Revised Procedures for Listing New Contracts

COMMODITY FUTURES TRADING COMMISSION

17 CFR Part 5

RIN 3038-AB42

Revised Procedures for Listing New Contracts

AGENCY: Commodity Futures Trading Commission.

ACTION: Final rules.

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SUMMARY: The Commodity Futures Trading Commission (Commission) is

adopting a final rule permitting exchanges to list contracts for

trading without Commission approval. 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 proposed a two-year pilot program to

permit the listing of contracts for trading prior to Commission

approval. 64 FR 40528 (July 27, 1999). Based upon the comments

received, the Commission is modifying the proposed rule to permit

exchanges to list commodity futures or option contracts for trading

without Commission approval of the contract or its terms and

conditions, including any subsequent amendments thereto. This new

listing procedure is an alternative to regular or fast-track procedures

for contract market designation. To meet its statutory mission of

ensuring market integrity and customer protection, the Commission will

place greater reliance on its existing oversight authorities to

disapprove, alter or supplement exchange rules or to take emergency

action, as appropriate. The Commission also is making a number of

technical changes to the rule, as suggested by the comments.

In a companion release published elsewhere in this edition of the

Federal Register, the Commission is proposing to permit all exchange

rules and rule amendments to be made effective without Commission

approval. As part of that proposed rulemaking, the Commission will seek

comment on whether the new procedure for listing contracts for trading

without approval which the Commission is adopting herein should become

the exclusive means of offering new exchange products and amending

their terms and conditions. In a second companion notice in this issue

of the Federal Register, the Commission is also proposing to delete

fees for applications for contract market designation in order to

remove any economic disincentive for using regular or fast-track review

procedures.

EFFECTIVE DATE: January 25, 2000.

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

Division of Economic Analysis, Commodity Futures Trading Commission,

Three Lafayette Centre, 1155 21st Street, N.W., Washington, D.C. 20581,

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

SUPPLEMENTARY INFORMATION:

[[Page 66374]]

I. The Proposed Rules

The Commission recently proposed rules to enable boards of trade to

list for trading new contracts \1\ without any waiting period. 64 FR

40528 (July 27, 1999). This proposal responded to testimony of

representatives of U.S. exchanges that the ability to list contracts

more quickly than currently possible is necessary for them to meet

competitive challenges by foreign exchanges.\2\ The proposed rule,

pursuant to the Commission's 4(c) exemptive authority, provided that

boards of trade already designated as a contract market in one

commodity could list new contracts for trading while their application

for designation in the contract was pending approval. Thus, the

proposed rules responded to the need for immediacy in listing new

contracts within the current statutory framework which requires that

the Commission designate boards of trade as a contract market in a

commodity and that the Commission approve that contract's terms and

conditions.\3\

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\1\ However, the Commission proposed that contracts subject to

the accord provision of section 2(a)(1)(B) of the Commodity Exchange

Act (Act) not be eligible for this relief, consistent with the

provisions of section 4(c) of the Act.

\2\ 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. CFTC 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 (NYMEX).

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.''

\3\ As the Commission noted, although the contracts during that

initial listing period would not have been designated, they would

have been designated subsequently using the current procedures,

including fast-track review. During the initial review period, the

contracts would have been valid and enforceable pursuant to the

Commission's rule which was proposed under the Commission's

exemptive authority. Id. at 40531.

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Specifically, the proposed rule would have required boards of trade

to file a contract's terms and conditions with the Commission by close

of business on the business day prior to, and an application for

contract market designation within forty-five days of, initially

listing a contract for trading. Boards of trade would have been

permitted to list and maintain up to a full year's trading months prior

to designation. Finally, they would have been required to identify the

contract as listed pending Commission designation, to enforce the

contract's terms and conditions, and to fulfill all of a contract

market's self-regulatory obligations during the period prior to its

designation as a contract market in that commodity. The proposed rule

also provided that while a designation application submitted under

regular or fast track procedures was pending, a second exchange could

not list the same, or a substantially similar, contract to trade under

the rule, nor could the listing procedure be used to evade an adverse

Commission proceeding involving the same or a substantially similar

contract.\4\

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\4\ 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 market.

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II. Comments Received

Seven entities commented on the proposed rule-- five futures

exchanges, a futures industry association and an association

representing commodity merchandisers.\5\ The exchanges generally

commented that the proposed rule did not provide sufficient relief.

They unanimously opposed the Commission designating a contract after it

has been listed for trading, advocating instead that the Commission

limit its role to disapproving a new contract or requiring its terms to

be amended. They also opposed limiting to one year the trading months

that initially could be listed and the Commission characterizing the

proposed rule's implementation as a ``pilot program.'' One commenter

supported the proposal. The comments are discussed in greater detail

below.

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\5\ The thirty-day comment period closed on August 26, 1999.

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Based on its administrative experience and in response to the

comments received, the Commission is adopting a final rule permitting

exchanges to list contracts for trading pursuant to exchange

certification, and without prior Commission approval. As one exchange

commenter noted, ``contract approval, while arguably useful in an era

before exchanges had developed [sophisticated] * * * self-regulatory

systems and procedures,'' is no longer necessary. New York Board of

Trade (NYBOT) comment letter at 3. The Commission agrees that it can,

and should, place greater reliance on the exchanges' role as self-

regulatory organizations, particularly in connection with their

decisions to list new products for trading.

