The Division of Market Oversight issued a letter granting no-action relief to permit the Osaka Securities Exchange Co., Ltd. (OSE), to make its electronic trading and order matching system, the OSE Trading System (OSE...

Summary: The Division of Market Oversight issued a letter granting no-action relief to permit the Osaka Securities Exchange Co., Ltd. (OSE), to make its electronic trading and order matching system, the OSE Trading System (OSE-TS or J-GATE), available to OSE Transaction Participants (TP or Remote TP) in the U.S. without obtaining contract market designation or registration as a derivatives transaction execution facility pursuant to Sections 5 and 5a of the CEAct. The relief applies to OSE TPs trading for their own accounts; OSE TPs who are registered as futures commission merchants (FCMs) or who are exempt from such registration pursuant to CFTC Rule 30.10 (Rule 30.10 Firms) submitting orders from or on behalf of U.S. customers to the OSE-TS for execution or accepting orders for U.S. customers transmitted via automated order routing systems for transmission to the OSE-TS; and OSE TPs who are registered as Commodity Pool Operators (CPO) or Commodity Trading Advisors (CTA), or who are exempt from such CPO or CTA registration pursuant to Commission Regulation 4.13 or 4.14, submitting orders to the OSE-TS on behalf of U.S. pools they operate or U.S. customer accounts for which they have discretionary authority, respectively, provided that an FCM or Rule 30.10 Firm acts as clearing firm and guarantees without limitation all such trades of the CPO or CTA effected through submission of orders on the OSE-TS.

U.S. COMMODITY FUTURES TRADING COMMISSION

Three Lafayette Centre

1155 21st Street, NW, Washington, DC 20581

Telephone: (202) 418-5260

Facsimile: (202) 418-5527

www.cftc.gov

Division of

Market Oversight

CFTC Letter No. 11-02

No-Action

June 1, 2011

Division of Market Oversight

Paul M. Architzel, Esq.

Wilmer Cutler Pickering Hale and Dorr, LLP

1875 Pennsylvania Avenue, NW

Washington, DC 20006

Re:

Osaka Securities Exchange Co., Ltd. Request for No-Action Relief from Contract

Market Designation and Derivatives Transaction Execution Facility Registration

Requirements

Dear Mr

CFTC Letter No. 11-02

No-Action

June 1, 2011

Division of Market Oversight

Paul M. Architzel, Esq.

Wilmer Cutler Pickering Hale and Dorr, LLP

1875 Pennsylvania Avenue, NW

Washington, DC 20006

Re:

Osaka Securities Exchange Co., Ltd. Request for No-Action Relief from Contract

Market Designation and Derivatives Transaction Execution Facility Registration

Requirements

Dear Mr. Architzel:

This is in response to your letter dated February 10, 2010 to the Division of Market

Oversight (Division) of the Commodity Futures Trading Commission (CFTC or Commission).1

By this correspondence, you request, on behalf of the Osaka Securities Exchange Co., Ltd. (OSE

or the Exchange) that the Division confirm that it will not recommend that the Commission take

enforcement action against OSE or its Transaction Participants (TP) or entities located in the

United States 2 (Remote TPs) that have been authorized to directly access the OSE’s electronic

trade matching system, the OSE Trading System (OSE-TS or J-GATE), if OSE does not seek

designation as a contract market (DCM) pursuant to Section 5 of the Commodity Exchange Act

(CEA or Act) 3 or as a derivative transaction execution facility (DTEF) pursuant to Section 5a of

the Act or Commission rules thereunder (no-action request). 4

1

Letter from Paul M. Architzel, Esq., Alston & Bird LLP, to Rick Shilts, Acting Director, Division of Market

Oversight, Commodity Futures Trading Commission (February 10, 2010), supplemented by a revised and amended

no-action request dated March 22, 2011.

2

For purposes of this letter and the relief provided herein, the term “United States” shall include the United

States, its territories and possessions.

3

7 U.S.C 1 et seq.

4

The Division notes that, pursuant to the Dodd-Frank Wall Street Reform and Consumer Protection Act, Public

Law 111-203, 124 Stat. 1376 (2010) (Dodd-Frank Act), DTEFs are to be eliminated as a class of registrant.

2

For purposes of this letter and the relief provided herein, the term “United States” shall include the United

States, its territories and possessions.

3

7 U.S.C 1 et seq.

4

The Division notes that, pursuant to the Dodd-Frank Wall Street Reform and Consumer Protection Act, Public

Law 111-203, 124 Stat. 1376 (2010) (Dodd-Frank Act), DTEFs are to be eliminated as a class of registrant.

Paul M. Architzel, Esq.

Page 2

Specifically, OSE wishes to make the OSE-TS available through direct access5 through

the online interface using a library of application program interfaces provided by OSE to

Remote TPs that are so authorized in the U.S. that:

(1) are located in the U.S and trade for their own accounts;

(2) are registered with the Commission as Futures Commission Merchants (FCM) or are

exempt from such registration pursuant to Commission Rule 30.10 (Rule 30.10 Firms)6

and that submit orders from or on behalf of U.S. customers7 to the OSE-TS for execution;

(3) are registered with the Commission as commodity pool operators (CPO) or

commodity trading advisors (CTA), or are exempt from such registration pursuant to

Commission Rules 4.13 or 4.14, and that submit orders for execution on behalf of U.S.

pools they operate or U.S. customer accounts for which they have discretionary authority,

respectively, provided that an FCM or Rule 30.10 Firm acts as the clearing firm and

guarantees without limitation all positions of the CPO or CTA effected through

submission of orders on the OSE-TS; and

ion pursuant to

Commission Rules 4.13 or 4.14, and that submit orders for execution on behalf of U.S.

pools they operate or U.S. customer accounts for which they have discretionary authority,

respectively, provided that an FCM or Rule 30.10 Firm acts as the clearing firm and

guarantees without limitation all positions of the CPO or CTA effected through

submission of orders on the OSE-TS; and

(4) are registered with the Commission as FCMs or are Rule 30.10 Firms and accept

orders through U.S. automated order routing systems (AORS)8 from U.S. customers for

transmission to the trading system.

5

For purposes of this letter and the relief provided herein, the term “direct access” refers to the explicit grant of

authority by OSE to a TP (including Remote TPs) to enter trades directly into OSE’s trading system.

6

Rule 30.10 permits a person affected by the requirements contained in Part 30 of the Commission's rules to

petition the Commission for an exemption from such requirements. Appendix A to the Part 30 rules provides an

interpretative statement that clarifies that a foreign regulator or self-regulatory organization (SRO) can petition the

Commission under Rule 30.10 for an order to permit firms that are members of the SRO and subject to regulation by

the foreign regulator to conduct business from locations outside of the United States for United States persons on

non-United States boards of trade without registering under the Act, based upon the person's substituted compliance

with a foreign regulatory structure found comparable to that administered by the Commission under the Act

rms that are members of the SRO and subject to regulation by

the foreign regulator to conduct business from locations outside of the United States for United States persons on

non-United States boards of trade without registering under the Act, based upon the person's substituted compliance

with a foreign regulatory structure found comparable to that administered by the Commission under the Act.

Among the issues considered by the Commission in determining whether to grant Rule 30.10 relief to a foreign

regulatory or self-regulatory authority are the authority's: (i) requirements relating to the registration, authorization,

or other form of licensing, fitness review, or qualification of persons through whom customer orders are solicited

and accepted; (ii) minimum financial requirements for those persons that accept customer funds; (iii) minimum sales

practice standards, including risk disclosures, and the risk of transactions undertaken outside of the United States;

(iv) procedures for auditing compliance with the requirements of the regulatory program, including recordkeeping

and reporting requirements; (v) standards for the protection of customer funds from misapplication; and (vi)

arrangements for the sharing of information with the United States. Interpretative Statement with Respect to the

Commission's Exemptive Authority Under § 30.10 of its Rules, 17 C.F.R. Part 30, Appendix A (2011).

7

For purposes of this letter and the relief provided herein, the term “United States or U.S. customers” shall have

the same meaning as the term “foreign futures or foreign options customers” as defined in Rule 30.1(c).

8

For purposes of this letter and the relief provided herein, the term “AORS” is defined to include any system of

computers, software or other devices that allows entry of orders through another party (an intermediary) that has

been granted direct access for transmission to OSE-TS where, without substantial human intervention, trade

matching or execution takes place.

defined in Rule 30.1(c).

8

For purposes of this letter and the relief provided herein, the term “AORS” is defined to include any system of

computers, software or other devices that allows entry of orders through another party (an intermediary) that has

been granted direct access for transmission to OSE-TS where, without substantial human intervention, trade

matching or execution takes place.

Paul M. Architzel, Esq.

Page 3

The Division has reviewed OSE’s no-action request pursuant to the Order issued by the

Commission on June 2, 1999, which first directed Commission staff to consider requests from

foreign exchanges for no-action relief to allow them to provide direct access to their trading

systems from the U.S.9 and the Policy Statement issued by the Commission on October 27, 2006,

in which the Commission affirmed the use of the no-action process to permit foreign boards of

trade to provide direct access to their electronic trading systems from the U.S.10 OSE’s no-action

relief and the information and documentation provided in support thereof have been examined by

relevant staff using the standards of review that have been used for similar no-action requests in

the recent past and the information and documentation have been deemed sufficient for the

purpose of the issuance of this no-action relief letter.

It should be noted that Section 738 of the Dodd-Frank Act amended section 4(b) of the

CEA11 to authorize the Commission to adopt rules and regulations requiring foreign boards of

trade that provide their members or other participants that are located in the U.S

d the information and documentation have been deemed sufficient for the

purpose of the issuance of this no-action relief letter.

It should be noted that Section 738 of the Dodd-Frank Act amended section 4(b) of the

CEA11 to authorize the Commission to adopt rules and regulations requiring foreign boards of

trade that provide their members or other participants that are located in the U.S. with direct

access to their electronic trading and order matching systems to register with the Commission,

including rules and regulations prescribing the procedures and requirements applicable to such

registration.12 Pursuant to this authority, the Commission issued proposed regulations on

November 19, 2010 that would obligate such foreign boards of trade to register with the

Commission.13 The proposed regulations also delineate the requirements and conditions that

would be imposed upon such registration. Nothing in this letter should be viewed as an

interpretation of the proposed regulations or any provision of the statute under which they were

issued.14

In the event that the Commission adopts final regulations pursuant to Section 738 that

would require OSE to register with the Commission, OSE would be obligated to demonstrate

that it satisfies all of the requirements of such registration in accordance with the standards

applicable to such registration (which may differ from the standards applicable to the no-action

9

Order of the CFTC Withdrawing Proposed Rules Regarding Access to Automated Boards of Trade, 64 FR

32829, 32830 (June 18, 1999).

10

Boards of Trade Located Outside of the United States and No-Action Relief from the Requirement to Become a

Designated Contract Market or Derivatives Transaction Execution Facility, 71 Fed. Reg. 64443 (Nov. 2, 2006).

11 7 U.S.C

s applicable to the no-action

9

Order of the CFTC Withdrawing Proposed Rules Regarding Access to Automated Boards of Trade, 64 FR

32829, 32830 (June 18, 1999).

10

Boards of Trade Located Outside of the United States and No-Action Relief from the Requirement to Become a

Designated Contract Market or Derivatives Transaction Execution Facility, 71 Fed. Reg. 64443 (Nov. 2, 2006).

11 7 U.S.C. 6(b)

12 Section 4(b) of the CEA defines “direct access” as “an explicit grant of authority by a foreign board of trade to

an identified member or other participant located in the United States to enter trades directly into the trade matching

system of the foreign board of trade.” Id.

13 Registration of Foreign Boards of Trade, 75 Fed. Reg. 70973 (proposed Nov. 19, 2010) (to be codified at 17

C.F.R. Part 48).

14 OSE has requested a no-action position from the Division in order to provide immediate, interim relief to it and

its TPs, pending the adoption of the final rules governing the registration of foreign boards of trade by the

Commission. OSE would be subject to any final regulations adopted by the Commission applicable to foreign

boards of trade that provide direct access to their electronic trading systems and regulations and that otherwise relate

to the issues addressed herein. Such regulations would supersede the no-action relief provided by this letter. In

addition, the Division retains the authority to condition further, modify, suspend, terminate or otherwise restrict or

revoke any and all of the terms of the no-action relief.

that provide direct access to their electronic trading systems and regulations and that otherwise relate

to the issues addressed herein. Such regulations would supersede the no-action relief provided by this letter. In

addition, the Division retains the authority to condition further, modify, suspend, terminate or otherwise restrict or

revoke any and all of the terms of the no-action relief.

Paul M. Architzel, Esq.

Page 4

relief granted herein). OSE may be obligated to provide additional or updated information,

documentation, or other materials staff deems necessary to its evaluation of OSE’s application

for registration or to establish that the requirements and conditions of such registration are

satisfied in accordance with the relevant standard of review.

