delivery terms of the CBT corn and soybean

futures contracts, ``Notification to the CBT to Amend Delivery

Specifications.'' 61 FR 68175 (December 12, 1995). The view that

appropriate contract design is an important component of a market

surveillance program and deters manipulation, price distortion and

market congestion is widely accepted internationally, as well. See,

the Tokyo Communique on Supervision of Commodity Futures Markets

issued at the Tokyo Commodity Futures Markets Regulators' Conference

on October 31, 1997.

\17\ Often, the Commission receives few or no public comments on

contract market designations or on exchange rule changes. This is to

be expected. It may indicate that the exchange has indeed received

and considered input from interested outside sources in connection

with a proposal. However, there are more than a few designation

applications or proposed exchange rule changes every year that

elicit a significant number of comments, casting doubt upon the

exchange's theory that its business self-interest will reliably

inform all of its regulatory judgements.

In this regard, in response to a Commission advisory on

alternative execution or block trading procedures, 64 FR 31195 (June

10, 1999), the Chicago Board of Trade (CBT) by letter dated June 29,

1999, urged the Commission to:

[S]olicit the input of, and coordinate with, various interested

parties by publishing for public comment any proposals to permit

alternative execution procedures. The Commission will in that way,

be able to get the benefit of additional analysis of such proposals

by knowledgeable members of the futures industry. * * *

---------------------------------------------------------------------------

Needed changes to contract designs are most easily made before

traders become accustomed to, or heavily reliant upon, a particular

term or condition. Although it is possible to make adjustments to

contract terms or conditions as needed, changing a term or condition of

a proposed contract prior to its listing does not have the market

impact of an after-the-fact rule change or of an emergency action. In

this regard, the terms or conditions for delivery of several contracts

for foreign currencies were changed while under Commission review.

Commission vetting of exchange rules and CFTC coordination with the

interested foreign governments resolved these delivery issues. Absent

prior Commission approval, these design flaws might very well have been

discovered through a default, a market emergency or similar

dislocation.

Review and approval of new contracts also gives the public an

opportunity to comment on proposed contracts and provides a forum for

resolving disputes. Often, an innovative contract may raise issues for

other government agencies. The Commission review process provides a

formal mechanism for those agencies to make their views known to the

Commission. Moreover, in cases where questions are raised about the

legality of a contract's terms, such as recent questions as to whether

the delivery terms of an electricity contract would violate certain

legal restrictions in effect at the delivery point, the Commission's

approval process provides a formal governmental decision on the issue,

short of a court challenge to the contract.

Although exchanges have a strong business incentive to list

contracts that will not be susceptible to manipulation, they may not

receive, and act upon, the breadth of opinion available to the

Commission. As discussed above, these views may come from foreign

regulators, other government agencies and

[[Page 40531]]

departments, futures intermediaries, commodity producers or users and

other nonmembers. For example, trade interviews by Commission staff

first revealed that the discounts for nonpar varieties and locations

for a proposed potato contract did not conform to cash market

practices. Subsequently, major producer groups opposed the proposed

contract's terms in public comments filed with the Commission, and the

exchange made extensive revisions. Accordingly, the Commission's review

and approval process, which expands participation in the process, may

bring to light information not previously considered by an exchange in

designing a proposed contract's terms.

Recognizing the potential benefit of receiving additional input

from a wider variety of sources, some exchanges, particularly the

smaller exchanges, have made positive use of the Commission's review

and approval process in developing new products. For example, one

exchange accepted Commission staff's suggestions on an appropriate

means of constructing an index with a large number of inactively traded

stocks. After these revisions, the contract obtained regulatory

approval from both the Commission and the Securities and Exchange

Commission.

The proposed pilot program for predesignation listing of new

contracts will permit exchanges to list new contracts quickly in

response to perceived competitive threats. However, it will also retain

current procedures, enabling exchanges to benefit from the comments

process included in the current procedures, from the Commission's

expertise in these issues and from its interaction with U.S. and

foreign regulators.