As the NYBOT points out, commodity futures and option exchanges

over the years have developed increasingly sophisticated self-

regulatory mechanisms and procedures to keep pace with the changing

nature of the products which they offer. During that time, the

Commission has kept pace with those changes by periodically updating

the requirements for an application for contract market designation and

its processing procedures.\6\ Based on that experience, the Commission

is confident that commodity futures and option exchanges stand ready to

assume greater responsibility for ensuring that their new products meet

the applicable statutory and regulatory requirements. The Commission is

equally assured that the exchanges will return that confidence through

their cooperative response to the Commission's efforts to exercise

greater oversight authority and to decrease its direct regulation.

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\6\ See, Guideline No. 1, 17 CFR Part 5, Appendix A, and 17 CFR

5.1 (fast-track designation procedures.)

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III. The Final Rule

A. Legal Certainty

All of the commenters opposing the proposed rule cited the need for

increased legal certainty. Several, such as the Chicago Mercantile

Exchange (CME) and the New York Mercantile Exchange (NYMEX) opposed

implementation of the rule as a two-year pilot program. They reasoned

that a pilot program created undue uncertainty because there was no

assurance that the rule would be continued or expanded at the end of

the initial two-year period. NYMEX additionally observed that ``the

Commission has not provided guidance on how it would evaluate the pilot

program.'' \7\ In order to provide greater legal certainty to the

market, the Commission is promulgating the rule for

[[Page 66375]]

an unlimited duration and not as a pilot program.

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\7\ NYMEX comment letter at p. 3. NYMEX also suggested that the

Notice of Proposed Rulemaking's description of certain benefits of

Commission review of exchange rules with no ``original assessment''

of the costs of that review called into question the Commission's

commitment to its proposed pilot program.'' The Commission

disagrees. The proposed rule on its face either reduced or did not

increase regulatory costs.

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All of the exchanges opposed the proposed rule's requirement that

boards of trade submit to the Commission an application for contract

market designation within forty-five days of listing a contract to

trade. The CME reasoned that the possibility that the Commission might

``disapprove the contract or require its terms to be amended * * * is

likely to discourage market participants from trading the new

contract.'' CME comment letter at 4. The Chicago Board of Trade (CBT)

objected that,

the Commission is expressly retaining the requirement of

Commission review of contract terms, along with the concomitant

authority to disapprove or require changes to the contract terms,

post-listing. The risk that contract terms could change by

Commission fiat during a post listing review period will discourage

market use of any contract listed under the pilot program.

CBT comment letter at 2. NYMEX concluded that ``uncertainty regarding

whether or not a pending application for designation would be approved

or denied, or perhaps modified from the original filing under terms

dictated to an exchange by the CFTC, could continue for a whole year.''

\8\ NYMEX comment letter at 3. The exchanges therefore concluded that

the proposed rule would better serve their competitive needs by

permitting them to ``list new contracts without Commission approval-not

``pending'' such approval.'' NYBOT comment letter at 2.

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\8\ NYMEX's conclusion regarding the relative degree and length

of any such uncertainty is based upon the assumption that the

Commission would take the entire statutorily-provided time for the

post-listing review and designation of new contracts. However,

nothing in either the fast-track or the proposed rule would have

precluded use of the Commission's fast track procedures (17 CFR

5.1), which provide either a ten or forty-five day review period.

Moreover, the fast-track rule empowers exchanges to request that, if

the Commission terminates fast track review, it either approve the

contract as submitted or initiate disapproval proceedings.

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The Commission, in response to the comments, is modifying the rule

as proposed to replace the requirement that boards of trade submit for

Commission review and approval an application for contract market

designation within forty-five days of listing a contract. Instead,

boards of trade only will be required to certify that the contract

listed for trading meets the requirements of the Commodity Exchange Act

and the Commission's rules thereunder. This certification must be filed

along with the contract's terms and conditions no later than the close

of business of the business day preceding the contract's listing. The

exchange's certification that the contract meets the statutory and

regulatory requirements is in lieu of the otherwise required

application for contract market designation and the Commission's review

and approval of the application and of the contract's terms. Under the

final rule, contracts may be listed for trading indefinitely in

reliance on the exchange's certification; \9\ and as discussed below

the Commission generally will not review and approve the contract's

terms under section 5a(a)(12) of the Act and Commission rule 1.41.

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\9\ The exchanges also commented that the proposed limitation of

delivery months which could be listed prior to designation to one

rolling year would discourage trading in contracts listed under the

rule. The final rule includes no limitation on the listing of

distant trading months.

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The exchange commenters also objected to the proposed requirement

that they notify the public on all public references to the contract or

its trading months that the contract is trading pending Commission

designation. The CBT stated that, according to certain market users,

highlighting the revised terms for deferred contract months in its

soybean oil contract as ``pending Commission approval'' ``discouraged

calendar spread trading'' and that ``even though open interest began to

slowly increase while [it] * * * waited for final Commission action,

that growth was slower than anticipated.'' \10\ CBT comment letter at

2. The NYMEX concurred, stating that ``uncertainty regarding whether or

not a pending application for designation would be approved or denied *

* * could continue for a whole year,'' and ``during that period * * * a

board of trade would have a continuing duty to notify the public * * *

that the contract was trading pending Commission designation.'' NYMEX

comment at 3.