In connection with its no-action request, OSE has forwarded the following information to

the Division:

• General information about OSE, including its history, location, and organization;

• OSE’s Articles of Incorporation;

• Information about the criteria governing access rights;

• Regulations for Transaction Participants;

• Enforcement Rules of Regulations for Transaction Participants;

• Information about the terms and conditions of the contracts proposed to be offered

pursuant to the no-action relief;

• Information about various aspects of the OSE-TS (including the order-matching system,

audit trail, response time, reliability, security, and adherence to the Principles for the

Oversight of Screen-Based Trading Systems for Derivative Products [IOSCO

Principles]);

• GATENET Access Guideline;

• Information about OSE’s clearing and settlement system;

• OSE’s Clearing Rules;

• OSE’s Clearing and Settlement Regulations;

• The OSE Clearing System Online Interface Specification;

• Information about OSE’s home country regulatory regime, including information

regarding OSE’s status in its home jurisdiction, applicable home country regulations and

the enforcement thereof (including market surveillance

’s clearing and settlement system;

• OSE’s Clearing Rules;

• OSE’s Clearing and Settlement Regulations;

• The OSE Clearing System Online Interface Specification;

• Information about OSE’s home country regulatory regime, including information

regarding OSE’s status in its home jurisdiction, applicable home country regulations and

the enforcement thereof (including market surveillance and trade practice surveillance);

• The Financial Instruments and Exchange Act (FIEA);

• OSE’s Business Regulations;

Paul M. Architzel, Esq.

Page 5

• OSE’s Regulations Regarding Fair and Equitable Principles of Transactions;

• OSE’s Regulations Regarding Examinations for Acquisition of Trading Qualification;

• OSE’s Special Rules for the Listing Regulations for Securities, Business Regulations,

Regulations regarding Margin and Loan Transactions, and Brokerage Agreement

Standards Relating to the J-NET Market;

• OSE’s Rules for Margins and Transfer of Unsettled Positions for Futures and Options

Trading (Rules for Margins);

• OSE’s Inspection Regulations;

• A description of current information–sharing agreements to which OSE and its regulators

are parties;

• A certification of an authorized representative of OSE as to the truth and completeness of

the material facts set forth in the no-action request; and

• An undertaking of an authorized representative of OSE to notify the Commission staff if

any material representation ceases to be true and complete.

The Division also received separately from the Financial Services Agency of Japan

(FSA), OSE’s regulatory authority, a representation regarding the existing information-sharing

arrangements between the FSA and the CFTC. This representation is described below in section

VII

representative of OSE to notify the Commission staff if

any material representation ceases to be true and complete.

The Division also received separately from the Financial Services Agency of Japan

(FSA), OSE’s regulatory authority, a representation regarding the existing information-sharing

arrangements between the FSA and the CFTC. This representation is described below in section

VII.

Representations made by OSE regarding the structure of OSE, OSE's activities in the

U.S., OSE's TP and clearing participant (CP) criteria, OSE’s electronic trading and order

matching system, OSE’s clearing and settlement system, the relevant regulatory regime in Japan,

to which OSE is subject and the information-sharing arrangements applicable to OSE and its

regulator are summarized in Sections I - VII below. For purposes of this response to OSE’s no-

action request, the Division has relied upon OSE's representations and the information and

documentation provided by OSE and has not conducted an independent review to confirm their

accuracy.15

15 The no-action relief provided herein is contingent upon the accuracy and completeness of the representations

made by, and the information and documentation provided by, OSE in support of its no-action request. Any

materially different, changed, or omitted facts or circumstances may render the no-action relief void or cause the

Division, in its discretion, to condition further, modify, suspend, terminate, or otherwise restrict the relief.

gent upon the accuracy and completeness of the representations

made by, and the information and documentation provided by, OSE in support of its no-action request. Any

materially different, changed, or omitted facts or circumstances may render the no-action relief void or cause the

Division, in its discretion, to condition further, modify, suspend, terminate, or otherwise restrict the relief.

Paul M. Architzel, Esq.

Page 6

I.

GENERAL INFORMATION REGARDING OSE

A.

History and Organization

The OSE was established on April 1, 1949, as a nonprofit membership organization

under Japan’s Securities and Exchange Law.16 On April 1, 2001, the OSE converted its

membership organization into a joint-stock corporation. Licensed to act as a financial

instruments exchange by the Prime Minister of Japan under the Financial Instruments and

Exchange Act (FIEA),17 the OSE is authorized to trade securities and to conduct a market for

transactions in derivatives and was the first financial instruments exchange to trade equity

derivatives in Japan.18 As a self-regulatory organization, the OSE is obligated to enforce its rules

and has established the Self-Regulation Committee to make decisions on matters relating to its

self-regulatory operations.

The OSE is the largest equity derivatives exchange in Japan as measured by trading

volume and contract values. The OSE is the second largest (after the Tokyo Stock Exchange) of

the six Japanese financial instruments exchanges that trade cash products based upon the amount

of business handled. The OSE is the leading exchange for derivatives products in Japan and its

trading volume is the largest among the seven Japanese exchanges handling derivatives products.

In 2010, the OSE handled 90% of the stock index futures market in Japan and almost 100% of

trading in the stock index options market as measured by volume

s that trade cash products based upon the amount

of business handled. The OSE is the leading exchange for derivatives products in Japan and its

trading volume is the largest among the seven Japanese exchanges handling derivatives products.

In 2010, the OSE handled 90% of the stock index futures market in Japan and almost 100% of

trading in the stock index options market as measured by volume.

The OSE is owned by its shareholders and, as of December 31, 2010, was capitalized in

the amount of ¥4.723 billion (approximately $55,943,900).19 It is overseen by a Board of

Directors (Board) composed of eleven individuals, six of whom are outside directors, and the

Self-Regulation Committee, composed of one full-time director and two outside directors,

pursuant to the FIEA, in order to provide for the independence of the Exchange’s self-regulating

activities. The OSE employs a statutory auditor system to monitor management and has a Board

of Auditors composed of three auditors, two of whom are outside auditors. In addition, the

Board has established three Standing Committees: the General Advisory Committee, the

Clearing & Settlement Committee, and the Clearing Risk Assessment Committee. These

committees assist the Board in discussing various proposals and recommending policies to be

adopted and actions to be taken by the Board. As of December 31, 2010, the OSE has a staff

comprised of 338 people.

16 The OSE’s predecessor was the Osaka Stock Exchange Co., Ltd., established in 1878.

17 The Securities and Exchange Law was superseded by the FIEA on September 30, 2007. The FIEA defines as a

“financial instruments exchange” an entity that the Securities and Exchange Law previously defined as a “stock

exchange.”

18 The equity derivatives products authorized for trading include futures and options on stock indexes and options

on securities, including options on equities, ETFs and REITs

urities and Exchange Law was superseded by the FIEA on September 30, 2007. The FIEA defines as a

“financial instruments exchange” an entity that the Securities and Exchange Law previously defined as a “stock

exchange.”

18 The equity derivatives products authorized for trading include futures and options on stock indexes and options

on securities, including options on equities, ETFs and REITs.

19 The OSE has a policy of stable and continuous dividend payments, with approximately 40% of dividend payout

ratio and approximately 4% of dividend on equity ratio at the minimum. The annual dividend for fiscal year 2009

(from April 2009 to March 2010) was ¥9,000 ($106.60) per share. As of April 6, 2011, ¥84.42 = $1.00.

Paul M. Architzel, Esq.

Page 7

B.

Products

OSE proposes to make the following five broad-based stock index futures contracts, each

of which previously has been the subject of a no-action relief letter from the Commission’s

Office of the General Counsel (OGC) permitting the contract to be traded by U.S. persons,

available for trading via direct access from the U.S.:

o MSCI Japan Index Futures Contract20

o Russell/Nomura Prime Index Futures Contract21

o Mini Nikkei 225 Index Futures Contract22

o Nikkei Stock Average Index (Nikkei 225) Futures Contract23

o Nikkei 300 Index Futures Contract24

You represent that OGC, in issuing the no-action relief letters for the contracts,

determined that OSE demonstrated that each contract satisfied the statutory standards, including

the following: (1) the contract must be cash-settled; (2) trading in the contract must not be

readily susceptible to manipulation; and (3) the group or index of securities must constitute a

broad-based security index.25 You represent that the five contracts remain in compliance with

these requirements and the terms of the OGC no-action letters

act satisfied the statutory standards, including

the following: (1) the contract must be cash-settled; (2) trading in the contract must not be

readily susceptible to manipulation; and (3) the group or index of securities must constitute a

broad-based security index.25 You represent that the five contracts remain in compliance with

these requirements and the terms of the OGC no-action letters. Division staff has reviewed the

contract specifications and concluded that the contracts do not otherwise present regulatory

issues warranting additional terms and conditions to those included in the OGC no-action letters.

C.

Presence in the United States

OSE currently does not have a representative office in the United States. Its activities in

the U.S. are limited to participation in various widely-attended industry conferences and trade

shows to acquaint the futures industry generally with OSE and the contracts traded thereon. In

connection with its participation in such industry events, the OSE responds to inquiries from the

press and the public and provides general information. It may also conduct seminars relating to

20 CFTC Staff Letter 03-06 (February 13, 2003).

21 CFTC Staff Letter 05-04 (March 14, 2005).

22 CFTC Staff Letter 06-14 (July 10, 2006).

23 CFTC Staff Letter 92-1 (January 16, 1992).

24 CFTC Staff Letter No. 94-43 (May 17, 1994).

25 Subsequent to passage of the Commodity Futures Modernization Act of 2000, Public Law 106-554, 114 Stat.

2763 (2000) (CFMA), the third criterion for issuance of OGC no-action relief is whether such contracts do not

constitute a narrow -based security index. Contracts granted relief prior to 2000 that met the broad-based criterion,

including OSE’s contracts, were grandfathered with respect to the revised criterion of “not constituting a narrow-

based security index.”

Public Law 106-554, 114 Stat.

2763 (2000) (CFMA), the third criterion for issuance of OGC no-action relief is whether such contracts do not

constitute a narrow -based security index. Contracts granted relief prior to 2000 that met the broad-based criterion,

including OSE’s contracts, were grandfathered with respect to the revised criterion of “not constituting a narrow-

based security index.”

Paul M. Architzel, Esq.

Page 8

trading on OSE.26 OSE’s English-language website is located at

http://www.ose.or.jp/e/index.html.27

Although OSE currently does not plan to open a representative office in the U.S., you

represent that it may do so in the future. Such an office would promote OSE and its trading

products in the U.S and represent OSE to the Commission and the press. If OSE does open such

a U.S. office, it would not provide investment advice or technical support from the U.S. The

office would neither be used to solicit, receive nor direct orders with respect to the products

traded on the Exchange, nor would it be used to conduct trade matching or to operate a clearing

facility in the U.S.28

II.

ACCESS TO THE TRADING SYSTEM

A.

Introduction

In order to ensure fair and efficient execution of transactions on its market, as well as to

ensure the financial integrity of its market, only those entities with access privileges may trade

directly on the OSE. As a result of demutualization, ownership interest in the OSE has been

separated from access privileges. OSE permits access to those that qualify as one of three types

of Transaction Participants (TP): (1) Cash TPs, (2) Futures, etc., TPs and (3) IPO TPs.

B.

Transaction Participants

Every entity wishing to become a TP must acquire a Trading Qualification (TQ), as

specified in the Regulations for Transaction Participants (Regulations for TPs), prior to

conducting transactions on the OSE

OSE permits access to those that qualify as one of three types

of Transaction Participants (TP): (1) Cash TPs, (2) Futures, etc., TPs and (3) IPO TPs.

B.

Transaction Participants

Every entity wishing to become a TP must acquire a Trading Qualification (TQ), as

specified in the Regulations for Transaction Participants (Regulations for TPs), prior to

conducting transactions on the OSE. A Futures, etc., TQ is needed to execute stock index futures

transactions, options on securities transactions or stock index options transactions. To acquire a

TQ, an entity must submit an application, be subject to examination by the OSE and pay a

qualification examination fee. A Japanese applicant for a TQ to trade futures and related

instruments, must have a stated capital amount of no less than ¥300 million (approximately

$3,553,500), a net asset ratio no less than 100% and a capital adequacy ratio of no less than

200%. Remote TPs will not be subject to the Japanese capital adequacy ratio. Rather, OSE will

rely on the capital rules that Remote TPs are subject to by their home-country regulators.

26 You represent that upon issuance of this no-action letter, the OSE may also hold informational meetings in the

U.S. for potential participants desiring to access the market directly.

27 The website includes general information relating to the Exchange, its corporate organization, the contracts

traded thereon and on various market mechanisms (such as give-ups, non-auction transactions and margin and

clearing). Moreover, the website provides the public with access to certain market data, including in the “Daily

Official List” daily open, high, low, close, volume, open interest, last quotation, net change and settlement price. It

also includes historical archived volume information

s

traded thereon and on various market mechanisms (such as give-ups, non-auction transactions and margin and

clearing). Moreover, the website provides the public with access to certain market data, including in the “Daily

Official List” daily open, high, low, close, volume, open interest, last quotation, net change and settlement price. It

also includes historical archived volume information.

