Hong Kong Futures Exchange Limited’s Request for No-Action Relief in Connection with the Offer and Sale of its Mini Futures Contracts Based on the Hang Seng Index and the Hang Seng China Enterprises Index in the Unite...

Summary: Hong Kong Futures Exchange Limited’s Request for No-Action Relief in Connection with the Offer and Sale of its Mini Futures Contracts Based on the Hang Seng Index and the Hang Seng China Enterprises Index in the United States.

U.S. COMMODITY FUTURES TRADING COMMISSION

Three Lafayette Centre

1155 21st Street, NW, Washington, DC 20581

Telephone: (202) 418-5120

Facsimile: (202) 418-5524

Office of General Counsel

CFTC Letter No. 09-01

January 16, 2009

No-Action

Office of General Counsel

Calvin Tai

Director

Hong Kong Futures Exchange Limited

12/F One International Finance Centre

1 Harbour View Street

Central, Hong Kong

Re:

Hong Kong Futures Exchange Limited’s Request for No-Action Relief in

Connection with the Offer and Sale of its Mini Futures Contracts Based on

the Hang Seng Index and the Hang Seng China Enterprises Index in the

United States

Dear Mr. Tai:

This is in response to your letter dated March 7, 2008 and attachments,

requesting on behalf of the Hong Kong Futures Exchange, Limited (“HKFE”), that the

Office of General Counsel of the Commodity Futures Trading Commission

(“Commission” or "CFTC") issue a no-action letter concerning the offer and sale in the

United States of HKFE’s mini futures contracts (collectively “mini futures”) based on the

Hang Seng Index (“HSI”) and the Hang Seng China Enterprises Index (“HSCEI”)

(collectively, “Indices”).1

We understand that all the representations about HKFE in your April 11, 2005

submission on HSCEI futures (attached as Appendix 1) remain true and correct, and

are incorporated into your present submission. Based on your April 11, 2005

submission, HKFE is one of the major derivatives markets in Asia

ex (“HSI”) and the Hang Seng China Enterprises Index (“HSCEI”)

(collectively, “Indices”).1

We understand that all the representations about HKFE in your April 11, 2005

submission on HSCEI futures (attached as Appendix 1) remain true and correct, and

are incorporated into your present submission. Based on your April 11, 2005

submission, HKFE is one of the major derivatives markets in Asia. In operation since

1976, HKFE has been recognized as an “exchange company” under the Securities and

Futures Ordinance of the Laws of Hong Kong (“SFO”) in order to operate a derivatives

1 This Office previously has granted no-action relief in connection with HKFE’s futures

contracts on: 1) the HSCEI and the HSI, see CFTC Staff Letters No. 06-22, [2005-2007

Transfer Binder] Comm. Fut. L. Rep. (CCH) ¶ 30,366 (Sept. 26, 2006) and No. 94-50,

[1992-1994 Transfer Binder] Comm. Fut. L. Rep. (CCH) ¶ 26,114 (June 1, 1994); and 2)

the HKFE Taiwan Index, see CFTC Staff Letter No. 99-25, [1998-1999 Transfer Binder]

Comm. Fut. L. Rep. (CCH) ¶ 27,715 (July 14, 1999).

2

market. HKFE and its wholly-owned subsidiary, HKFE Clearing Corporation Limited

(“HKCC”), are subject to the regulatory oversight of the Hong Kong Securities and

Futures Commission (“SFC”). SFC is responsible for enforcing the SFO and ensuring

exchange participants’ compliance with statutory requirements, including provisions

related to market manipulation, financial requirements, internal control requirements,

and the SFC’s Code of Conduct for Persons Licensed by or Registered with the SFC.2

The HSI mini futures contract began trading on October 9, 2000 and the HSCEI

mini futures contract began trading on March 31, 2008

ensuring

exchange participants’ compliance with statutory requirements, including provisions

related to market manipulation, financial requirements, internal control requirements,

and the SFC’s Code of Conduct for Persons Licensed by or Registered with the SFC.2

The HSI mini futures contract began trading on October 9, 2000 and the HSCEI

mini futures contract began trading on March 31, 2008. The HSI is a broad-based,

modified-free-float-adjusted-market-capitalization-weighted index designed to reflect the

performance of the overall Hong Kong stock market.3 The HSCEI is a broad-based,

modified-free-float-adjusted-market-capitalization-weighted index composed of all H-

share common stocks that are listed on the Stock Exchange of Hong Kong (“SEHK”)

and that are included in the Hang Seng Composite Index (“HSCI”). Compiled and

managed by HSI Services Limited, the HSCEI is designed to reflect the overall

performance of the H-share companies in the HSCI.4

As of January 31, 2008, there were 43 stocks in each of the Indices, with a total

adjusted market capitalization of the HSI and the HSCEI of U.S. $652,770 million and