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\10\ The CBT amendments to the soybean contract raised a number

of potential issues under U.S. antitrust laws which the Commission,

under section 15 of the Act, was obliged to consider in approving

the rule. In addition, the Commission found it necessary to amass a

sizeable administrative record to determine the relative merit of

the claims of non-members of the exchange opposed to the CBT's

amendment.

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However, as long as boards of trade have available two means of

listing contracts, either by self-certification or Commission approval,

the public has a right to know the legal status of a contract. The

final rule clarifies that this public notice obligation is satisfied

through an appropriate reference in the board of trade's rule book and

includes other conforming changes. Accordingly, the Commission is

adopting as final a requirement that the board of trade identify the

contract in its rules as ``listed for trading pursuant to exchange

certification.''

Two commenters suggested that trading in contracts listed pursuant

to the rule would be discouraged without greater legal certainty that a

subsequent Commission finding disapproving or altering a contract term

would not also invalidate open contracts. As the Futures Industry

Association (FIA) noted:

although the Commission states in the Federal Register release

accompanying the proposed rule that any contract listed under the

revised procedures would be valid and enforceable pending approval,

the proposed rule itself is silent on this issue. Without such

certainty, the enforceability of any contract subsequently

determined to be in violation of the Act would also be open to

question.

FIA comment letter at 2. The NYBOT concurred in this view. NYBOT

comment letter at 3. Others informally have expressed the view that the

applicability of the Act would be uncertain legally unless contracts

which are ``listed pursuant to exchange certification'' were also

deemed to be ``designated contract markets'' under the Act. The final

rule addresses both of these concerns.

The final rule, in response to these comments, explicitly preserves

the validity and enforceability of contracts listed pursuant to

exchange certification despite a possible violation of the rule by the

listing board of trade. For example, if a board of trade incorrectly

certifies that the terms of a contract that it is listing for trading

do not violate the Act, it will be subject to Commission remedial

action for that violation. However, the individual contracts that have

been traded are valid and enforceable nonetheless.\11\ The Commission

in the final rule also has made explicit that all sections of the Act

and Commission rules which refer to ``designated contract markets'' are

applicable to contracts listed for trading pursuant to rule 5.3.\12\

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\11\ Similarly, although the Commission found that the CBT corn

and soybean futures contract markets violated the provisions of

section 5a(a)(10) of the Act, the individual contracts traded were

valid, enforceable contracts.

\12\ Compare, 17 CFR 33.2.

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Accordingly, in exempting boards of trade from the designation and

rule approval requirements of the Act, the Commission is not thereby

ceding any of its broad oversight authorities over designated contract

markets. These include, among others, its authority to disapprove,

alter or supplement contract

[[Page 66376]]

rules under sections 5a(a)(12) \13\ and 8a(7) \14\ of the Act and its

section 8a(9) authority to direct a contract market to take action in

market emergencies.\15\ The Commission has used these authorities

sparingly in the past.\16\ In light of the futures exchanges' steadfast

commitment to fulfilling their self-regulatory responsibilities, the

Commission anticipates that despite the absence of its affirmative

prior review of exchange contracts and rules, such adverse actions will

continue to be infrequent.\17\

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\13\ Section 5a(a)(12) of the Act provides in part that: ``the

Commission shall disapprove, after appropriate notice and

opportunity for hearing, any such rule which the Commission

determines at any time to be in violation of the provisions of this

Act or the regulations of the Commission. If the Commission

institutes proceedings to determine whether a rule should be

disapproved pursuant to this paragraph, it shall provide the

contract market with written notice of the proposed grounds for

disapproval, including the specific sections of this Act or the

Commission's regulations which would be violated. At the conclusion

of such proceedings, the Commission shall approve or disapprove such

rule. Any disapproval shall specify the sections of this Act or the

Commission's regulations which the Commission determines such rule

has violated or, if effective, would violate.'' The Commission is

not waiving in any way its authority under section 5a(a)(12) to

disapprove ``at any time'' a rule of a contract which has been

listed for trading pursuant to this exemption.

\14\ Section 8(a)(7) of the Act provides in part that the

Commission is authorized: ``to alter or supplement the rules of a

contract market insofar as necessary or appropriate by rule or

regulation or by order, if after making the appropriate request in

writing to a contract market that such contract market effect on its

own behalf specified changes in its rules and practices, and after

appropriate notice and opportunity for hearing, the Commission

determines that such contract market has not made the changes so

required, and that such changes are necessary or appropriate for the

protection of persons producing, handling, processing, or consuming

any commodity traded for future delivery on such contract market, or

the product or byproduct thereof, or for the protection of traders

or to insure fair dealing in commodities traded for future delivery

on such contract market. Such rules, regulations, or orders may

specify changes with respect to such matters as--

(A) terms or conditions in contracts of sale to be executed on

or subject to the rules of such contract market; (B) the form or

manner of execution of purchases and sales for future delivery; (C)

other trading requirements, excepting the setting of levels of

margin; (D) safeguards with respect to the financial responsibility

of members; (E) the manner, method, and place of soliciting

business, including the content of such solicitations; and (F) the

form and manner of handling, recording, and accounting for

customers' orders, transactions, and account; The Commission is not

in any way waiving its authority to alter, supplement or amend a

rule of a contract that has been listed for trading pursuant to this

exemption.