28 Accordingly, you request that the Commission not treat it as a change in the facts or circumstances represented

in its no-action request if OSE in the future opens such a representative office, as long as the operation of such an

office is only for the purposes stated in the request.

Paul M. Architzel, Esq.

Page 9

Additionally, the applicant must have a sound management structure and an appropriate system

for business operation and is expected to show stable profitability.

After its application to become a TP is approved by the OSE, the entity, pursuant to the

Regulations for TPs, must pay a participation fee, execute a TP Agreement, undertake

procedures to acquire any clearing qualifications (CQ) or establish a clearing relationship with a

CP, deposit guarantee funds, and execute any other procedures stipulated by the OSE for

acquiring a TQ. TPs also must pay a basic fee, a transaction fee, access fees, give-up fees,

positions transfer fees, and cancellation fees on a monthly basis. In addition, TPs are required to

register with OSE either a director or executive officer (TP Representative) to represent the TP at

the OSE. Although only the TP Representative may represent the TP in its relationship with the

OSE, routine day-to-day business, the scope of which has been determined in advance, can be

carried out by an agent registered with the OSE. Similarly, TPs must notify OSE of an office

which is conveniently located for liaising with the OSE to receive notifications from the OSE

represent the TP at

the OSE. Although only the TP Representative may represent the TP in its relationship with the

OSE, routine day-to-day business, the scope of which has been determined in advance, can be

carried out by an agent registered with the OSE. Similarly, TPs must notify OSE of an office

which is conveniently located for liaising with the OSE to receive notifications from the OSE. A

remote TP is required to register with OSE the name and address in Japan of its representative

person, as prescribed in the FIEA.

TPs must deposit ¥3 million (approximately $35,535) (or, except for remote TPs,

securities in lieu of cash in accordance with OSE stipulations) with the OSE as a guarantee fund,

designed to assist in the settlement of contracts for the TP’s customers.29 In contrast to the

clearing deposit, customers for whom a TP has executed the purchase and sale of market

transactions in derivatives have the right to receive, in preference over other creditors, payment

from the guarantee funds of the TP for claims that arise due to such executions. The remainder

of the guarantee fund may be used to recoup the losses caused to OSE, in accordance with the

OSE’s loss-sharing rule, in the event of a default of a TP that is a CP.30 The OSE holds the

guarantee funds separately from its own assets and manages them in the following ways: (1)

purchase of government bonds or municipal bonds, (2) bank deposits, or (3) monetary trust with

a bank engaging in trust business. As of December 31, 2010, the guarantee fund held deposits of

¥605 million (approximately $7,166,230).

In addition to qualifications, fees and notification requirements, TPs must, pursuant to the

Regulations for TPs, comply with several self-regulatory requirements and OSE mandates. For

example, TPs must establish transaction management procedures which help prevent unfair

trading and establish order management procedures to prevent the acceptance and placement of

erroneous orders

166,230).

In addition to qualifications, fees and notification requirements, TPs must, pursuant to the

Regulations for TPs, comply with several self-regulatory requirements and OSE mandates. For

example, TPs must establish transaction management procedures which help prevent unfair

trading and establish order management procedures to prevent the acceptance and placement of

erroneous orders. Furthermore, TPs must ensure fair pricing and smooth circulation on the OSE

markets and make best efforts to preserve and improve the function of the OSE as a financial

instrument exchange market. Additionally, a TP must notify the OSE in advance, and in some

cases seek OSE approval, when terminating its business, merging with another legal entity,

29 Payments to the guarantee fund are deposited with OSE in its capacity as a financial instruments exchange.

Only TPs are required to deposit into the guarantee fund. Accordingly, only CPs that are also TPs are required to

contribute. Upon resolution of the Board, if specifically considered necessary, the OSE can raise the guarantee fund

amount and/or limit the securities eligible to be deposited in lieu of cash.

30 A TP cannot request the return of the guarantee funds until six months after the date from which its TQ is

withdrawn. Moreover, TPs cannot assign or offer for collateral the right to claim the return of the guarantee funds.

Paul M. Architzel, Esq.

Page 10

dissolving, transferring the whole business, changing the corporate name, or changing directors.

Lastly, TPs must submit documents in response to OSE’s requests regarding investigations into

the financial condition of the TP, investigations for purposes of maintaining fairness in

transactions, or where the OSE considers it appropriate

he guarantee funds.

Paul M. Architzel, Esq.

Page 10

dissolving, transferring the whole business, changing the corporate name, or changing directors.

Lastly, TPs must submit documents in response to OSE’s requests regarding investigations into

the financial condition of the TP, investigations for purposes of maintaining fairness in

transactions, or where the OSE considers it appropriate.

A TP may trade for its own account or on behalf of others, subject to certain specific

requirements if the TP is trading on behalf of another.31 TPs that trade on behalf of others are

required to comply with the Brokerage Agreement Standards stipulated by the OSE, and such

TPs must conduct an investigation in advance of opening a customer account to verify the

customer’s name and various other matters.

In addition to these self-regulation and compliance requirements, the OSE reserves

emergency authority which allows it to impose restrictions on a TP’s business when the OSE

believes there is an urgent need to do so in light of the objectives of OSE and operation of its

markets. Pursuant to its Articles of Incorporation, the OSE, by resolution of its Self-Regulation

Committee, may take disciplinary action(s), including suspension from trading and imposing

fines of not more than ¥100 million (approximately $1,184,500), against a TP for breaches of

laws and regulations, of dispositions of government authorities thereunder or OSE rules, or for

behaving contrary to the fair and equitable principles of transactions.

III.

THE OSE TRADING SYSTEM

At the outset, the Division notes that the description of OSE-TS set forth herein is based

upon representations made by OSE or its representatives. The Division has not performed an

independent assessment of the security or soundness of OSE-TS in connection with this request.

A

r

behaving contrary to the fair and equitable principles of transactions.

III.

THE OSE TRADING SYSTEM

At the outset, the Division notes that the description of OSE-TS set forth herein is based

upon representations made by OSE or its representatives. The Division has not performed an

independent assessment of the security or soundness of OSE-TS in connection with this request.

A.

Introduction

The OSE-TS, known as J-GATE, was developed by using Click-XT, a trading system for

exchanges powered by NASDAQ OMX Group.32 OSE provides TPs with certain components of

the system, while requiring them to purchase other elements. Specifically, OSE supplies the

central order processing facilities of the system, known as the Central System and located in

Japan, and a library of application program interfaces (API Kit) for the online interface, through

which a TP’s front-end trading application (API Client) communicates with the Central System.

31 Trading on behalf of others is referred to in the OSE Regulations for TPs as “acceptance of entrusted

transactions.”

32 OMX provides technology to over 60 exchanges, clearing organizations and central securities depositories in

more than 50 countries. Commission staff has previously reviewed earlier versions of OMX trading systems. For

example, the OM CLICK trading system, used by BrokerTec Futures Exchange, L.L.C. (BTEX), was thoroughly

examined by the Division and the Commission’s Office of Information Resources Management in connection with

BTEX’s application to become a DCM. The Commission approved BTEX as a DCM on June 18, 2001; it ceased

operations in November 2003. Commission staff also has previously described OM CLICK in connection with the

granting of direct access no-action relief to the OM London Exchange Limited (no longer in operation) and, more

recently, to Nord Pool ASA (Nasdaq OMX Oslo ASA)

ment in connection with

BTEX’s application to become a DCM. The Commission approved BTEX as a DCM on June 18, 2001; it ceased

operations in November 2003. Commission staff also has previously described OM CLICK in connection with the

granting of direct access no-action relief to the OM London Exchange Limited (no longer in operation) and, more

recently, to Nord Pool ASA (Nasdaq OMX Oslo ASA). See CFTC Staff Letters 00-93 (September 21, 2000) and

08-14 (August 20, 2008), respectively.

Paul M. Architzel, Esq.

Page 11

OSE TPs choose their own, and are responsible for their own use of, communication equipment,

communication lines and a connection configuration from the communication equipment and

access line products, which include, for example, provider, line type, and bandwidth. OSE

provides an integrated network (GATENET) for TPs to perform transactions with OSE

employing leased lines to deliver high quality, high performance, high reliability and security. J-

GATE is comprised of the following main components: (1) the Central System; (2) API Client;

(3) GATENET; and (4) the security system.

B.

The Central System

The Central System performs the security, order processing, and connection monitoring

functions of the J-GATE Among other things, the Central System maintains a database of

currently authorized OSE traders, validates a trader's authority to trade on OSE, processes and

records all orders, validates requests for order modifications and cancellations, matches orders,

maintains the central order book, sends market broadcast data messages (i.e., order book

information, open, high, low and close prices and the data on trading suspension, etc.) to the API

Client, and monitors the status of the system connections between the Central System and the

API Client. You represent that the Central System underwent comprehensive business and

technical testing before it was declared operational.

1

ends market broadcast data messages (i.e., order book

information, open, high, low and close prices and the data on trading suspension, etc.) to the API

Client, and monitors the status of the system connections between the Central System and the

API Client. You represent that the Central System underwent comprehensive business and

technical testing before it was declared operational.

1.

The Auction-driven Market

The J-GATE is used to access two forms of trading. 33 The first is the auction-driven

market under which bids and offers are entered through the J-GATE where they are matched by

the Central System using an auction process.34 The Central System uses time-price priority

sequencing in matching and executing orders, so that the best bid is matched to the best offer,

giving priority for bids or offers at the same price to the first entered into the system. If an order

can only be partially filled, the next oldest bid or offer at that price is matched until the

remainder of the order is filled, and if the amount bid or offered at that price is exhausted, the

unfilled portion of the order is then executed at the next best price beginning with the oldest bid

or offer.

In the auction-driven market, the J-GATE supports the following types of orders: (1)

market order, submitted without a specified limit price and to be executed against the best bid or

best offer in order (any unfilled part of the market order is cancelled); (2) limit order, submitted

with a specified limit price and to be executed at the specified or a better price; (3) market to

limit order, a limit order submitted without the specified limit price and to be executed against

the best bid or best offer at the time;35 and (4) stop order, an order recorded in a separate database

33 See http://www.ose.or.jp/e/index.html.

34 The auction-driven market is open for two sessions daily (all times shown in JST): the Day Session, 9:00 am to

3:15 pm; and the Evening Session, 4:30 pm to 11:30 pm

t order submitted without the specified limit price and to be executed against

the best bid or best offer at the time;35 and (4) stop order, an order recorded in a separate database

33 See http://www.ose.or.jp/e/index.html.

34 The auction-driven market is open for two sessions daily (all times shown in JST): the Day Session, 9:00 am to

3:15 pm; and the Evening Session, 4:30 pm to 11:30 pm.

35 If there is no best offer or best bid to be matched with, a market to limit order conditioned as fill and store is

recorded on the order book as a limit order at the better price than the best bid or best offer by one tick; provided,

however, that the order becomes invalid if there is no best bid or best offer.

Paul M. Architzel, Esq.

Page 12

in conjunction with one of the three types of orders identified above and containing a pre-

specified triggering condition that, when touched, causes the order to enter into the trading

system for execution as a market, limit or market to limit order, as applicable. Orders may

additionally specify the following conditions: (1) Fill and Store (FAS), where any unfilled

volume after the order is partially executed remains on the order book to be matched; (2) Fill and

Kill (FAK), where any unfilled volume after the order is partially executed is canceled, (3) Fill or

Kill (FOK), where the order is canceled if the entire order cannot be executed immediately, (4)

Good for Day (GFD), where an order remains valid until the end of the trading session, (5) Good

till Date (GTD), where an order remains valid until the end of the day session on the date the

specified period ends (up to 255 days), and (6) Good till Cancel (GTC), where an order remains

valid until cancelled (if not cancelled, it is valid until the end of the day session on the last

trading day).

2.

Non-Auction Trade Matching

In addition, the J-GATE supports non-auction trade matching (the J-NET market)

der remains valid until the end of the day session on the date the

specified period ends (up to 255 days), and (6) Good till Cancel (GTC), where an order remains

valid until cancelled (if not cancelled, it is valid until the end of the day session on the last

trading day).

2.