III. The Proposed Rule

Although the rule which the Commission is proposing permits

exchanges to list new contracts for a limited period prior to

designation, it conforms to the underlying legal requirement that all

contracts must be designated by the Commission in order legally to

trade. Moreover, the proposed listing rule is consistent with the

spirit of the Act's provision which contemplates that in certain

instances exchanges may make proposed rules effective pending

Commission action. Specifically, section 5a(a)(12) of the Act permits

exchanges to make proposed rules effective without Commission approval

if the Commission fails to act on the proposed rules within specified

time limits. Those exchange rules may remain in effect while Commission

action is pending. The Commission's rule on predesignation listing of

proposed contracts would apply the same concept in instances where an

exchange believes that competitive or other factors make immediate

listing of a proposed contract necessary.

Contracts listed under the proposed procedure, although not

designated, would be valid and enforceable pursuant to the Commission's

rule, which is being proposed under the exemptive authority of section

4(c) of the Act. The board of trade, pursuant to the Commission's rule

and section 5a(8)(iii) of the Act, would be required to enforce the

contract's terms and conditions, although not yet approved by the

Commission.\18\ In addition, the board of trade would be required to

fulfill all of a contract market's self-regulatory obligations during

the period the contract is listed for trading as though it were

designated. Upon designation, the Commission, as it does for all

contracts, would approve the contract's terms and conditions under

section 5a(a)(12) of the Act.

---------------------------------------------------------------------------

\18\ Compare, 17 CFR 1.53.

---------------------------------------------------------------------------

The Commission is proposing that predesignation listing be

available only when an exchange already is a designated contract market

for at least one nondormant contract. This is because the initial

designation of a board of trade as a contract market often entails a

more lengthy review which includes analysis of its trading and

clearance systems and its self-regulatory programs. Such start up

exchanges are not appropriate candidates for the proposed immediate

listing rule.

Moreover, the Commission is proposing that while a designation

application submitted under regular or fast track procedures is

pending, a second exchange may not list the same, or a substantially

similar, contract to trade using the pilot procedure. Such a result

would penalize the first exchange for submitting a proposed contract

market application for Commission review and preapproval, clearly and

unwarranted competitive use of the proposed rule. As proposed, the

second exchange would be required to wait until the day following

approval of the first application to notify the Commission that it

intends to list the same, or a substantially similar, contract to

trade. Thus, for example, an application for contract designation filed

for fast-track review, absent a regulatory problem, would be deemed

approved forty-five days after receipt. Not until the forty-sixth day

after the Commission has received the application could a second

exchange notify the Commission that it intended to list the same or a

substantially similar contract for trading prior to designation. The

second exchange could then list for trading the contract on the forty-

seventh day after receipt of the original application. In this way, the

rule would not permit a competing exchange to short-circuit the review

process and to disadvantage the exchange choosing to subject a proposed

contract to prior Commission review. Of course, where the first

contract was listed prior to designation, there would be no purpose

served by preventing a second exchange from also listing the contract

for trading prior to approval. In that case, both exchanges could list

contracts for trading the day after they notify the Commission.\19\

---------------------------------------------------------------------------

\19\ Exchanges would not be able to use this proposed rule to

forestall a competitor from introducing a new contract by filing an

application in bad faith. Although a second exchange could not use

the predesignation listing procedure while a prior application was

pending, nothing would prevent the second exchange from filing an

application for review and approval by the Commission on its own

merits.

---------------------------------------------------------------------------

In addition, the proposed prelisting procedure is not intended to

be a means of evading an adverse Commission proceeding involving the

same or a substantially similar contract. Accordingly, where the

Commission has initiated a proceeding to alter an exchange rule under

section 8a(7) of the Act, to disapprove a proposed or existing contract

term or condition under section 5a(a)(12) of the Act, to alter or

change delivery points or commodity or locational differentials under

section 5a(a)(10) of the Act or to disapprove an application for

designation or suspend a designation under section 6 of the Act, or any

similar adverse action, an exchange could not list a ``new'' contract

for trading and thereby frustrate the proceeding against, or evade

application of the Commission's process applicable to the original,

designated contract.\20\ In addition, predesignation listing would not

be available for stock indexes, commodities which are subject to the

specific approval procedures of the Johnson-Shad jurisdiction.\21\

---------------------------------------------------------------------------

\20\ Similarly, the Commission is not proposing that the listing

provision be applicable for a futures contract that is based upon

the occurrence of a single event or that is intended to be listed

temporarily. For example, a futures contract in a fuel that was

being phased out of use, such as leaded gasoline, raises deliverable

supply issues. Such a contract should not be able to evade the

review and approval provisions of the Act by being listed during the

last few months when the commodity is available. Moreover, although

single event futures contracts have not yet been proposed, it would

be possible to construct such contracts. The proposed rule is not

intended to be used as a means to avoid addressing the designation

issues which may be raised by such contracts.