\15\ Section 8a(9) of the Act provides in part that the

Commission is authorized: ``to direct the contract market, whenever

it has reason to believe that an emergency exists, to take such

action as in the Commission's judgment is necessary to maintain or

restore orderly trading in or liquidation of any futures contract,

including, but not limited to, the setting of temporary emergency

margin levels on any futures contract, and the fixing of limits that

may apply to a market position acquired in good faith prior to the

effective date of the Commission's action.'' The Commission is not

in any way waiving its authority to declare a market emergency in a

contract which has been listed for trading pursuant to this

exemption and to order appropriate remedial measures.

\16\ The CME maintains that a new standard for rule disapproval

is necessary. It suggests that an exchange rule be subject to

disapproval only when the rule ``is likely to cause fraud, render

trading readily susceptible to manipulation, or threaten the

financial integrity of the market.'' CME comment at 6. However,

under section 5a(a)(12) of the Act, exchange rules are subject to

disapproval if they are in ``violation of the provisions of this Act

or the regulations of the Commission.'' This standard is far less

ambiguous than the one proposed by the CME. Moreover, in light of

the limited number of times that the Commission has in fact

instituted a proceeding to disapprove or alter a rule, the CME's

fear that the Act's current disapproval standard has been, or is,

subject to overuse, is misplaced. Moreover, the CME points to the

Commission's process for approving an increase to the tick size of

the E-Mini S&P 500 contract as an example of Commission

micromanagement and why a new standard for disapproval is warranted.

Reliance on that example is also misplaced. The Commission's review

and request for public comment was triggered by section 15 of the

Act and the potential anti-trust implications of increasing the

contract's tick size. However, if a contract is not submitted for

Commission approval, potential anti-trust issues involving its terms

and conditions generally would not be considered by the Commission.

\17\ Section 8c(a)(1) of the Act provides the Commission with

the authority to discipline directly any exchange member if the

exchange, as the self-regulator, fails to act. The Commission is not

waiving this oversight authority in any way.

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B. Approval of Contract Terms and Conditions

Currently, the Commission approves a contract's initial terms and

conditions under section 5a(a)(12) of the Act and Commission rule 1.41

when it issues an Order designating a board of trade as a contract

market in that commodity. The Commission also reviews and approves all

amendments to the contract's terms and conditions. As proposed, rule

5.3 would have preserved this framework by requiring the exchange to

file an application for designation after the contract initially was

listed for trading. Filing an application for designation would have

triggered the Commission's authority to review and approve the

contract's terms and conditions as well as any subsequent amendments.

64 FR at 40532.

As modified, the final rule permits a board of trade indefinitely

to list a contract for trading under its provisions. Accordingly, the

final rule does not require that an application for contract market

designation be submitted to the Commission. Consistent with that

provision, a contract listed pursuant to the rule will not have its

initial terms and conditions approved by the Commission.\18\

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\18\ However, the Commission on its own initiative and in its

sole discretion may review and approve certain exchange rules, such

as exchange speculative position limits, when Commission approval

would be in the public interest. The Commission is empowered under

section 4a(5) of the Act to enforce exchange speculative position

limits which it has ``approved.'' This authority is an important

enforcement tool in cases where the violation is by a non-member of

an exchange. Accordingly, the Commission may determine to approve

some, or all, of the speculative position limits of contracts

trading pursuant to this rule. Commission review and approval of

such an exchange rule, however, would require no action by, and

place no burden on, the board of trade.

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However, as the Commission noted in the Notice of Proposed

Rulemaking, contract amendments may raise additional issues for

Commission review, such as their potential

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 * * *.

64 FR 40528. Nevertheless, the exchange commenters suggested that

amendments to contract terms and conditions be accorded the same

treatment as newly listed contracts. As the NYBOT stated, ``if a new

contract can be listed without prior approval, then rules that relate

to contract terms and conditions, amendments thereto, and any other

rules should likewise be allowed to become effective immediately upon

filing with the Commission. NYBOT Comment letter at 4.

The Commission is modifying the final rule to permit boards of

trade to amend the terms of a contract listed for trading by exchange

certification on the same conditions that apply to its initial listing.

As proposed, all contract terms and conditions would have been subject

to Commission review and approval soon after the contract's initial

listing. The proposed requirement that the Commission also approve

contract amendments was consistent with that framework. However,

because under the final rule a contract's initial terms no longer will

be approved by the Commission, significant public confusion would ensue

were the Commission to retain authority to approve contract amendments.

That inconsistency could result in Commission approval of only the

amendments to a contract term, but not of the underlying exchange rule

itself. Moreover, had the Commission in the final rule retained the

proposed requirement that contract amendments be subject to Commission

pre-approval while initial contract terms were not, simply listing an

amended contract as a

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new one would provide a ready means to bypass the requirement.\19\

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\19\ It is not unusual for contract markets currently to list

for simultaneous trading an ``A'' and a ``B'' contract when

substantial amendments to a contract's terms have been made and the

board of trade wishes to list nearby trading months with the amended

contract terms.