Non-Auction Trade Matching

In addition, the J-GATE supports non-auction trade matching (the J-NET market). This

facility, known as the J-NET Derivatives Trading System, makes use of the J-GATE to execute

orders such as block trades, Exchange of Futures for Physicals, Volume Weighted Average

Price, option strategy trading (strangle, calendar spreads, etc.), and strategies combining block

trades of futures and options, such as hedging futures by options and arbitrage trade of futures

using options. 36 The J-NET market began as a block trading facility for cash products and, in

January 2008, replaced the Non-Auction Large Block Trading System, which had enabled buyers

and sellers to trade futures and options contracts in increments larger than those prescribed by

OSE at previously agreed upon prices that were within price ranges prescribed by OSE.37

In addition to enabling TPs to execute orders such as block trades, that are within a range

specified by OSE but which are agreed upon before being entered into the J-GATE , the J-NET

market provides the functionality to enter into trading strategies that make use of theoretical

pricing relationships keyed off of a market-based price, such as calendar spreads. Finally, the J-

NET market provides for the entry of transactions based upon observed market prices, such as

volume weighted average prices. All of these types of transactions take place subject to the rules

of OSE, which provide strict conditions for their use.

C.

The API Client

The API Client is the software installed to connect to the Central System by using the

API Kit provided by OSE

ly, the J-

NET market provides for the entry of transactions based upon observed market prices, such as

volume weighted average prices. All of these types of transactions take place subject to the rules

of OSE, which provide strict conditions for their use.

C.

The API Client

The API Client is the software installed to connect to the Central System by using the

API Kit provided by OSE. Currently, OSE TPs may use the API Client developed internally or

an application provided by independent software vendors to access the Central System.

36 The J-NET Derivatives Trading Market is open for two sessions daily (all times shown in JST): 8:20 am to

4:00 pm and 4:30 pm to 11:30 pm.

37

For example, Nikkei 225 Futures and Nikkei 300 Futures were traded in increments of at least 200 contract

units (although this was later reduced to 100 units) and 500 contract units, respectively.

Paul M. Architzel, Esq.

Page 13

D.

GATENET

The GATENET connects the Central System in the Tokyo metropolitan area to its TPs in

Japan. When OSE adopts remote TPs in the near future, the GATENET may be expanded to

connect TPs outside of Japan to the Central System. In this case, hubs in major financial centers,

including hubs located in the U.S., will connect to the Central System in Japan.38 You represent

that orders of Remote TPs (including U.S.-located Remote TPs) arriving at the Central System

through an existing point of connection or through new hubs which may be established in the

future will not be treated any differently or disadvantaged by the Central System from those of

OSE’s TPs located in Japan.

GATENET provides two (redundant) routes for TPs to access the J-GATE. TPs connect

to the Central System, which performs order acceptance, match processing, and other tasks,

using the Network Gateway, which executes communication management for the API Client

in the

future will not be treated any differently or disadvantaged by the Central System from those of

OSE’s TPs located in Japan.

GATENET provides two (redundant) routes for TPs to access the J-GATE. TPs connect

to the Central System, which performs order acceptance, match processing, and other tasks,

using the Network Gateway, which executes communication management for the API Client.

Routers are also required per line and may be provided by OSE for a fee or procured by users.

Purchased bandwidth is allocated to each TP and is not affected by traffic of other TPs. Access

lines may be selected from among multiple providers, types and bandwidths which may be

available in the TP’s area. The GATENET is designed to satisfy OSE requirements, operated to

strict service levels, and managed by major international network providers.

E.

Audit Trail

The J-GATE captures and retains a complete audit trail including all orders, executed

trades, pricing information and confirmations entered into the Central System. Information that

is required to be included in orders, and which is retained by the J-GATE, includes the time of

the order receipt, type of order (sell or buy), order condition, the participant code, the order price

and the order amount. Audit trail information is stored and retained on magnetic media for a

period of 10 years, and is readily accessible for the first five business days.

F

Information that

is required to be included in orders, and which is retained by the J-GATE, includes the time of

the order receipt, type of order (sell or buy), order condition, the participant code, the order price

and the order amount. Audit trail information is stored and retained on magnetic media for a

period of 10 years, and is readily accessible for the first five business days.

F.

Data Dissemination

OSE disseminates trading data (prices/quotes) to TPs via the J-GATE.39 Additional

information such as total trading volume, daily high, low and last prices, inter-month spread,

open interest and total trade value separately for each contract, is distributed publicly by OSE

through a website on a daily basis.40 Daily trading data and data for the past five business days

are available from the same website and monthly data is available in the Monthly Statistics

38 Until such new hubs are established, the manner in which the TP connects to the GATENET is up to the TP.

The TP could, for example, connect to the GATENET by leasing its own lines.

39 OSE Participants also have available to them from the J-GATE a summary of the TP’s activity during that

session, including the TP’s orders entered during the current trading session and completed trades.

40 http://www.ose.or.jp/market/daily_report/pdf_en.html /

Paul M. Architzel, Esq.

Page 14

Report or Stock Quotations section of the OSE website.41 OSE also generally makes data

available to purchasers and through third party vendors, such as Bloomberg and Reuters.

G.

System Reliability and Failure Recovery

The J-GATE incorporates both mechanisms for detecting system failures and procedures

for ensuring recovery from such failures

Report or Stock Quotations section of the OSE website.41 OSE also generally makes data

available to purchasers and through third party vendors, such as Bloomberg and Reuters.

G.

System Reliability and Failure Recovery

The J-GATE incorporates both mechanisms for detecting system failures and procedures

for ensuring recovery from such failures. Specifically, J-GATE ensures reliability by duplicating

all key components of the system, including power supply, computer equipment, and network

components.42 To that end, OSE monitors the connection service, including the connected

communications equipment, 24 hours a day, and 365 days a year. If and when OSE detects a

malfunction in the communication line and believes it could potentially cause some impediment

to operation of the router or another key mechanical component, the TPs are contacted

immediately. If it is determined that some malfunction in the communication equipment

(routers, etc.) may impact the entire GATENET, the TP is required to upgrade its Internetwork

Operating System version, as directed by OSE.

The J-GATE also employs backup terminals, located in Osaka and Tokyo, which allow

TPs to continue to operate during most failures if the TP does not have an alternative terminal

server.43 To utilize the backup terminal, the TP would simply input its participant code and the

user ID assigned to itself. Following recovery and prior to the resumption of trading, TPs would

be informed when trading would be resumed and would be provided with the opportunity to

delete their orders.

H.

System Security

The J-GATE includes a security system that provides for authentication and

confidentiality designed to prevent unauthorized use during API Client applications. It also

ensures the integrity of the J-GATE by using features embedded in the API that cannot be

accessed externally

rading would be resumed and would be provided with the opportunity to

delete their orders.

H.

System Security

The J-GATE includes a security system that provides for authentication and

confidentiality designed to prevent unauthorized use during API Client applications. It also

ensures the integrity of the J-GATE by using features embedded in the API that cannot be

accessed externally. The security system is responsible for: (1) maintaining the database of

currently certified users; (2) authenticating certified users as they log on; and (3) distributing

session keys as part of the login process. The J-GATE maintains a list of currently logged-in

users on a real time basis through the market management terminal.

OSE assigns a unique participant code and user ID to each TP, and each TP creates a

password for login to connect to the Central System. While logged into the Central System,

concurrent login to the Central System using the same user ID through another API Client is not

allowed.

41 http://www.ose.or.jp/e/market/5067 OSE also makes available on its website the SPAN parameters and the

theoretical option prices that are used in risk management calculations. http://www.ose.or.jp/e/market/5052.

42 All key components of the OSE clearing system (OSE-CS) are also duplicated to ensure reliability.

43 OSE also maintains geographically separate back-up and disaster recovery sites where clearing and settlement

data are stored and OSE-CS operations can resume. Data are sent to the back-up site every 10 to 20 minutes.

Operations can be moved to the back-up site within 24 hours after a failure and clearing and settlement functions can

be resumed within two hours.

ed to ensure reliability.

43 OSE also maintains geographically separate back-up and disaster recovery sites where clearing and settlement

data are stored and OSE-CS operations can resume. Data are sent to the back-up site every 10 to 20 minutes.

Operations can be moved to the back-up site within 24 hours after a failure and clearing and settlement functions can

be resumed within two hours.

Paul M. Architzel, Esq.

Page 15

I.

Adherence to IOSCO Principles

You represent that the Exchange, in developing, deploying and operating J-GATE,

complies with, and intends to continue to comply with, the “Principles for the Oversight of

Screen-Based Trading Systems for Derivative Products” developed by the Technical Committee

of the International Organization of Securities Commissions (IOSCO Principles) 44 and adopted

in principle by the Commission on November 21, 1990.45 OSE’s adherence to the IOSCO

Principles is illustrated by the fact that OSE has developed, deployed and operated J-GATE

under the supervision of, and to the satisfaction of, the FSA of Japan, which, like the CFTC, has

endorsed the IOSCO Principles.

IV.

SETTLEMENT AND CLEARING

A.

Introduction

You have represented that OSE operates as the clearing house for all stock index futures

and options transactions executed on the Exchange. As such, OSE is the universal counterparty

to all such transactions on the Exchange and provides a guarantee against counterparty credit

risk. You have represented that OSE conducts its clearing operation (known as a “financial

instruments obligation assumption service” under applicable Japanese law) as a business

incidental to its business as a financial instruments exchange pursuant to the FIEA and with the

approval of the Prime Minister of Japan (by delegated authority to the Commissioner of the

FSA)

t counterparty credit

risk. You have represented that OSE conducts its clearing operation (known as a “financial

instruments obligation assumption service” under applicable Japanese law) as a business

incidental to its business as a financial instruments exchange pursuant to the FIEA and with the

approval of the Prime Minister of Japan (by delegated authority to the Commissioner of the

FSA). You have represented further that, with respect to OSE’s clearing and settlement

operations, the Exchange adheres to the Recommendations for Central Counterparties (RCCPs)

issued by the IOSCO Technical Committee (IOSCO) and the Committee on Payments and

Settlement Systems (CPSS) in 2004, and conducts self-assessments to confirm conformity with

such standards. As noted above, the Division has reviewed OSE’s no-action request and the

information and documentation provided in support thereof in accordance with the standard of

review that it has used previously when considering no-action requests of its type. Consistent

with that approach, the Division has not required OSE to demonstrate the manner in which it

satisfies each of the RCCPs.

44

Japan was one of eight jurisdictions that participated in Working Party 7 of IOSCO (Working Party), whose

mandate included, among other things, the identification of issues related to screen-based trading systems for

derivative products. In considering the special concerns for screen-based trading systems, the Working Party

identified and addressed the following issues: transparency, order execution algorithms, operational issues, security

and system vulnerability, access, financial integrity, disclosure, and the role of system providers, and articulated for

each issue a broad principle to assist regulatory authorities in overseeing screen-based trading systems

for screen-based trading systems, the Working Party

identified and addressed the following issues: transparency, order execution algorithms, operational issues, security

and system vulnerability, access, financial integrity, disclosure, and the role of system providers, and articulated for

each issue a broad principle to assist regulatory authorities in overseeing screen-based trading systems. The IOSCO

Principles were adopted by IOSCO on November 15, 1990 and set out in broad terms the international consensus as

to the regulatory considerations to be addressed in reviewing mechanisms for cross-border screen-based trading.

45 The Commission adopted the IOSCO Principles as a statement of regulatory policy for the oversight of screen-

based trading systems for derivative products. Policy Statement Concerning the Oversight of Screen-Based Trading

Systems. 55 Fed. Reg. 48670 (Nov. 21, 1990).

Paul M. Architzel, Esq.

Page 16

B.

Organizational Structure

You have represented that OSE’s clearing and settlement operations generally are

conducted within OSE’s Clearing and Settlement (C&S) Division, which is under the

responsibility of OSE’s Market Operations Department46 of OSE and is subject to oversight by

OSE’s Internal Inspection Office. Among other things, the C&S Division is responsible for: (1)

examining applicants for clearing qualifications (CQs); (2) inspecting clearing participants

(CPs); (3) monitoring clearing risk management, including the monitoring of the futures and

options positions held by each CP; and (4) setting SPAN risk parameters and saving the SPAN

data

to oversight by

OSE’s Internal Inspection Office. Among other things, the C&S Division is responsible for: (1)

examining applicants for clearing qualifications (CQs); (2) inspecting clearing participants

(CPs); (3) monitoring clearing risk management, including the monitoring of the futures and

options positions held by each CP; and (4) setting SPAN risk parameters and saving the SPAN

data. OSE’s Internal Inspection Office is charged with: (A) conducting inspections of OSE’s

business, platforms, and systems operations;47 (B) ensuring compliance with OSE’s internal

rules, including its Articles of Incorporation, management policies, orders, and/or instructions;

and (C) other activities necessary to maintain and improve OSE’s business platforms and rules.

C.

Clearing Participant Requirements

You have represented that all security index futures and options transactions executed on

OSE have been designated, pursuant to the Clearing Rules, as clearable transactions, the clearing

of which must be conducted by or through a CP that holds a CQ48 Thus, a TP that wishes to

trade futures and options on its own behalf or on behalf of customers on OSE must either: (1)

become a CP or (2) enter into a clearing entrustment agreement with a general clearing

participant (GCP). TPs that do not become CPs must designate a GCP for each type of clearing

qualification for which they have a clearing entrustment agreement. TPs must obtain approval

from OSE prior to designating or changing their GCPs and must report to OSE when any of their

clearing entrustment agreements have been terminated and the reasons for the termination. A

termination based on the transactions cleared must be reported on the same day as the

termination.