U.S. $227,839 million, respectively.5 Also as of that date, the largest single stock

represented 15.56%, and the five most heavily weighted stocks accounted for 40.76%

of the HSI.6 The largest stock represented 10.5%, and the five most heavily weighted

stocks accounted for 43.01% of the HSCEI. The stocks comprising the lowest 25% of

the HSI and HSCEI over a six-month period ending January 31, 2008 had an aggregate

value of average daily trading volume in excess of U.S. $30 million: approximately U.S.

$1,528 million and U.S. $1,554 million, respectively.7

2 See letter from Calvin Tai, HKFE, to Julian E. Hammar, CFTC, dated April 11, 2005, at

1-4.

3 See letter from Mr. Tai to Mr. Hammar, dated March 7, 2008, at 7.

4 See letter from Mr. Tai to Mr. Hammar, dated April 11, 2005, at 10

ume in excess of U.S. $30 million: approximately U.S.

$1,528 million and U.S. $1,554 million, respectively.7

2 See letter from Calvin Tai, HKFE, to Julian E. Hammar, CFTC, dated April 11, 2005, at

1-4.

3 See letter from Mr. Tai to Mr. Hammar, dated March 7, 2008, at 7.

4 See letter from Mr. Tai to Mr. Hammar, dated April 11, 2005, at 10.

5 Effective March 6, 2006, the weighting methodology of the HSCEI changed to a

modified-free-float-adjusted market capitalization index (with a 15 percent cap on any

component stock), from a market capitalization weighted methodology. See electronic

mail from Ernest Po, HKFE, to Mr. Hammar, dated December 13, 2005.

6 See letter from Calvin Tai to Mr. Hammar, dated March 7, 2008, at 8.

7 Id. at 8-9.

3

HKFE’s mini futures based on the HSI and HSCEI are cash-settled.8 The

notional value for the contracts is determined by multiplying the relevant index level by

HK $10 (approximately U.S. $1.28).9 Prices are quoted in index points with each index

point equal to HK $10 per contract. The minimum price fluctuation is 1.00 index point

(HK $10 per contract). HKFE lists for trading the spot month, the next calendar month,

and the next two nearest months of the March quarterly cycle, and the last trading day

of the contracts is the business day immediately preceding the last business day of the

contract month. Cash settlement occurs on the first business day after the last trading

day based on the final settlement price. The final settlement price for the contracts is

calculated on the last trading day and is based on the relevant average of HSI and

HSCEI observations taken in five minute intervals during the last trading day.10

The Commodity Exchange Act (“CEA”),11 as amended by the Commodity

Futures Modernization Act of 2000 (“CFMA”),12 provides that the offer or sale in the

U.S

e final settlement price. The final settlement price for the contracts is

calculated on the last trading day and is based on the relevant average of HSI and

HSCEI observations taken in five minute intervals during the last trading day.10

The Commodity Exchange Act (“CEA”),11 as amended by the Commodity

Futures Modernization Act of 2000 (“CFMA”),12 provides that the offer or sale in the

U.S. of futures contracts based on a group or index of securities, including those

contracts traded on or subject to the rules of a foreign board of trade, is subject to the

Commission's exclusive jurisdiction,13 with the exception of security futures products,14

over which the Commission shares jurisdiction with the Securities and Exchange

Commission (“SEC”).15 Thus, the Commission’s jurisdiction remains exclusive with

8 This Office previously issued no-action letters regarding the HKFE’s standard-sized

HSI and HSCEI futures contracts on June 1, 1994 and September 26, 2006,

respectively. The subject mini futures contracts are identical to the standard-sized HSI

and HSCEI futures contracts. The only substantive difference is the contract size

(multiplier). See letter from Mr. Tai to Mr. Hammar, dated March 7, 2008, at 2.

9 The HK/U.S. dollar spot rate on October 28, 2008 was 7.75 HK$ per U.S. dollar (see

http://www.bloomberg.com/markets/currencies/asiapac_currencies.html)

10 See letter from Mr. Tai to Mr. Hammar, dated March 7, 2008, at Appendix 2.

11 7 U.S.C. § 1 et seq.