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Accordingly, the Commission is modifying the final rule from the

rule as proposed to make consistent the regulatory treatment and status

of the contract's initial terms and any amendments thereto. Thus, the

final rule provides that the text of a contract amendment be submitted

to the Commission by close of business of the business day preceding

its being implemented. The board of trade must also submit its

certification that the rule amendment does not violate and is not

inconsistent with any provisions of the Commodity Exchange Act or the

rules thereunder.\20\

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\20\ Proposed rule 5.3 (c) provided that boards of trade must

enforce each bylaw, rule, regulation and resolution that relates to

the terms or conditions of a contract listed for trading under the

rule. This is to make operative section 5a(8) of the Act which

requires each contract market to enforce its rules which have been

approved by the Commission, which have become effective under

section 5a(a)(12) of the Act or which ``must be enforced pursuant to

any commission rule. * * *'' As self-regulatory organizations,

boards of trade are expected to follow, be bound by, and to enforce

their rules. This provision requires that boards of trade trading

contracts pursuant to this rule adhere to this high standard. No

comments specifically discussed this provision and the Commission is

adopting it as final.

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In addition, the final rule requires that amendments to the terms

and conditions of contracts trading pursuant to exchange certification

be implemented only for contract months having no open interest. That

implementation practice generally has been required by the Commission

when reviewing proposed exchange rules for its approval to provide

traders with legal certainty regarding the contract's terms and

conditions.\21\ Even in the absence of rule 5.3 so requiring, boards of

trade would adhere to this practice. As the NYBOT observed, ``any

changes to terms and conditions * * * should be made effective only

with respect to contract months in which there is no open interest.

This is consistent with the approach taken by the exchanges today, and

endorsed by the Commission, when amendments which affect terms and

conditions are introduced to existing contracts.'' NYBOT comment at 3.

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\21\ The Commission has approved contract amendments for

implementation in trading months with open interest only where

implementation of the proposed rule change would not affect the

value of existing positions or traders had notice of the impending

change prior to opening their positions.

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This exemption from the requirement of prior Commission approval

applies only to the amendment of contracts that are traded pursuant to

rule 5.3. In a companion notice being published in this edition of the

Federal Register, the Commission is proposing a similar exemption for

amendments to the rules of a designated contract market. That Notice of

Proposed Rulemaking raises two issues that also are applicable to these

final rules. First, should the exemption specifically require that

contract amendments be implemented only in delivery months with no open

interest at the time the rule is made effective? Secondly, to reduce

public confusion, should the Commission withdraw the availability of

designation of new contracts under regular and fast-track procedures

and of Commission approval of exchange rules and rule changes and make

the rule 5.3 procedure the sole means of listing new contracts and

amending their terms? The Commission is also proposing by separate

notice in this edition of the Federal Register, to delete application

fees for contract market designation. If the Commission determines to

retain regular and fast-track designation procedures as alternative

methods to rule 5.3 for introducing new products, retaining fees for

contract market designation would operate as a disincentive to their

use.

C. Conditions

The proposed rule included a number of qualifying conditions for

boards of trade and the contracts to be listed thereunder. The

Commission proposed that a qualifying board of trade must be designated

as a contract market in at least one other non-dormant contract. The

CME concurred with the proposed requirement that a board of trade

already be a designated contract market in one non-dormant contract,

noting that:

start up exchanges are not appropriate candidates for the

proposed pilot program because the initial designation of a board of

trade as a contract market entails a more lengthy review and

analysis of its trading and clearing systems and its self-regulatory

programs. This restriction makes sense, and we support it.

CME comment letter at 3. The Commission is adopting this provision as

final without modification.

In addition, the Commission proposed that a contract not be

eligible for immediate listing under the rule if it is the same or

substantially the same as one for which an application for contract

designation is pending before the Commission. As it explained in the

Notice of Proposed Rulemaking, the proposed restriction on listing

contracts which are the same as contracts pending before the Commission

for contract market designation and approval of their terms and

conditions is necessary in order to avoid a ``competing exchange [from]

* * * short-circuit[ing] the review process and to disadvantage the

exchange choosing to subject a proposed contract to prior Commission

review.'' 64 FR at 40531. The Commission concluded that such a use of

the proposed listing procedure would have been ``an unwarranted

competitive use of the proposed rule.'' Id. The Minneapolis Grain

Exchange (MGE) agreed that the ``proposed rule adequately prevents

attempts by exchanges to use the * * * pilot program to jump ahead of

an exchange submitting the same or similar contract under regular or

fast track procedures.'' MGE comment letter at 2.

The CME opposed the proposal. It reasoned that an exchange which is

lagging in developing a new product ``could file an application for

contract market designation under the regular or fast track procedures,

thereby preventing the exchange that is ready to list the new product

sooner from using the pilot procedure to exploit its timing

advantage.'' CME comment letter at 4-5. However, as the Commission

pointed out in the notice,

exchanges would not be able to use this proposed rule to

forestall a competitor from introducing a new contract * * *.

[N]othing would prevent the second exchange from filing an

application for review and approval by the Commission on its own

merits.