You have represented that an entity wishing to become a CP must apply for a CQ49 and is

subject to an examination by OSE

to designating or changing their GCPs and must report to OSE when any of their

clearing entrustment agreements have been terminated and the reasons for the termination. A

termination based on the transactions cleared must be reported on the same day as the

termination.

You have represented that an entity wishing to become a CP must apply for a CQ49 and is

subject to an examination by OSE. In considering whether to grant an application for a CQ, OSE

46

You note that OSE’s Market Operations Department is separate from its Derivatives Department, which

contains OSE’s Derivatives Business Development Division (the division responsible for developing new products

and new systems for OSE, as well as for developing internal rules for futures and options trading). Accordingly, the

C&S Division and the Derivatives Business Development Division report to different executive directors. You

further note that OSE’s marketing and promotional activities are conducted by a separate division (Marketing &

Sales).

47 You represent that the reviews conducted by OSE’s Internal Inspection Office are equivalent to the types of

reviews conducted by internal review units in the U.S.

48 OSE assumes the obligations of both the selling and the purchasing CP.

49 You have represented that there are two types of CQs: (1) an “Individual CQ,” which does not allow brokerage

(i.e., it qualifies the CP only to clear transactions done by itself as TP) and (2) a “General CQ,” which permits

brokerage (i.e., it qualifies the CP to clear transactions done by itself [if it is also a TP] and by others). A CP with an

individual CQ is referred to as an “Individual CP”; a CP with a general CQ is referred to as a “GCP.” All Individual

CPs are also TPs and, accordingly, are required to satisfy all of the TP participant requirements. Not all GCPs are

nd (2) a “General CQ,” which permits

brokerage (i.e., it qualifies the CP to clear transactions done by itself [if it is also a TP] and by others). A CP with an

individual CQ is referred to as an “Individual CP”; a CP with a general CQ is referred to as a “GCP.” All Individual

CPs are also TPs and, accordingly, are required to satisfy all of the TP participant requirements. Not all GCPs are

Paul M. Architzel, Esq.

Page 17

assesses: (1) the structure of the applicant’s management system; (2) the applicant’s financial

condition; and (3) the applicant’s business operations, including whether the applicant has an

appropriate method for the settlement of contracts and an appropriate risk management structure.

The CQ application assessment is performed by OSE’s C&S Division. You have represented

that the application assessment is primarily performed through the examination of relevant

documents. Such documents include: the applicant’s company profile; the applicant’s Articles

of Incorporation; the applicant’s corporate registration; the application packet required by the

FIEA, and registration certification; the applicant’s internal rules governing its operations, risk

management, and fund segregation; the applicant’s organization chart; the applicant’s business

reports for the last three fiscal years; descriptions of the applicant’s business operations and the

status of its property for the last three fiscal years; notification of the applicant’s capital

adequacy ratio filed at the term-end for the last three fiscal years; the report on off-site

monitoring conducted by the FSA for the last year; and the inspection report issued by and/or

business improvement report submitted to the applicant’s regulators (e.g., the FSA or SESC), if

any

ions and the

status of its property for the last three fiscal years; notification of the applicant’s capital

adequacy ratio filed at the term-end for the last three fiscal years; the report on off-site

monitoring conducted by the FSA for the last year; and the inspection report issued by and/or

business improvement report submitted to the applicant’s regulators (e.g., the FSA or SESC), if

any. You also have represented that, prior to the approval of a CQ application, the person(s) in

charge of the assessment visits the applicant’s offices to examine the applicant’s business

operation system, including its infrastructure.

You have represented that OSE requires all CPs to have appropriate business operations

to support their respective clearing activities. OSE specifically requires a GCP to be a “type-I

financial instruments business operator” or a “registered financial institution.” Registered

financial institutions include financial institutions that are not securities companies, but that are

allowed to engage in part of a financial instruments business. They include some banks and

insurance companies. OSE requires all CPs to provide advance notice to OSE of any material

change in their respective management systems and business operations including, among others,

the cessation of business operations, mergers, changes in directors, or relocations of their head

offices. You represent that OSE reviews such changes to determine whether they are

appropriate.

You have represented that OSE also imposes certain ongoing financial requirements upon

CPs. The financial requirements differ in accordance with the various methods established under

Japanese law for calculating the financial soundness of different types of core businesses. For

example, “registered financial institutions” are required to demonstrate their financial soundness

through the calculation of their “capital ratio” under Japanese law

ongoing financial requirements upon

CPs. The financial requirements differ in accordance with the various methods established under

Japanese law for calculating the financial soundness of different types of core businesses. For

example, “registered financial institutions” are required to demonstrate their financial soundness

through the calculation of their “capital ratio” under Japanese law. The capital ratio is intended

to indicate, for instance, the amount of capital that a bank holds against assets that are at risk of

bad debts. You have represented that OSE requires a CP that is a bank with overseas operations

offices to maintain a capital ratio of no less than eight percent, calculated in accordance with the

Basel II minimum capital requirements. A bank without overseas operation offices is required to

maintain a capital ratio of not less than four percent in accordance with the Japanese standard.

You have represented that, under Japanese law, securities firms are required to

demonstrate their financial soundness using a “capital adequacy ratio,” calculated in accordance

TPs, however. You have represented that, as of December 2010, more than eighty firms were eligible to clear

futures and options trades through OSE.

Paul M. Architzel, Esq.

Page 18

with the FIEA.50 The capital adequacy ratio is intended to indicate how much “unfixed capital” a

securities company holds to cover various risks, such as the price volatility risk of securities

held. Securities companies are required by the FIEA to maintain a capital adequacy ratio of no

less than 120%. If a security company’s capital adequacy ratio falls below 140%, it is required

to report that fact to the FSA. You have represented that OSE requires CPs that are financial

instruments business operators applying for a GCQ to maintain a capital adequacy ratio of no

less than 200%

held. Securities companies are required by the FIEA to maintain a capital adequacy ratio of no

less than 120%. If a security company’s capital adequacy ratio falls below 140%, it is required

to report that fact to the FSA. You have represented that OSE requires CPs that are financial

instruments business operators applying for a GCQ to maintain a capital adequacy ratio of no

less than 200%. You have represented that current Japanese law requires that all CPs be located

in Japan; Remote CPs are not permitted. Accordingly, all CPs are subject to the Japanese capital

adequacy ratio requirement.

You have represented that OSE requires GCPs to have stated capital of at least ¥300

million (approximately $3,553,500) and net assets of at least ¥20 billion (approximately

$236,900,000) that exceed the amount of stated capital. Individual CPs are required to have net

assets of at least ¥2 billion (approximately $23,690,000) that exceed the amount of stated capital.

You have represented that, after a CP has obtained a CQ, OSE’s Risk Management

Team51 monitors the financial condition of the CP by reviewing certain “monitoring documents”

that OSE requires the CP to submit to the Exchange. Such documents include: an annual

business report; an annual financial statement; an annual report affirming the CP’s continued

regulatory status and detailing the status of its property, in accordance with the FIEA, related

ordinances and OSE Regulations; monthly reports on the CP’s capital adequacy ratio; monthly

financial and accounting data; and a monthly report on transactions by product. You represent

that, if a CP is unable to maintain the above-referenced financial requirements and falls below

the level specified by OSE, OSE reserves the right, after a hearing,52 to suspend the whole or part

of the assumption of the obligations based on clearable transactions to which the CP is a party

; monthly

financial and accounting data; and a monthly report on transactions by product. You represent

that, if a CP is unable to maintain the above-referenced financial requirements and falls below

the level specified by OSE, OSE reserves the right, after a hearing,52 to suspend the whole or part

of the assumption of the obligations based on clearable transactions to which the CP is a party.

You have represented that all CPs are required to register with the FSA and that OSE

checks the registration status of its CPs through the FSA’s website on a daily basis. You also

note that OSE rules require CPs to notify OSE upon the rescission of their regulatory license,

registration, authorization or approval to conduct their respective activities and that, should a CP

50 The “capital adequacy ratio” is also known as the “capital-to-risk ratio.” You have represented that it is

calculated as follows: (unfixed capital)/[(market risk equivalent) + (counterparty risk equivalent) + (operational risk

equivalent)] x 100, where the unfixed capital = (own capital) – (illiquid assets). For purposes of this calculation: (1)

“market risk equivalent” is the amount of risk arising from price fluctuations in the securities held; (2) “counterparty

risk equivalent” is the amount of risk arising from the default of a counterparty; (3) “operational risk equivalent” is

the amount of risk arising from executing routine business; (4) “own capital” includes stated capital; reserve funds;

profit surplus; unrealized profits for securities (excluding those securities held for trade, held-to-maturity securities,

and securities used by affiliates); Treasury shares; allowances; and subordinated liabilities; and (5) “illiquid assets”

include fixed assets (excluding exchange-listed securities and Japanese government bonds), deferred assets,

deposits, short-term loans to affiliates, advances paid, advance payments, securities issued by affiliates, and bonds

ities held for trade, held-to-maturity securities,

and securities used by affiliates); Treasury shares; allowances; and subordinated liabilities; and (5) “illiquid assets”

include fixed assets (excluding exchange-listed securities and Japanese government bonds), deferred assets,

deposits, short-term loans to affiliates, advances paid, advance payments, securities issued by affiliates, and bonds.

51 The Risk Management Team is within the C&S Division of OSE’s Market Operations Department and is

managed and overseen by the General Manager of the C&S Division. You represent that all persons on the Risk

Management Team have sufficient statistical expertise to identify and correct risk management issues and to review

and address back testing results.

52 A CP may submit written statements in lieu of a hearing.

Paul M. Architzel, Esq.

Page 19

fail to provide such notice to OSE in a timely manner, OSE could take disciplinary action against

the CP (including the suspension of the assumption of obligations or the revocation of the CP’s

CQ). You note that, in the event of an emergency (e.g., upon the possible failure of the CP), the

relevant regulatory authorities would inform OSE directly).

You have represented that, upon the OSE’s approval of the acquisition of a CQ, the CP

must make a clearing deposit with OSE in order to secure performance of the CP’s obligations.

Clearing deposit payments are made to OSE in the Exchange’s capacity as a “financial

instruments clearing organization.” Financial instruments clearing organizations have the right

to receive payment from clearing deposits in preference over other creditors with regard to

claims incurred. OSE manages the clearing deposit for each CP separately from its proprietary

resources and other resources of OSE. You have represented that the amount of clearing deposit

that OSE requires of a particular CP varies in accordance with the risk involved

ing organizations have the right

to receive payment from clearing deposits in preference over other creditors with regard to

claims incurred. OSE manages the clearing deposit for each CP separately from its proprietary

resources and other resources of OSE. You have represented that the amount of clearing deposit

that OSE requires of a particular CP varies in accordance with the risk involved. CP clearing

deposit obligations are calculated by dividing the sum total of the clearing deposit required53 pro-

rata by a monthly-averaged margin requirement for each CP. The CP cannot assign, contract to

assign, or offer for the purposes of collateral to any other party the right to claim the return of the

clearing deposit. If the clearing deposit falls short of the amount required, the CP must deposit

with OSE an amount equal to or greater than the shortfall by noon the following day. You

represent that the sum total of the clearing deposit required as of December 31, 2010 is ¥61.5

billion (approximately $728,468,000). The aggregate clearing deposit is reviewed by OSE on a

monthly basis.

You have represented further that, after becoming a CP, a firm also must pay a basic fee,

pay monthly clearing fees, enter into a CP Agreement, maintain internal rules for the

management of positions, and appoint, and register a director or employee to coordinate with

OSE and to oversee the CP’s operations relating to the settlement and clearing of contracts.

You have represented that OSE possesses the authority to demand that a CP submit

reports or other documents regarding the CP’s business or property to the Exchange. OSE also

maintains the right to inspect the status of the business, property, books, documents and other

materials of the CP

nate with

OSE and to oversee the CP’s operations relating to the settlement and clearing of contracts.

You have represented that OSE possesses the authority to demand that a CP submit

reports or other documents regarding the CP’s business or property to the Exchange. OSE also

maintains the right to inspect the status of the business, property, books, documents and other

materials of the CP. The OSE’s inspection authority is exercised through regular, on-site

examinations of a CP that are conducted by OSE’s Participant Affairs (PA) Division once every

several years and through special examinations, which are performed by the PA Division on an

as-needed basis at the request of the C&S Division. You have represented that such

examinations are aimed at discovering the status of the CP’s compliance with OSE’s Rules, the

CP’s financial status, the reliability of the CP’s performance of its obligations, and for the

purpose of ensuring the fairness of futures and options trading on the OSE markets. Regular

examinations typically take one or two weeks. You have represented that, during regular CP

examinations, OSE inspects the CP’s books and records and examines the CP for its

management of margin for futures and options trading, customer risk exposure management,

53 OSE calculates its Probable Maximum Loss (PML) on a daily basis and, at the end of each month, designates

the highest PML during the prior six month period as the aggregate amount of clearing deposit for the next month.