\21\ See section 2(a)(1)(B) of the Act.

---------------------------------------------------------------------------

[[Page 40532]]

The Commission is proposing that exchanges be able to determine

whether and when to make use of the new listing procedure, and is not

restricting an exchange's use of the predesignation listing of

contracts to a defined set of circumstances. The exchanges have argued

that as a matter of business self-interest they will design contracts

that comply with the Act's designation requirements and that prior

Commission review is an unnecessary check on their role as self-

regulators. Based upon these representations, the Commission expects to

be able to designate new contracts listed under the proposed pilot

rules and to approve their terms and conditions as initially listed.

However, exchanges not infrequently have revised the terms and

conditions of pending contracts submitted to the Commission for prior

review. Changes to the terms or conditions of a contract listed under

the proposed procedure would be required to be approved by the

Commission under section 5a(a)(12) of the Act and Commission rules

thereunder before being made effective. The Commission generally would

approve such changes when designating the contract. Presumably, the

revisions would be minor, made in advance of the contract's first

expiration, made before a large open interest had been established, and

cause no disruption to traders or to the markets generally.

Some designation applications filed with the Commission, however,

have included serious flaws. If it becomes evident during the

Commission's review that a contract already listed for trading fails to

meet a designation requirement, the exchange would have to take

appropriate corrective measures. Depending upon the nature of the

problem, these steps might be exigent in nature, have to be applied to

trading months with open positions and require an exchange to act under

its emergency authority. Although this is not the preferred mechanism

for vetting new contracts, it may be an unavoidable consequence of

listing a contract with a deficiency prior to approval. Accordingly, as

with the Commission's fast-track designation procedures, an exchange's

choice to list contracts for trading prior to designation would most

appropriately be used for contracts which clearly raise no legal or

practical impediments to trading.

As proposed, exchanges choosing to list contracts prior to

Commission review and designation must notify the Commission of their

intent by filing the contract's terms and conditions with the

Commission's Office of the Secretariat and the Commission's regional

office having jurisdiction over the exchange by close of business on

the business day prior to listing the contracts for trading. As

proposed, exchanges may list no more than one full year's trading

months at any time prior to the contract's designation. An application

for designation would be required to be filed within forty-five days of

the initial listing, unless during this period the trading months have

been delisted. Finally, the exchange would be required to identify the

contract listed as pending Commission designation.

As discussed above, the Commission is proposing this rule under its

section 4(c) exemptive authority. That section provides that the

Commission may exempt from the Act's requirements contracts between

appropriate persons. Because the proposed rule applies to contracts

listed on designated exchanges subject to the self-regulatory

requirements of the Act, the Commission finds all traders are

``appropriate'' for application of this proposed exemptive rule.

Moreover, for the reasons explained above, the Commission believes that

the proposed rule would be consistent with the public interest and

would not have a material adverse effect on the ability of the

Commission to discharge its regulatory responsibilities or of any

contract market to discharge its self-regulatory responsibilities under

the Act. The Commission specifically requests comment on these

findings.

IV. Related Matters

A. Regulatory Flexibility Act

The Regulatory Flexibility Act (RFA), 5 U.S.C. 601 et seq.,

requires that agencies, in promulgating rules, consider the impact of

these rules on small entities. The Commission has previously determined

that contract markets are not ``small entities'' for purposes of the

RFA, 5 U.S.C. 601 et seq. 47 FR 18618 (April 30, 1982). These

amendments propose a two-year pilot program to permit exchanges under

section 4(c) of the Act to list new contracts for trading prior to

designation as a contract market. Accordingly, the Acting Chairman, on

behalf of the Commission, hereby certifies, pursuant to 5 U.S.C.

605(b), that the action taken herein will not have a significant

economic impact on a substantial number of small entities.

B. Paperwork Reduction Act

The Paperwork Reduction Act of 1995 (PRA) (44 U.S.C. 3501 et seq.