64 FR 40531, n. 19. Presumably were the second exchange really further

along in developing a new contract, it would retain its timing

advantage by being the first approved, while the exchange, which had

filed an incomplete application preemptively, continued its contract

development.\22\ Accordingly, the Commission is adopting the provision

as proposed. If in practice the rule is subject to the ``competitive

gamesmanship'' postulated by the CME, the Commission will propose

deleting it.\23\

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\22\ In this regard, fast-track approval procedures are

available only for applications for contract market designation

which are not amended once filed.

\23\ The CME also suggests that the language of the proposed

rule be modified to make clear that ``an exchange is not prevented

from using the pilot procedure to expedite listing a new contract

even though it had originally submitted the same contract to the

CFTC for pre-approval under the regular or fast track procedures.''

CME comment letter at 4. Nothing in the Act or Commission rules

prevents an exchange from withdrawing an application for contract

market designation at any time. Accordingly, an exchange could have

simply withdrawn its application for contract market designation and

listed the contract under the rule as proposed. Nevertheless, the

Commission is making explicit in the rule that this limitation

applies only to a board of trade other than the one with the pending

application. Of course, an exchange which abandons a pending

application for contract market designation in favor of listing

without Commission approval must be able to make the required

certification taking into consideration any adverse information

arising during consideration of the application. Moreover, in order

to conserve its resources, the Commission may determine not to

continue processing an application for contract market designation

if it is listed for trading while the application is pending.

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[[Page 66378]]

The Commission also proposed that rule 5.3 not be able to be used

``as a means of evading an adverse Commission proceeding involving the

same or a substantially similar contract.'' 64 FR 40531. As the

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Commission explained in the Notice of Proposed Rulemaking:

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.

Id. One commenter, the MGE, discussed this provision, noting that it

``believes the Commission's proposed rule adequately prevents attempts

by exchanges to use the predesignation listing to evade an adverse

Commission proceeding involving the same or similar contract * * * .''

The Commission is adopting the limitation as proposed, and notes that

it applies to all boards of trade, not just to the respondent in the

adverse action.\24\

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\24\ This limitation applies to all boards of trade because the

Commission presumes that no exchange could make the required

certification for a new contract with the same terms and conditions

as one against which the Commission has initiated an adverse action.

However, a competing exchange would not be estopped from listing a

contract for the same commodity but which did not include the

allegedly violative terms or conditions. On the other hand, the

respondent exchange might be precluded from doing so if listing the

revised contract were determined to be an attempt to frustrate the

prosecution of the adverse action or in violation of a Commission

Order issued in the course of the adverse action.

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Finally, rule 5.3 as proposed would not apply to futures contracts

on stock indexes, commodities which are subject to the specific

approval procedures of the Johnson-Shad jurisdictional accord.\25\ That

limitation is statutory in origin and is adopted as proposed.

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\25\ See, section 2(a)(1)(B) of the Act.

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IV. Section 4(c) Findings

Commission rule 5.3 was proposed under section 4(c) of the Act,

which grants the Commission broad exemptive authority. In proposing

rule 5.3, the Commission found that

because the proposed rule applies to contracts listed on

designated exchanges subject to the self-regulatory requirements of

the Act, * * * 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.

64 FR 40532. The Commission specifically requested comment on its

findings.

The CME and the CBT both objected that the Commission should not

apply the exemptive criteria of section 4(c)(2) of the Act because in

their view, ``the standards of Section 4(c)(1) apply to exemptive

relief for existing exchanges with contract designation in place.'' CBT

comment letter at n.1; See also, CME comment letter at n.1. However,

section 4(c)(2) of the Act provides that the Commission shall grant an

exemption from the requirements of section 4(a) of the Act only if

certain specified conditions are met. Section 4 (a)(1) of the Act

provides that to be lawful, transactions must be ``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)(1) (emphasis added). Rule 5.3 exempts boards of trade from that

designation requirement. Thus, an exemption under section 4(c)(2) of

the Act is necessary and its criteria for exemption must be satisfied

for futures contracts to be lawfully traded on a board of trade

pursuant to rule 5.3 without Commission designation in that

commodity.\26\ The Commission in the Notice of Proposed Rulemaking

found that proposed rule 5.3 met the criteria for exemption.\27\

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\26\ For administrative convenience, the Commission treats

separately traded contracts for the same generic commodity with

differing terms and conditions and pricing characteristics as

separate commodities for purposes of contract market designation.

See, Part 5, Appendix A, 64 FR 29221 (June 1, 1999).

\27\ Section 4(c)(2) of the Act provides that: 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.

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The FIA disagreed with the Commission's findings that the proposed

rule met those criteria. It concluded that because the proposed rule

``would create both practical and legal uncertainty with respect to any

contract listed under the revised procedures * * * [it] question[s]

whether adoption of the proposed rule `would be consistent with the

public interest.' '' FIA comment letter 1. The Commission has addressed

the basis for FIA's questioning whether adoption of the proposed rule

would be in the public interest by modifying the final rule as

recommended by FIA and the other commenters.