The PML is obtained from the results of stress tests that are conducted every day in accordance with the Lamfalussy

standard.

rading, customer risk exposure management,

53 OSE calculates its Probable Maximum Loss (PML) on a daily basis and, at the end of each month, designates

the highest PML during the prior six month period as the aggregate amount of clearing deposit for the next month.

The PML is obtained from the results of stress tests that are conducted every day in accordance with the Lamfalussy

standard.

Paul M. Architzel, Esq.

Page 20

credit exposure management, and sales management. You have represented that OSE reviews,

among other things, the CP’s internal rules for futures and options trading, customer account

ledger, daily trial balance sheet, and status report on margins deposited for futures and options

trading. OSE also performs checks to identify inadequacies in the notification of clearing margin

requirements. You represent that, if any problems were found in the CP’s management of

margins from a risk management perspective, the PA Division would notify the C&S Division

for appropriate escalation of the matter.

You have represented that OSE retains certain disciplinary authority against a CP that

violates applicable rules or requirements or that becomes insolvent. For example, if a CP

becomes insolvent and is unable to return easily to solvency, OSE can revoke its CQ. OSE can

also revoke a CQ if a CP fails to pay, deliver, or deposit money or securities that it is obligated to

pay, deliver or deposit with OSE, other CPs, or TPs that are not CPs. If a CP holds an excessive

position in comparison to the status of its property, such as net assets or cash, OSE may raise the

amount of clearing margin or clearing deposit required of the CP or take other measures. Such

disciplinary matters may be publicly announced by OSE

posit money or securities that it is obligated to

pay, deliver or deposit with OSE, other CPs, or TPs that are not CPs. If a CP holds an excessive

position in comparison to the status of its property, such as net assets or cash, OSE may raise the

amount of clearing margin or clearing deposit required of the CP or take other measures. Such

disciplinary matters may be publicly announced by OSE. If the CQ of a CP is suspended (i.e.,

the assumption of the whole or part of the obligations based on clearable transactions to which

the CP is a party is suspended) or revoked, OSE ensures the smooth transition of the unsettled

clearing contracts of the CP. For example, OSE may cause the CP to transfer the unsettled

clearing contracts to another CP, to settle the transactions, or take other actions OSE may deem

necessary.

A CP may withdraw its CQ in accordance with the OSE Clearing Rules, which you

represent include procedures for the orderly cancellation of clearing brokerage agreements and

the unwinding of open positions or (in the case of a merger) the transfer of open positions.

D.

Clearing System

You have represented that the OSE clearing system (OSE-CS) was developed internally

by OSE. Users can connect to the OSE-CS through two interfaces – a web-browser interface for

human interface54 and a direct-connection interface for machine interface.55 The execution data

and open interest data generated on the J-GATE are interfaced to the OSE-CS on a real-time

basis and are synchronized between the systems. You have represented that the OSE-CS

includes appropriate security measures, such as authentication of users and data filtering to

ensure against unauthorized use and contamination of the system through, e.g., viruses.

With respect to OSE’s procedures for ensuring the ongoing reliability of the OSE-CS,

you have represented that OSE maintains a business continuity plan. You have represented

specifically that each OSE-CS server uses a load balancer to distribute the load

h as authentication of users and data filtering to

ensure against unauthorized use and contamination of the system through, e.g., viruses.

With respect to OSE’s procedures for ensuring the ongoing reliability of the OSE-CS,

you have represented that OSE maintains a business continuity plan. You have represented

specifically that each OSE-CS server uses a load balancer to distribute the load. Each OSE-CS

server also employs hot-standby configuration consisting of a primary server and a backup

54 A web-browser interface uses the services of the OSE-CS by using data display, data input, and file transfer

through Microsoft Internet Explorer from a client PC of a user.

55 A direct-connection interface uses the services of the OSE-CS by connecting a user’s computer system directly

to the OSE-CS.

Paul M. Architzel, Esq.

Page 21

server. You have represented that all key components of the OSE-CS system, including the

power supply and all network components, are duplicated. You have represented that OSE

maintains geographically separate back-up and disaster recovery sites where data is stored and

where clearing and settlement operations could be replicated and resumed in the case of an

emergency. The back-up site is located approximately 30 km from the primary site. You have

noted that the primary and back-up sites are located on different fault lines, and have explained

that any shifts in the fault line that affect the main site are unlikely to affect the back-up site. In

addition, the electronic power supply and communication lines for the back-up site are provided

and secured separately from the primary site, and you have noted that this may avoid having both

sites being affected by the same disaster at the same time.

You have represented that clearing and settlement data is sent to the back-up site in a

timely manner and that clearing and settlement functions could be resumed within two hours

after the failure occurrence

back-up site are provided

and secured separately from the primary site, and you have noted that this may avoid having both

sites being affected by the same disaster at the same time.

You have represented that clearing and settlement data is sent to the back-up site in a

timely manner and that clearing and settlement functions could be resumed within two hours

after the failure occurrence. Operations could be switched to the back-up site within twenty-four

hours. You have represented further that OSE conducts annual or more frequent testing of its

ability to switch to the back-up site. In addition, when developing a new clearing and settlement

function, or when making an adaptation to an existing function that may affect OSE’s back-up

site, OSE conducts testing of the application subject to development or adaptation, including

confirmation that the development or adaptation would have no effect on the whole system.

OSE also performs additional testing for performance, capacity, and reliability and the like on a

case-by-case basis.

E.

Risk Management

You have represented that OSE has established “Risk Management Rules” which specify

OSE’s risk management procedures. You have represented that the outline of OSE’s risk

management system was developed jointly by the C&S and Derivatives Business Development

Divisions of the Exchange. The detailed operations, procedures, and methods of that system,

however, were developed by OSE’s Risk Management Team. You have represented further that

OSE designates a “person responsible for risk management” at each of its divisions and requires

such person to identify the risks at that division, analyze the size and impact of the risks and the

probability of occurrence and, based upon the results of the analyses, appropriately respond to

those risks.

You have represented that OSE bases its exposure thresholds to individual CPs upon

whether an individual CP’s position is appropriate in terms of its financial size

sions and requires

such person to identify the risks at that division, analyze the size and impact of the risks and the

probability of occurrence and, based upon the results of the analyses, appropriately respond to

those risks.

You have represented that OSE bases its exposure thresholds to individual CPs upon

whether an individual CP’s position is appropriate in terms of its financial size. OSE recognizes

this risk exposure to be “the ratio of possible losses to net assets,” which OSE obtains from the

results of a stress test for each CP. You have represented that, under normal circumstances, if

this ratio were to exceed 50%,56 OSE would take certain action to determine whether the CP’s

position is excessive. Such action would include: (1) checking positions (e.g., OSE would

require the CP to report a breakdown of its customer positions, whether any customer had an

excessive position, whether a particular position is concentrated with a certain customer, the

56 If market volatility becomes extremely high, OSE may change the threshold. In the past, it has changed the

threshold to 30%.

Paul M. Architzel, Esq.

Page 22

status of its clearing margin deposit, etc.); (2) If OSE suspected problems based upon (1), OSE

would conduct an inspection of the status of the CP’s business, property, books, or other

documents or materials; and (3) If the position continues to grow and OSE continues to be

concerned after performing (1) and (2), OSE may require an increase of margin deposit or

implement other measures, such as issuing a warning or instructing the CP to make

improvements to its risk management system. If the CP does not comply with OSE’s

instructions, OSE may suspend assumption of obligations or revoke the CP’s CQ

and (3) If the position continues to grow and OSE continues to be

concerned after performing (1) and (2), OSE may require an increase of margin deposit or

implement other measures, such as issuing a warning or instructing the CP to make

improvements to its risk management system. If the CP does not comply with OSE’s

instructions, OSE may suspend assumption of obligations or revoke the CP’s CQ.

You represent that OSE performs stress testing for each CP, taking the Nikkei 225 index

as a risk factor and the market volatility during the time period (including the most volatile time

periods, such as the fall of Lehman Brothers in 2008 and Black Monday in 1985). Although you

define such period as a period under “normal market environments,” you believe the required

amount can cover an “extreme, but plausible” market environment because you take, in your

view, a conservative approach when calculating the PML by including the most volatile periods,

setting the confidence level at 99.7%, and adopting the highest value during the past six months

(not the value on the day of calculation), as a calculation result.

You have represented that, in order to prevent a CP from holding excessive positions,

OSE’s Clearing Rules require a CP to establish internal rules to provide for the management of

futures and options positions and to submit a copy of such rules to OSE. OSE’s Clearing Rules

also require a CP to establish the maximum amount of positions that can be held separately for

its proprietary account and customer accounts, which amounts must be set at a reasonable level

that allows for the positions to be managed in a proper way. OSE’s Risk Management Team is

responsible for reviewing a CP’s internal rules regarding the management of positions initially

and upon notification of a new rule or a change to an existing rule

of positions that can be held separately for

its proprietary account and customer accounts, which amounts must be set at a reasonable level

that allows for the positions to be managed in a proper way. OSE’s Risk Management Team is

responsible for reviewing a CP’s internal rules regarding the management of positions initially

and upon notification of a new rule or a change to an existing rule. If the Risk Management

Team considers the CP’s internal rules to be clearly inappropriate for the proper and reliable

operation of the CP’s financial instruments obligation assumption services, or insufficient to

manage positions in an appropriate way (e.g., when the upper limit of positions in futures and

options transactions to be held for the CP’s proprietary account or for customer accounts is

extremely large), OSE may instruct the CP to implement the necessary improvements to its rules.

OSE also reviews a CP’s overall risk management system, and may require the CP to implement

improvements to the system.

F.

Settlement Price

You have represented that OSE has specific rules governing settlement prices used for

daily mark-to-market and margin calculation for futures and options transactions. Typically,

OSE establishes the settlement price for each contract month of stock index futures transactions

for each trading day after the close of the day session of the trading day. The settlement price

will be the last contract price of stock index futures in a set time period on a trading day

specified by OSE. In the event the settlement price is found to be erroneous, OSE may change

the price to a value it deems appropriate. In the event a difference arises between the contract

price of stock index futures and the settlement price for the trading day on which the contract

was executed, the CP pays or receives the difference in cash the following day. The settlement

trading day

specified by OSE. In the event the settlement price is found to be erroneous, OSE may change

the price to a value it deems appropriate. In the event a difference arises between the contract

price of stock index futures and the settlement price for the trading day on which the contract

was executed, the CP pays or receives the difference in cash the following day. The settlement

Paul M. Architzel, Esq.

Page 23

price rules may vary depending on the specific product. Option settlement prices are determined

based upon the option’s theoretical value.

G.

Margining System

You have represented that OSE has adopted SPAN® as the margin calculation system for

futures and option transactions listed for trading on OSE. 57 You have represented that the

margin requirement for futures and options trading on the OSE is calculated by deducting the

“Total Amount of Net Option Value” from the “SPAN Requirement,” which is the estimate

calculated by SPAN® of the largest possible loss an entire portfolio of futures and options

contracts could reasonably be expected to experience from one day’s market fluctuations,

excluding the loss which could be offset by gains arising from each issue in the portfolio. The

Total Amount of Net Option Value is intended to cover the risk arising from the exercise of

options, etc. and is calculated by deducting the total amount of short option value (short positions

× settlement price × trading unit) from that of the long option value (long positions × settlement

price × trading unit). The margin requirement is calculated by the software PC-SPAN® using a

SPAN Risk Parameter File distributed by OSE every business day. The SPAN Parameter, which

is used as the basic factor for calculation of the SPAN Risk Parameter File, is reviewed by the

Risk Management Team every week

ice × trading unit) from that of the long option value (long positions × settlement

price × trading unit). The margin requirement is calculated by the software PC-SPAN® using a

SPAN Risk Parameter File distributed by OSE every business day. The SPAN Parameter, which

is used as the basic factor for calculation of the SPAN Risk Parameter File, is reviewed by the

Risk Management Team every week. With respect to the Risk Parameters that OSE expects to

cover through its inputs into SPAN, you have represented that the Exchange uses two

observation periods, four weeks and twenty-four weeks. OSE adopts the larger one that covers a

one-day price move at 99% during the selected observation periods as a risk parameter. You

have represented that OSE is able to alter the Risk Parameter on short notice, based upon rapid

changes in volatility or to make extraordinary margin calls.

You have represented that OSE back tests its margin by examining how often the actual

price movement of OSE’s leading contract, the Nikkei 225 futures contract, has exceeded the

Price Scan Range in the 250 days prior to the testing day and determining whether such

occurrence falls within the scope of the assumption. You represent that such testing is performed

on a monthly basis, and was performed eight times during fiscal year 2010.