(Supp. I 1995)) imposes certain requirements on federal agencies

(including the Commission) in connection with their conducting or

sponsoring any collection of information as defined by the PRA.

The Office of Management and Budget (OMB) approved the collection

of information associated with this proposed rule (3038-0022, Rules

Pertaining to Contract Markets and their Members) on October 24, 1998.

While the proposed rule discussed herein has no burden, the group of

rules (3038-0022) of which it is a part has the following burden:

Average burden hours per response..... 3,609.89

Number of Respondents................. 15,893

Frequency of response................. On occasion.

Copies of the OMB-approved information collection submission are

available from the CFTC Clearance Officer, 1155 21st Street, NW,

Washington, DC 20581, (202) 418-5160.

List of Subjects in 17 CFR Part 5

Contract markets, Designation application.

In consideration of the foregoing, and pursuant to the authority

contained in the Commodity Exchange Act and, in particular, sections 4,

4c, 5, 5a, 6 and 8a thereof, 7 U.S.C. 6, 6c, 7, 7a, 8, and 12a, the

Commission proposes to amend chapter I of title 17 of the Code of

Federal Regulations as follows:

PART 5--CONTRACT MARKET COMPLIANCE

1. The authority citation for part 5 is revised to read as follows:

Authority: 7 U.S.C. 6(c), 6c, 7, 7a, 8 and 12a.

2. Part 5 is amended by adding a new Sec. 5.3 to read as follows:

Sec. 5.3 Predesignation listing of new contracts.

(a) Notwithstanding any contrary provision of the Act or Commission

rules, a board of trade seeking designation as a contract market under

sections 4c, 5 and 5a(a) of the Act may list for trading delivery

months or expirations prior to designation, if the board of trade:

(1) Is already designated as a contract market in at least one

other contract which is not dormant within the meaning of Sec. 5.2 of

this part;

(2) Complies with all other requirements of the Act and Commission

regulations thereunder applicable to designated contract markets during

the period the contract is listed for trading prior to its designation

as a contract market;

(3) Files with the Commission at its Washington, DC, headquarters

and the regional office having jurisdiction over

[[Page 40533]]

it a copy of the contract's terms and conditions no later than the

close of business of the day preceding listing; and

(4) Notifies the public on all public references to the contract or

its trading months that the contract is trading pending Commission

designation.

(b) The board of trade may not list for trading delivery months or

option expirations for more than one year at any time prior to the

contract's designation as a contract market under sections 4c, 5, 5a

and 6 of the Act and regulations thereunder, or under Sec. 5.1 of this

part.

(c) The board of trade must file with the Commission an application

for contract market designation which meets the requirements of

Appendix A of this part within forty-five days of initially listing for

trading a contract under this section, unless the contract is delisted

during this period.

(d) The board of trade must enforce each bylaw, rule, regulation

and resolution that relates to the terms or conditions of a contract

listed for trading under this section. Any proposed revisions to the

terms or conditions of the contract as initially listed for trading

under this section must be submitted for Commission review under

section 5a(a)(12) of the Act and Sec. 1.41 of this chapter.

(e) The provisions of this section for listing trading months prior

to contract market designation shall not apply to:

(1) A contract subject to the provisions of section 2(a)(1)(B) of

the Act;

(2) A contract that is the same or substantially the same as one

for which an application for contract market designation under sections

4c,5, 5a and 6 of the Act or Sec. 5.1 of this part was filed for

Commission approval prior to being listed for trading while the

application is pending before the Commission.

(3) A contract that is the same or substantially the same as one

which is the subject of a Commission proceeding to disapprove

designation under section 6 of the Act, to disapprove a term or

condition under section 5a(a)(12) of the Act, to alter or amend a term

or condition under section 8a(7) of the Act, to amend terms or

conditions under section 5a(a)(10) of the Act, to declare an emergency

under section 8a(9) of the Act, or to any other proceeding the effect

of which is to disapprove, alter, amend, or require a contract market

to adopt a specific term or condition, trading rule or procedure, or to

refrain from taking a specific action.

Issued in Washington, DC, this 20th day of July, 1999, by the

Commodity Futures Trading Commission.

Jean A. Webb,

Secretary of the Commission.

[FR Doc. 99-18985 Filed 7-26-99; 8:45 am]

BILLING CODE 6351-01-M