The Commission's section 4(c) findings were based, in part, on

proposed rule 5.3's provision that, after having been listed for

trading, contracts were required to be designated and their terms and

conditions approved by the Commission. The Commission noted that

proposed rule 5.3 would have preserved the public interest in

Commission approval of new contracts and of contract amendments. That

interest, it explained, arose because ``appropriate contract design is

the best deterrent to market manipulation, price distortion or market

congestion * * *. [C]ontract approval assures that contracts meet these

widely-accepted design criteria.'' 64 FR 40530. The Commission further

noted, however, that the proposed rule was ``consistent with the spirit

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

exchanges may make proposed rules effective pending Commission

action.'' 64 FR 40531.

The exchange commenters disagreed that there was a public interest

in Commission designation of contracts and approval of their terms and

conditions. The NYBOT countered that:

An effective market surveillance system is the best way to avoid

such market situations. Therefore, to us it is most important that

an exchange has a self-regulatory track record to ensure that

trading will be conducted in a fair and orderly manner. We believe

the sophisticated systems developed over decades of experience,

coupled with the oversight provided by the Commission, have proven

to be exceptionally effective in identifying and dealing with the

types of market situations which the Commission

[[Page 66379]]

seeks to protect against. This track record strongly suggests that

contract approval, while arguably useful in an era before exchanges

had developed these self-regulatory systems and procedures, no

longer serves any positive purpose.

NYBOT comment letter at 3. The CME concurred, stating that it did not

agree with the premise that ``in-depth CFTC review of new contract

applications serves an important public purpose by providing an

opportunity for public comment and by improving contract design.'' The

CME explained that it agrees with those objectives, ``has a strong

business interest in designing its contracts so that they are not

readily susceptible to manipulation'' and in developing contracts

``talks with commercial users.'' CME comment letter at 3. NYMEX argued

that:

in view of the powerful economic forces that drive exchanges to

be thorough and vigilant in developing a new product, the Commission

should be confident in allowing exchanges to list contracts for

trading and implement rules without detailed prior review. In this

regard, NYMEX finds it significant that * * * British exchanges are

not currently subject to a preapproval process for their contracts

and rules.

NYMEX comment letter at 4; But see, ``Futures Exchange and Contract

Authorization Standards and Procedures in Selected Countries,''

Office of International Affairs, Commodity Futures Trading

Commission, August 3, 1999.

The Commission agrees with the exchanges that a strong self-

regulatory program and an effective market surveillance system are

necessary to remedy adverse market situations and to deter potential

manipulators. However, it is generally accepted that appropriate

contract design is a key component of an effective market surveillance

system.\28\ In this regard, exchanges have a strong business incentive

to design contracts that will not be susceptible to manipulation.\29\

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\28\ 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. See, the Tokyo Communique on Supervision of

Commodity Futures Markets issued at the Tokyo Commodity Futures

Markets Regulators' Conference on October 31, 1997.

\29\ One commenter, the National Grain and Feed Association,

supported proposed rule 5.3, in part, because ``industry groups will

still have an opportunity to comment during the formal approval

process.'' The final rule no longer provides a formal opportunity

for comment by industry groups. However, the exchanges have assured

the Commission that it is their practice to seek out such views when

designing their contracts. Moreover, the Commission will continue to

provide a forum for industry groups to make their views known to it

regarding the terms and conditions of all contracts, including newly

listed contracts.

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Prior to the 1974 amendments to the Act, the statutory scheme did

not require the Commodity Exchange Authority, the Commission's

predecessor agency, to approve in advance the trading of all new

futures contracts,\30\ 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.\31\ The prior approval

requirements were included in the 1974 amendments to the Act as one of

a number of measures to strengthen federal regulatory oversight of the

futures industry. These measures included the Commission's authority

under section 8a(7) of the Act to alter or amend contract market rules

and its section 8a(9) emergency authority.

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\30\ 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.

\31\ See, Pub. L. No. 90-258, Sec. 23, 82 Stat. 33 (1968).

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The exchanges argue forcefully that their ability to counter

competition from foreign exchanges requires that the Commission rely

less on its prior-approval authority. They argue that the ability to

list contracts without Commission approval is central to their ability

to meet foreign competition. To date, relatively few contracts traded

on foreign exchanges directly compete with contracts traded on U.S.

exchanges, and for those that do, few, if any, U.S. contracts have been

displaced by a foreign competitor.\32\ Nevertheless, the Commission

believes that, consistent with its mandate to protect market integrity,

financial integrity, guard against market manipulation and protect

customers, it should ensure that the regulatory scheme not

unnecessarily impede the exchanges from competing. By this rulemaking,

the Commission is exercising its mandate flexibly to accomplish those

goals.

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\32\ See, ``The Global Competitiveness of U.S. Futures Markets

Revisited,'' Report of the Division of Economic Analysis to the

Commodity Futures Trading Commission (October, 1999).

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The public interest in the integrity and fairness of the futures

markets can be achieved through greater reliance by the Commission on

its surveillance and enforcement authorities. As the exchanges

recognize, the Commission has available to it strong oversight

authorities over boards of trade and their contracts without approving

an application for contract market designation and the contract's

terms. As one exchange noted, ``by letting such an exchange list new

contracts without Commission approval * * * the CFTC would not have

lost oversight authority over the exchange or its contracts.'' NYBOT

comment letter at 2. The CBT observed that, ``eliminating the

requirement of Commission approval of new contracts would not affect

the Commission's general authority over a contract's terms and

conditions.'' CBT comment letter at 3.