12 Appendix E of Pub. L. No. 106-554, 114 Stat. 2763 (2000).

13 See CEA Section 2(a)(1)(C)(ii).

14 Security futures products are defined as a security future or any put, call, straddle,

option, or privilege on any security future. See CEA Section 1a(32). A security future is

defined as a contract of sale for future delivery of a single security or of a narrow-based

security index, including any interest therein or based on the value thereof, with certain

exceptions

n 2(a)(1)(C)(ii).

14 Security futures products are defined as a security future or any put, call, straddle,

option, or privilege on any security future. See CEA Section 1a(32). A security future is

defined as a contract of sale for future delivery of a single security or of a narrow-based

security index, including any interest therein or based on the value thereof, with certain

exceptions. See CEA Section 1a(31).

15 See CEA Section 2(a)(1)(D).

4

regard to a futures contract on a group or index of securities that is broad-based

pursuant to CEA Section 1a(25).16

CEA Section 2(a)(1)(C)(iv) generally prohibits any person from offering or selling

a futures contract based on a security index in the U.S., except as permitted under CEA

Section 2(a)(1)(C)(ii) or CEA Section 2(a)(1)(D).17 By its terms, CEA Section

2(a)(1)(C)(iv) applies to futures contracts on security indices traded on both domestic

and foreign boards of trade. CEA Section 2(a)(1)(C)(ii) sets forth three criteria to govern

the trading of futures contracts on a group or index of securities on designated contract

markets and registered derivatives transaction execution facilities (“DTEFs”):

(1)

the contract must provide for cash settlement;

(2)

the contract must not be readily susceptible to manipulation nor to being

used to manipulate any underlying security; and

(3)

the group or index of securities must not constitute a narrow-based

security index.18

While Section 2(a)(1)(C)(ii) provides that no designated contract market or DTEF

may trade a security index futures contract unless it meets the three criteria noted

above, it does not explicitly address the standards to be applied to a foreign security

index futures contract traded on a foreign board of trade. This Office has applied those

same three criteria in evaluating requests by foreign boards of trade to allow the offer

and sale within the U.S

ract market or DTEF

may trade a security index futures contract unless it meets the three criteria noted

above, it does not explicitly address the standards to be applied to a foreign security

index futures contract traded on a foreign board of trade. This Office has applied those

same three criteria in evaluating requests by foreign boards of trade to allow the offer

and sale within the U.S. of their foreign security index futures contracts when those

16 See CEA Section 2(a)(1)(C)(ii).

17 CEA Section 2(a)(1)(D) governs the offer and sale of security futures products.

18 The first two criteria under CEA Section 2(a)(1)(C)(ii) were unchanged by the CFMA.

With regard to the third criterion, an index is a “narrow-based security index” under both

the CEA and the Securities Exchange Act of 1934 (“Exchange Act”), 15 U.S.C. § 78a et

seq., if it has any one of the following four characteristics: (1) it has nine or fewer

component securities; (2) any one of its component securities comprises more than

30% of its weighting; (3) the five highest weighted component securities in the

aggregate comprise more than 60% of the index’s weighting; or (4) the lowest weighted

component securities comprising, in the aggregate, 25% of the index’s weighting, have

an aggregate dollar value of average daily trading volume of less than $50 million (or in

the case of an index with 15 or more component securities, $30 million). See CEA

Section 1a(25)(A)(i)-(iv); Exchange Act Section 3(a)(55)(B)(i)-(iv). Thus, an index that

does not have any of these elements is not a narrow-based security index for purposes

of CEA Section 2(a)(1)(C)(ii). See also CEA Section 1a(25)(B); Exchange Act Section

3(a)(55)(C).

ume of less than $50 million (or in

the case of an index with 15 or more component securities, $30 million). See CEA

Section 1a(25)(A)(i)-(iv); Exchange Act Section 3(a)(55)(B)(i)-(iv). Thus, an index that

does not have any of these elements is not a narrow-based security index for purposes

of CEA Section 2(a)(1)(C)(ii). See also CEA Section 1a(25)(B); Exchange Act Section

3(a)(55)(C).