You have represented that OSE maintains specific rules regarding its margin

requirements for futures and options trading. There are two types of margin for a customer’s

account: (1) “clearing margin” and (2) “brokerage margin.” Clearing margin is the margin

deposited by a customer with OSE through a CP as agent. If a customer agrees in writing, a CP

may instead keep the margin deposited by the customer as “brokerage margin.” In the case of

brokerage margin, the CP deposits with OSE its own money or securities as clearing margin in

place of the customer’s money or securities

ring margin” and (2) “brokerage margin.” Clearing margin is the margin

deposited by a customer with OSE through a CP as agent. If a customer agrees in writing, a CP

may instead keep the margin deposited by the customer as “brokerage margin.” In the case of

brokerage margin, the CP deposits with OSE its own money or securities as clearing margin in

place of the customer’s money or securities. This is referred to as “substitution of direct

deposit.” A CP may deposit margin in securities in lieu of cash.58

57 It monitors price trends and price volatility, and uses this data to determine the appropriate margin levels

required and whether extraordinary intra-day margin calls are appropriate.

58 As discussed further below, OSE, in the event of a default, may exercise its right to the clearing margin so as to

repay the debt pertaining to such default. In addition, a CP, a Non-CP or a customer who is an intermediate broker

(a financial instruments dealer who commissions a TP to carry out futures and options trading, acting as an agent)

Paul M. Architzel, Esq.

Page 24

OSE notifies CPs every day, after accounting for positions, of the respective proprietary

account clearing margin requirement for the trading day. A CP is required to notify OSE of the

clearing margin requirement for the customers’ accounts (i.e., the total of the clearing margin

requirements for its customers’ accounts and the clearing margin requirement for brokerage for

clearing) for the day no later than the time prescribed by OSE.59 A Non-CP performing

brokerage for clearing is required to notify its designated GCP of the sum total of the clearing

margin requirements for its proprietary account and customers’ accounts

ounts (i.e., the total of the clearing margin

requirements for its customers’ accounts and the clearing margin requirement for brokerage for

clearing) for the day no later than the time prescribed by OSE.59 A Non-CP performing

brokerage for clearing is required to notify its designated GCP of the sum total of the clearing

margin requirements for its proprietary account and customers’ accounts.

When a sale or purchase of a futures contract or a sale of an option contract is concluded

for a proprietary account or a customer account, the CP must deposit clearing margin with OSE

by noon of the day following the date on which the contract was executed. A CP is required to

deposit with OSE all clearing margin submitted by its customer on behalf of the customer. A

Non-CP is required to deposit with its designated GCP the clearing margin for its proprietary

account and all clearing margin submitted by a customer on behalf of that customer.

If the customer has deposited its margin as brokerage margin, the CP must deposit with

OSE its own money or securities as the clearing margin, in an amount not less than the amount

deposited with it by the customer. OSE may raise the required amount of margin, if OSE finds

that a particular CP holds, or is likely to hold, an excessive position in light of market activities

and the CP’s financial status.

You have represented that, when there is a deficit in the amount of the clearing margin

for a CP’s proprietary or customer accounts (the total of the clearing margin for its customers’

accounts and for brokerage of clearing) deposited, the CP must deposit the additional clearing

margin, in an amount not less than the shortfall, by noon of the day following the occurrence of

the shortfall

You have represented that, when there is a deficit in the amount of the clearing margin

for a CP’s proprietary or customer accounts (the total of the clearing margin for its customers’

accounts and for brokerage of clearing) deposited, the CP must deposit the additional clearing

margin, in an amount not less than the shortfall, by noon of the day following the occurrence of

the shortfall. A customer or a Non-CP conducting brokerage for clearing must deposit with the

designated CP acting as its agent the additional margin, in an amount not less than the shortfall,

by the time specified by the CP that is no later than noon of the day following the occurrence of

the shortfall. Additionally, upon request of OSE, CPs are required to immediately report to OSE

in writing the number of customer account positions and other matters relating to customer

account futures and options trading, which OSE has deemed necessary for risk management.

You have represented further that OSE also has emergency clearing margin provisions in

place. For example, in the event the market for stock index futures has fluctuated beyond the

range prescribed by OSE at 11:00 am or OSE has deemed it necessary for any other reason, OSE

would impose emergency clearing margins. If, as a result, the clearing margin deposited by a CP

for a proprietary account falls below the emergency clearing margin requirements, the CP would

may exercise his or her right to the clearing margin or other margin up to the amount to which each has a claim for

return to repay the debt.

59 The CP has data on each of its customer’s individual positions. OSE does not have that information in the first

instance; rather it has information on the CP's total customer position. Accordingly, OSE requires the CP to report

to OSE the clearing margin requirement for its customers’ accounts, calculated based on each customer’s individual

position, on a gross basis. In this way, OSE is able to collect customer margin on a gross basis.

idual positions. OSE does not have that information in the first

instance; rather it has information on the CP's total customer position. Accordingly, OSE requires the CP to report

to OSE the clearing margin requirement for its customers’ accounts, calculated based on each customer’s individual

position, on a gross basis. In this way, OSE is able to collect customer margin on a gross basis.

Paul M. Architzel, Esq.

Page 25

be required to deposit additional proprietary account clearing margin with OSE in an amount not

less than the shortfall by 4:00 pm on the day on which the emergency clearing margin is called.

If this were to occur, OSE would determine the emergency settlement price for each contract.

You have represented further that OSE maintains rules governing a TP’s ability to

withdraw margin deposits. If the total amount of margin deposited exceeds the margin

requirement, a TP may allow the customer to withdraw the money or substitute securities up to

the exceeding amount, or the money up to the excess cash amount, whichever is smaller, only if

there is still an excess cash margin deposited after the withdrawal (i.e., the amount of money

deposited as margin exceeds the amount of money to be paid). Additionally, if an unrealized

profit (i.e., a mark-to-market profit) for stock index futures arises in a customer’s position and

the total amount of margin deposited exceeds the margin requirement, a TP may, upon request

by the customer, pay the customer cash equivalent to such unrealized profit up to the exceeding

amount.

H.

Segregation of Customer Funds

You have represented that, pursuant to the FIEA and OSE’s Rules, CPs are required to

segregate customer funds and securities from their proprietary funds and securities.

Accordingly, a CP must segregate margins for customers’ positions from the clearing margins

supporting its proprietary positions

lent to such unrealized profit up to the exceeding

amount.

H.

Segregation of Customer Funds

You have represented that, pursuant to the FIEA and OSE’s Rules, CPs are required to

segregate customer funds and securities from their proprietary funds and securities.

Accordingly, a CP must segregate margins for customers’ positions from the clearing margins

supporting its proprietary positions. OSE sets up a margin account for each CP and manages the

margins directly deposited by customers with OSE and substituted margins for customers’

accounts separately from the OSE’s proprietary and other resources. Similarly, OSE manages

CP clearing deposits separately from the proprietary and other resources of OSE.

I.

Default Remedies and Procedures

You have represented that OSE maintains rules governing measures to be taken in case of

a CP’s default. If a CP has failed, or OSE has grounds to believe that it will fail, to settle any of

its clearing contracts, OSE will suspend the assumption of the obligations to which the CP is a

party. If the CP has failed to settle any of the clearing contracts, OSE may designate another CP

and cause such other CP to sell or buy the securities which are required for the settlement of the

failed clearing contracts. As discussed in detail below, OSE also maintains provisions for

recouping any losses that it suffers as a result of a CP’s failure. You have represented that OSE

has emergency measures in place in the event that the settlement of clearing contracts has

become impossible, extremely difficult due to a natural disaster, an extreme change in the

economic situation, a supply shortage, or any other event beyond the control of OSE. In such

situations, OSE may stipulate new settlement conditions for the affected contracts.

You represent that, in the event of a CP’s default, OSE will recoup losses incurred in

accordance with the loss-sharing rules prescribed by OSE

xtremely difficult due to a natural disaster, an extreme change in the

economic situation, a supply shortage, or any other event beyond the control of OSE. In such

situations, OSE may stipulate new settlement conditions for the affected contracts.

You represent that, in the event of a CP’s default, OSE will recoup losses incurred in

accordance with the loss-sharing rules prescribed by OSE. Specifically, OSE will recover such

losses in the following order: (1) the clearing margin deposited with OSE for the defaulting CP’s

proprietary account; (2) the clearing margin to which the defaulting CP has the right to claim the

Paul M. Architzel, Esq.

Page 26

return; 60 (3) the clearing deposit deposited with OSE by the defaulting CP; (4) the surplus in any

of the accounts described in (1) through (3) after being used according to the purpose of the

deposits; 61 (5) other deposits deposited with OSE by the defaulting CP; (6) the guarantee fund of

the defaulting CP held by OSE; 62 (7) the Default Compensation Reserve for Futures and Options

Trading (Default Reserve); 63 (8) the clearing deposit deposited with OSE by CPs other than the

defaulting CP64 and the OSE’s earned surplus equivalent; 65 and (9) special dues that OSE

requires CPs to pay as of the default date, in the event there are any unrecoverable losses

remaining after using the procedures in (1) through (8) above. 66

You have represented that, as of December 31, 2010, certain relevant amounts include:

learing deposit deposited with OSE by CPs other than the

defaulting CP64 and the OSE’s earned surplus equivalent; 65 and (9) special dues that OSE

requires CPs to pay as of the default date, in the event there are any unrecoverable losses

remaining after using the procedures in (1) through (8) above. 66

You have represented that, as of December 31, 2010, certain relevant amounts include:

(1) total clearing margin = ¥581.696 billion (approximately $6.890 billion); total clearing deposit

= ¥84.312 billion (approximately $998,676,000); total Guarantee Fund = ¥605 million

(approximately $7,166,230);67 Default Reserve = ¥7.111 billion (approximately $84,229,800);

OSE’s earned surplus equivalent ¥31.173 billion (approximately $369,244,000). In addition to

the foregoing, OSE had approximately ¥130 billion (approximately $1.540 billion) available to

satisfy its liquidity needs as of December 31, 2010. This sum includes approximately ¥26.624

60 In the event of a customer default, the CP directly damaged from the default has a right to claim the return of

the clearing margin deposited by the defaulting customer with OSE through direct deposit. Where the CP itself

defaults, however, the clearing margin deposited by the defaulting customer becomes available to compensate the

losses to OSE.

61 The deposits referenced in (1) through (3) are made for the following purpose: (a) with respect to (1), to ensure

the settlement of the loss caused by the defaulting CP’s proprietary transactions; (b) with respect to (2), to ensure

settlement of the loss caused by the transactions for the defaulting CP’s customers’ account; and (c) with respect to

ilable to compensate the

losses to OSE.

61 The deposits referenced in (1) through (3) are made for the following purpose: (a) with respect to (1), to ensure

the settlement of the loss caused by the defaulting CP’s proprietary transactions; (b) with respect to (2), to ensure

settlement of the loss caused by the transactions for the defaulting CP’s customers’ account; and (c) with respect to

(3), to ensure settlement to all the unsettled amount of the defaulting CP. If there is any surplus in any of these

deposits after being used for the stated purpose, the remaining amount will be used to compensate the loss.

62 This refers to the guarantee fund deposited by OSE by a defaulting CP that is also a TP.

63 The Default Reserve is comprised of funds contributed by members to OSE when OSE was a membership

organization (i.e., prior to March 31, 2001). After demutualization on April 1, 2001, OSE merged the Default

Reserve into its shareholders’ equity as part of retained earnings. At a general meeting of OSE members held on

February 27, 2001, it was resolved that the Default Reserve could only be used in the event of defaults. Specifically,

it may be used to compensate any remaining loss arising from a CP’s default that cannot be covered after the funds

referenced in (1) through (5) have been used. No contributions will be made to the Default Reserve after it has been

appropriated to compensate for loss.

64 This means the remaining amount of the reserves that OSE requires to ensure the stable settlement in the case of

a CP’s default, excluding the deposit made by the defaulting CP (which would have already been used in (3)).

65 OSE’s earned surplus equivalent is the amount remaining in OSE’s retained earnings after deducting funds the

purpose of which is determined, such as legal retained earnings, the Default Compensation Reserve for Cash

Transactions, the Default Compensation Reserve for Futures and Options Trading in (7)

xcluding the deposit made by the defaulting CP (which would have already been used in (3)).

65 OSE’s earned surplus equivalent is the amount remaining in OSE’s retained earnings after deducting funds the

purpose of which is determined, such as legal retained earnings, the Default Compensation Reserve for Cash

Transactions, the Default Compensation Reserve for Futures and Options Trading in (7).

66 In the event that there are any unrecoverable losses remaining after the resources referenced in (1) through (8)

are used, OSE will require all CPs, other than the defaulting CP, to pay special dues in proportion. Special dues are

intended to compensate loss through the mutual guarantee of CPs, to ensure the stable settlement at OSE as a

clearing house.

67 The amount of clearing margins, clearing deposits, and guarantee funds are the sum totals of such funds

deposited by all CPs or TPs, as applicable, and may not be used in full to compensate the loss arising from a CP’s

deposit.