For the reasons explained above, the Commission believes that rule

5.3 is 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. Moreover, because

the rule applies to contracts listed on exchanges subject to the self-

regulatory requirements of the Act, the Commission finds all traders

are ``appropriate'' for application of this exemptive rule under

section 4(c) of the Act.

V. 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 final

amendments permit exchanges under section 4(c) of the Act to list new

contracts for trading without designation as a contract market in that

contract. Accordingly, the 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

Guideline No. 1 (17 CFR Part 5 Appendix A), which sets forth the

requirements for applications for contract designation, contains

information collection requirements. As required by the PRA of 1995

(Pub. L. 104-13 (May 13, 1996)), the Commission submitted a copy of the

proposed rule to the Office of Management and Budget (OMB) for its

review (44 U.S.C. 3504(h)) and indicated that there was no implication

[[Page 66380]]

for the paperwork burden. Based on the comments the Commission received

in response to the proposed rulemaking, the Commission is revising the

paperwork burden associated with the new rule as reflected below.

OMB previously approved the collection of information related to

this rule as information collection 3038-0022, Regulations Pertaining

to the Responsibilities of Contract Markets and Their Members. The

final rule adopted by the Commission, which has been submitted to OMB

for approval, has the following paperwork burden:

Number of respondents: 11.

Estimated average hours per response: 29.

Frequency of response: On occasion.

Number of responses per year: 11.

Annual reporting burden: 319.

This represents a reduction of 1073 burden hours based on the

Commission's estimation of the number of contract market designation

applications that would no longer be submitted under regular or fast-

track procedures. Persons wishing to comment on the paperwork burden

contained in the final rules may contact the Desk Officer, CFTC, Office

of Management and Budget, Room 10202, NEOB, Washington, DC 20503, (202)

395-7340. Copies of the information collection submission to OMB 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

Commodity futures, Contract markets, Designation application,

Reporting and recordkeeping requirements.

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 hereby amends 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 Listing contracts for trading by exchange certification.

(a) Notwithstanding the provisions of section 4(a)(1) of the Act or

Sec. 33.2 of this chapter, a board of trade may list for trading

contracts of sale of a commodity for future delivery or commodity

option contracts, if the board of trade:

(1) Is designated under sections 4c, 5, 5a(a) and 6 of the Act as a

contract market in at least one commodity which is not dormant within

the meaning of Sec. 5.2 of this part;

(2) In connection with the trading of the contract complies with

all requirements of the Act and Commission regulations thereunder

applicable to designated contract markets, except for the requirement

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

that the terms and conditions of the contract be approved by the

Commission;

(3) Files with the Commission at its Washington, D.C., headquarters

and the regional office having jurisdiction over it a copy of the

contract's initial terms and conditions and a certification by the

board of trade that the contract's initial terms and conditions neither

violate nor are inconsistent with any provision of the Commodity

Exchange Act or of the rules thereunder, and the filing is received no

later than the close of business of the business day preceding the

contract's initial listing;

(4) Files with the Commission at its Washington, D.C., headquarters

and the regional office having jurisdiction over it the text of each

amendment to the contract terms and conditions (with deletions in

brackets and additions underscored), a brief explanation of the

amendment including a description of any substantive opposing views by

members of the board of trade or others and a certification by the

board of trade that the amendment neither violates nor is inconsistent

with any provision of the Commodity Exchange Act or of the rules

thereunder, and the filing is received no later than the close of

business of the business day preceding the amendment's implementation;

(5) Implements amendments to the contract terms and conditions only

in trading months having no open interest at the time of

implementation; and

(6) Identifies the contract in its rules as listed for trading

pursuant to exchange certification.

(b) 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.

(c) Contracts listed for trading pursuant to this section shall not

be void or voidable as a result of:

(1) A violation by the board of trade of the provisions of this

section; or

(2) Any 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 supplement a term or condition under

section 8a(7) of the Act, to amend the contract's terms or conditions

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

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

is to disapprove, alter, supplement, or require a contract market to

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

take or refrain from taking a specific action.

(d) Except as specified in paragraph (a) of this section and unless

the context otherwise requires, the board of trade listing contracts,

and the contracts listed, for trading under this section shall be

subject to all of the provisions of the Act and Commission regulations

thereunder which are applicable to a ``board of trade,'' ``board of

trade licensed by the Commission,'' ``exchange,'' ``contract market,''

``designated contract market,'' or ``contract market designated by the

Commission'' as though those provisions were set forth in this section

and included specific reference to contracts listed for trading

pursuant to this section.

(e) The provisions of this section shall not apply to :

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

the Act;

(2) A contract to be listed initially for trading 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 already was filed for Commission approval by

another board of trade while the application is pending before the

Commission;

(3) A contract to be listed initially for trading that is the same

or substantially the same as one which is the subject of a pending

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 supplement 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,

supplement, or require a contract market to adopt a specific term or

condition, trading rule or procedure, or to take or refrain from taking

a specific action.

[[Page 66381]]

Issued in Washington, DC, this 17th day of November, 1999, by

the Commodity Futures Trading Commission.

Jean A. Webb,

Secretary of the Commission.

[FR Doc. 99-30510 Filed 11-24-99; 8:45 am]

BILLING CODE 6351-01-P