5

foreign boards of trade do not seek designation as a contract market or registration as a

DTEF to trade those products.19

Accordingly, this Office has examined the HSI and the HSCEI, and the mini

futures based thereon, to determine whether the Indices and the mini futures meet the

requirements enumerated in CEA Section 2(a)(1)(C)(ii). Based on the information noted

herein and as set forth in the letters and attachments noted above, we have determined

that the Indices and the mini futures conform to these requirements.20

In determining whether a foreign futures contract based on a foreign security

index is not readily susceptible to manipulation or being used to manipulate any

underlying security, one preliminary consideration is the requesting exchange’s ability to

access information regarding the securities underlying the index. As noted above, all

the securities underlying the HSI and HSCEI are traded on the SEHK. Both the HKFE

and the SEHK are wholly owned subsidiaries of Hong Kong Exchanges Clearing

Limited (“HKEx”). HKEx is the “recognized exchange controller” (which is a person

recognized by the SFC as the shareholder controller of a recognized exchange

company) of both HKFE and SEHK, and is required under the SFO to ensure, so far as

reasonably practicable, an orderly, informed and fair market in securities and futures

contracts traded on the stock market and futures market operated by SEHK and HKFE

). HKEx is the “recognized exchange controller” (which is a person

recognized by the SFC as the shareholder controller of a recognized exchange

company) of both HKFE and SEHK, and is required under the SFO to ensure, so far as

reasonably practicable, an orderly, informed and fair market in securities and futures

contracts traded on the stock market and futures market operated by SEHK and HKFE.

Both the SEHK and the HKFE may disclose information to each other and to HKEx

pursuant to exchange rules.21 Pursuant to a memorandum of understanding between

SFC and HKEx, HKEx’s obligations include conducting cross-market surveillance in

connection with the markets operated by HKEx.22 Thus, HKFE should have access to

information necessary to detect and deter manipulation. In the event that HKFE is

unable to obtain access to adequate surveillance data in this regard, or is unable to

19 With regard to the third criterion, the CFTC and SEC jointly promulgated Rule 41.13

under the CEA and Rule 3a55-3 under the Exchange Act, governing security index

futures contracts traded on foreign boards of trade. These rules provide that “[w]hen a

contract of sale for future delivery on a security index is traded on or subject to the rules

of a foreign board of trade, such index shall not be a narrow-based security index if a

futures contract on such index were traded on a designated contract market or

registered derivatives transaction execution facility.” CFTC Rule 41.13, 17 C.F.R. §

41.13; Exchange Act Rule 3a55-3, 17 C.F.R. § 240.3a55-3.

20 In making this determination, the Commission staff has concluded that the HSI and

HSCEI do not have any of the elements of a narrow-based security index as

enumerated in CEA Section 1a(25)(A), and accordingly the Indices would not be

narrow-based security indices if traded on a designated contract market or DTEF.

21 See letter from Mr. Tai to Mr. Hammar, dated March 7, 2008, at 5. See also letter

from Mr

termination, the Commission staff has concluded that the HSI and

HSCEI do not have any of the elements of a narrow-based security index as

enumerated in CEA Section 1a(25)(A), and accordingly the Indices would not be

narrow-based security indices if traded on a designated contract market or DTEF.

21 See letter from Mr. Tai to Mr. Hammar, dated March 7, 2008, at 5. See also letter

from Mr. Tai to Mr. Hammar, dated April 11, 2005, at 7.

22 See letter from Mr. Tai to Mr. Hammar, dated April 11, 2005, at 8.

6

share such data with the CFTC, this Office reserves the right to reconsider the position

we have taken herein.23

In light of the foregoing, this Office will not recommend any enforcement action to

the Commission based on Sections 2(a)(1)(C)(iv), 4(a), or 12(e) of the CEA, as

amended, if HKFE’s mini futures based on the HSI and HSCEI are offered or sold in the

U.S. Because this position is based upon facts and representations contained in the

letters and attachments cited above, it should be noted that any different, omitted or

changed facts or conditions might require a different conclusion. This position also is

contingent on the continued compliance by HKFE with all regulatory requirements

imposed by the SFC, and the applicable laws and regulations of Hong Kong. In

addition, this position may be affected by any rules that the Commission may adopt

regarding futures contracts based on non-narrow-based security indices.

HKFE also has requested that, upon issuance of the relief granted herein, it be

permitted to make its mini futures based on the HSI and HSCEI available for trading by

direct access through its HKATS electronic terminals in the U.S

. In

addition, this position may be affected by any rules that the Commission may adopt

regarding futures contracts based on non-narrow-based security indices.

HKFE also has requested that, upon issuance of the relief granted herein, it be

permitted to make its mini futures based on the HSI and HSCEI available for trading by

direct access through its HKATS electronic terminals in the U.S. in accordance with the

terms and conditions of the foreign terminal no-action letter dated June 9, 2000, as

amended July 30, 2001, issued by Commission staff to HKFE.24 In this regard, HKFE

has certified that it is in compliance with the terms and conditions of the June 9, 2000

23 HKFE has confirmed that it is willing and able to share with the Commission, either

directly or indirectly through SFC or HKEx, information, including customer identification

information, concerning its mini futures based on the HSI and HSCEI, and the securities

underlying the respective Indices. See letter from Mr. Tai to Mr. Hammar, dated March

7, 2008, at 4-5. HKFE also is a signatory to the International Information Sharing

Memorandum of Understanding and Agreement signed on March 15, 1996, at Boca

Raton, Florida.

In addition, HKFE’s regulator (the SFC) and the CFTC entered into a Memorandum of

Understanding concerning Consultation and Cooperation in the Administration and

Enforcement of Futures Laws (October 5, 1995). The SFC also is a signatory to the

International Organization of Securities Commissions’ Multilateral Memorandum of

Understanding Concerning Consultation and Cooperation and the Exchange of

Information (“IOSCO MOU”), to which the Commission also is a signatory. The IOSCO

MOU is a multilateral mechanism for sharing surveillance information on a bilateral

basis between regulators. Prior to signing the IOSCO MOU, a regulator must establish

through a fair and transparent process that it has the legal capacity to fulfill its terms and

conditions

and Cooperation and the Exchange of

Information (“IOSCO MOU”), to which the Commission also is a signatory. The IOSCO

MOU is a multilateral mechanism for sharing surveillance information on a bilateral

basis between regulators. Prior to signing the IOSCO MOU, a regulator must establish

through a fair and transparent process that it has the legal capacity to fulfill its terms and

conditions. Moreover, the SFC is a signatory to the Declaration on Cooperation and

Supervision of International Futures Markets and Clearing Organizations for the sharing

of large exposure information, signed on March 15, 1996, at Boca Raton, Florida.

24 See CFTC Staff Letter No. 00-75 [1999-2000 Transfer Binder] Comm. Fut. L. Rep.

(CCH) ¶ 28,180 (June 9, 2000) and CFTC Staff Letter No. 01-74 [2000-2002 Transfer

Binder] Comm. Fut. L. Rep. (CCH) ¶ 28,612 (July 30, 2001).

7

SI and HSCEI.

foreign terminal no-action letter.25 We have consulted with the Commission’s Division

of Market Oversight (“Division”), which is the Division in the Commission that

administers foreign terminal no-action letters. The Division has concluded that allowing

HKFE to make its mini futures on the HSI and HSCEI available for trading pursuant to

the June 9, 2000 letter would not be contrary to the public interest. Accordingly, on

behalf of the Division, this Office hereby confirms that the no-action relief granted to

HKFE in the June 9, 2000 foreign terminal no-action letter extends to HKFE’s mini

futures based on the H

26

The offer and sale in the U.S. of HKFE’s mini futures on the HSI and HSCEI is, of

course, subject to Part 30 of the Commission’s regulations, which governs the offer and

sale of foreign futures and foreign option contracts in the U.S.27

Sincerely,

Terry S. Arbit

General Counsel

25 See letter from Mr. Tai to Mr. Hammar, dated April 11, 2005, at 11-12 and letter from

Mr. Tai to Mr

ini futures on the HSI and HSCEI is, of

course, subject to Part 30 of the Commission’s regulations, which governs the offer and

sale of foreign futures and foreign option contracts in the U.S.27

Sincerely,

Terry S. Arbit

General Counsel

25 See letter from Mr. Tai to Mr. Hammar, dated April 11, 2005, at 11-12 and letter from

Mr. Tai to Mr. Hammar, dated September 20, 2005, at 10.

26 Please be advised that if HKFE intends to list options on its mini futures based on the

HSI and HSCEI, it may offer and sell those options in the U.S. with no further action

from this Office, see 61 Fed. Reg. 10891 (March 18, 1996). However, if HKFE intends

to make such options available for trading via direct access from electronic trading

terminals in the U.S., HKFE must so notify the Division in accordance with the Notice of

Revision of Commission Policy Regarding the Listing of New Futures and Option

Contracts by Foreign Boards of Trade That Have Received Staff No-Action Relief to

Provide Direct Access to Their Automated Trading Systems From Locations in the

United States, issued on April 18, 2006. See 71 Fed. Reg. 19877 (April 18, 2006).

27 See 17 C.F.R. Part 30.