Paul M. Architzel, Esq.

Page 27

billion (approximately $315,361,000) of OSE’s own funds (cash and deposits) and a bank line of

credit (¥80billion (approximately $947,600,000) of overdraft and ¥20 billion (approximately

$236,900,000) of commitment line.

You have represented that the deposit status of margins, guarantee funds, and clearing

deposits is monitored by the custody team of the C&S Division through a function of the clearing

platform. However, the appropriateness of the required amount of each deposit (except

guarantee funds, which have a fixed amount) is monitored by the Risk Management Team.

V.

OVERVIEW OF THE REGULATORY STRUCTURE IN JAPAN

A.

Introduction

OSE and its TPs are subject to a comprehensive regulatory regime

nitored by the custody team of the C&S Division through a function of the clearing

platform. However, the appropriateness of the required amount of each deposit (except

guarantee funds, which have a fixed amount) is monitored by the Risk Management Team.

V.

OVERVIEW OF THE REGULATORY STRUCTURE IN JAPAN

A.

Introduction

OSE and its TPs are subject to a comprehensive regulatory regime. This regime provides

for financial and competency requirements for exchange TPs and other industry participants;

reporting and recordkeeping requirements; procedures governing the treatment of customer funds

and property; sales practice and other conduct of business standards; measures designed to

protect the integrity of the markets; and statutory prohibitions on fraud, customer abuse and

market manipulation.

B.

Applicable Law

The regulatory framework governing OSE is established by the FIEA. The FIEA was

enacted in September 2007 by amending and renaming the Securities and Exchange Law and by

moving the regulation of the sale and solicitation of financial instruments from its own discrete

set of regulations to the broader law which applies generally to all financial instrument firms.

The FIEA broadened the scope of existing regulations in order to eliminate the different

regulations for financial instruments whose economic functions were identical and was enacted

to: establish an over-all single framework for a wide range of financial instruments and services;

enhance disclosure requirements; provide organizational structures for the self-regulatory

functions of financial instruments exchanges; and increase maximum criminal penalties against

market fraud. The FIEA developed a comprehensive definition of a “derivative transaction” to

include futures, 68 forwards, options, swaps and credit derivatives

wide range of financial instruments and services;

enhance disclosure requirements; provide organizational structures for the self-regulatory

functions of financial instruments exchanges; and increase maximum criminal penalties against

market fraud. The FIEA developed a comprehensive definition of a “derivative transaction” to

include futures, 68 forwards, options, swaps and credit derivatives. This new definition greatly

expanded the scope of regulated financial instruments and services.69

68 See FIEA, Chapter 1, Article 2(21)(i), in which futures transactions of “Market Transactions of Derivatives” is

defined as “transactions wherein the parties promise to deliver or receive the Financial Instruments or the

consideration for them at a fixed time in the future, and when the resale or repurchase of the underlying Financial

Instruments are made, settlement thereof may be made by paying or receiving the differences.”

69

Additionally, the FIEA enhanced disclosure requirements by introducing a quarterly reporting system and

internal control reporting system for listed companies. The internal control reporting system is analogous to that of

the Sarbanes-Oxley Act in the U.S. For example, quarterly financial statements attached to quarterly reports are

subject to audits by certified public accountants or auditing firms and the submission of false quarterly reports is

subject to criminal and civil money penalties. Reports evaluating internal controls of financial reporting are

mandatory and management must submit a certification stating that the financial statements are appropriate under

the FIEA.

tatements attached to quarterly reports are

subject to audits by certified public accountants or auditing firms and the submission of false quarterly reports is

subject to criminal and civil money penalties. Reports evaluating internal controls of financial reporting are

mandatory and management must submit a certification stating that the financial statements are appropriate under

the FIEA.

Paul M. Architzel, Esq.

Page 28

In addition, to ensure user protection, secure fairness and transparency of trading and to

establish public confidence in the markets, the FIEA increased maximum criminal penalties for

misconduct and various market abuses. The criminal penalties for unfair trading, spreading

rumors, use of fraudulent means and market manipulation were raised for individuals to possible

incarceration for a maximum of 10 years or the assessment of a maximum of ¥10 million

(approximately $118,450) in fines or a combination thereof. Criminal penalties for corporations

with dual liability were raised to a maximum fine of ¥700 million (approximately $8,291,500).

The FIEA also imposes civil penalties for making false statements, spreading rumors, trading by

fraudulent means, market manipulation and insider trading, where the amount of penalty

imposed is to be the amount of the financial benefit received as a result of such misconduct.

The FIEA provides that a financial instruments exchange is required to have in place an

appropriate self-regulatory framework and to conduct self-regulation related services which

include, among other things, the investigation of TPs with respect to their adherence to laws and

regulations, to the exchange rules, or to fair and equitable principles of transactions.70 For a

financial instruments exchange’s self-regulatory committee, such as that established at OSE,

independence is crucial and approval by a majority of the directors present at the meeting and a

majority of outside directors present is nece

vestigation of TPs with respect to their adherence to laws and

regulations, to the exchange rules, or to fair and equitable principles of transactions.70 For a

financial instruments exchange’s self-regulatory committee, such as that established at OSE,

independence is crucial and approval by a majority of the directors present at the meeting and a

majority of outside directors present is necessary for decision-making. The self-regulatory

committee must, among other things, conduct market surveillance, examine TP qualifications,

investigate TP compliance with acts or regulations, and examine the listing or delisting of

financial instruments and financial indicators or options. Additionally, a self-regulatory

committee must develop, amend or abolish exchange rules regarding disciplinary procedures

against TPs, as well as other measures regarding self-regulatory operations.

OSE has established a self-regulation committee. By resolution of this committee, OSE

may take disciplinary action against TPs violating the laws and regulations, including the

revocation of the TP’s trading qualification, suspension from or limitation on trading or the

handling of customers’ orders for up to six months, issuance of a fine of up to ¥100 million

(approximately $1,184,500) for certain violations and up to ¥500 million (approximately

$5,922,500) for severe violations, and issuance of a reprimand.

C.

Requirements Applicable to Exchange Operations

Under the FIEA, financial instruments exchanges are required to include detailed

provisions within their rules relating to: TPs; kind and period of market transactions of

derivatives; starting, ending and suspending market transactions of derivatives; methods of

conclusion of a contract for market transactions of derivatives; method of transfer and other

settlement for market transactions of derivatives; and other matters necessary for market

transaction of derivatives

d

provisions within their rules relating to: TPs; kind and period of market transactions of

derivatives; starting, ending and suspending market transactions of derivatives; methods of

conclusion of a contract for market transactions of derivatives; method of transfer and other

settlement for market transactions of derivatives; and other matters necessary for market

transaction of derivatives. A financial instruments exchange must also demonstrate that it has

sufficient resources to properly manage its operations.

70 Financial instruments exchanges can delegate their self-regulatory functions to either a self-regulatory

corporation, which is a separate entity specialized for self-regulatory operations and for which the FSA’s approval is

necessary, or to an independent self-regulatory committee within the same organization.

Paul M. Architzel, Esq.

Page 29

Additionally, financial instruments exchanges must require that TPs conform to the FIEA

and all related laws, regulations and government orders. Specifically, financial instruments

exchanges must be operated to achieve the fair and orderly sale and purchase of market

transactions of derivatives, as well as to conduct market surveillance and to contribute to the

protection of investors. OSE provides that TPs must ensure fair pricing and orderly transition

from trading of derivatives to the settlement thereof on the OSE markets, and use their best

efforts to preserve and improve the function of the OSE as a financial instruments exchange.

D.

Requirements Applicable to Customer Protection

OSE has promulgated rules detailing the requirements of brokerage agreements

tors. OSE provides that TPs must ensure fair pricing and orderly transition

from trading of derivatives to the settlement thereof on the OSE markets, and use their best

efforts to preserve and improve the function of the OSE as a financial instruments exchange.

D.

Requirements Applicable to Customer Protection

OSE has promulgated rules detailing the requirements of brokerage agreements. The

OSE’s Brokerage Agreement Standards include conditions for acceptance of orders, methods of

settlement, customers’ clearing margin requirements, confirmations and various other matters

with which customers and TPs must comply.71 In addition, OSE requires that TPs establish

systems which prevent the acceptance and entry of erroneous customer orders. OSE also

requires that TPs establish transaction management systems to prevent unfair trading practices in

accordance with OSE stipulations. OSE prohibits the abuse of customers’ orders, including the

practice of trading ahead of customer orders by TPs.72 When the OSE department which

supervises TPs conducts an inspection, the staff checks the existence and adequacy of the TP’s

internal control system designed to prevent such abuses and to determine whether such abuses

have occurred.73

E.

Regulatory Regime Applicable to Clearing and Settlement Functions.

OSE is a “financial instruments clearing organization” that conducts financial instruments

obligation assumption services as a business incidental to the establishment of a financial

instruments exchange market. A “financial instruments clearing organization” is defined by the

FIEA as a person who has been granted a license or approval to operate as such from the Prime

Minister of Japan. 74 You have represented that, as a financial instruments clearing organization,

OSE is subject to certain provisions of the FIEA and to oversight by the FSA.

71 As previously discussed with respect to clearing and clearing margin requirements, customer margin funds must

be held in segregation

on who has been granted a license or approval to operate as such from the Prime

Minister of Japan. 74 You have represented that, as a financial instruments clearing organization,

OSE is subject to certain provisions of the FIEA and to oversight by the FSA.

71 As previously discussed with respect to clearing and clearing margin requirements, customer margin funds must

be held in segregation.

72 See, Regulations Regarding Fair and Equitable Principles of Trade, Rule 4, Paragraph 1, Item 7 and Rule 3,

Item 5 (violation of the fair and equitable principles of transactions). The abuse of customer orders is also

prohibited under Article 117 (1) (x), (xi), (xii) and (xxiv) of the Cabinet Office Ordinance regarding the Financial

Instruments Business.

73

A TP that is a Type-I Financial Instruments Business Operator is also required to be a member of the Japan

Securities Dealers Association (JSDA), an Authorized Financial Instruments Firms Association. The JSDA is a self-

regulatory organization which has the authority to promote fair practices and prescribe rules to eliminate unfair

trading. The rules and the guidelines prescribed by JSDA require a Type-I Financial Instruments Business Operator

to establish an internal control system for preventing the actions prohibited under the FIEA.

74 The authority of the Prime Minister to grant a license to operate as a financial instruments clearing organization

has been delegated to the Commissioner of the FSA.

eliminate unfair

trading. The rules and the guidelines prescribed by JSDA require a Type-I Financial Instruments Business Operator

to establish an internal control system for preventing the actions prohibited under the FIEA.

74 The authority of the Prime Minister to grant a license to operate as a financial instruments clearing organization

has been delegated to the Commissioner of the FSA.

Paul M. Architzel, Esq.

Page 30

You have represented that OSE conducts financial instruments obligation assumption

services as a business incidental to the establishment of a financial instruments exchange market

by a financial instruments exchange with the approval from the Prime Minister (delegated to the

Commissioner of the FSA) pursuant to Article 156-19 of the FIEA. The requirements relating to

operation of a financial instruments clearing organization by OSE are continuing in nature and

include, among others, the requirements that OSE is not subject to any fines for violating FIEA;

that OSE has not had its license rescinded; that none of its directors, officers, accounting

advisors, or auditors have been disqualified; that OSE’s Articles of Incorporation and rules

conform to relevant laws and regulations and are sufficient to conduct its obligation assumption

business appropriately and with certainty; that OSE has sufficient financial resources for soundly

conducting its clearing business; that the expected income and expenditure pertaining to OSE’s

financial instruments obligation assumption service is favorable; and that OSE’s personnel have

the knowledge and expertise to conduct its clearing business.

You further represent that the FIEA mandates that clearing organizations conduct their

business pursuant to and enforce their respective rules. Clearing organizations also must submit

to the Commissioner of the FSA and receive approval for all rule amendments or changes to their

Articles of Incorporation

hat OSE’s personnel have

the knowledge and expertise to conduct its clearing business.

You further represent that the FIEA mandates that clearing organizations conduct their

business pursuant to and enforce their respective rules. Clearing organizations also must submit

to the Commissioner of the FSA and receive approval for all rule amendments or changes to their

Articles of Incorporation. In addition, clearing organizations are required to notify the

Commissioner of the FSA of any change in the clearing organization’s stated capital.

You represent that the FIEA requires that the rules of a clearing organization, among

other things, set forth the type of transactions that are clearable by the clearing organization, the

qualifications of the clearing organization’s CPs and other matters related to CPs, matters

relating to the novation of transactions and other aspects of the assumption by the clearing

organization of the financial obligations of CPs, and matters concerning securing the

performance of transactions (e.g., rules related to collateral and the deposit and management of

clearing margin). The FIEA also requires that clearing organizations take appropriate measures

for securing the clearing of transactions in the event of a CP’s default and to stipulate in their

rules that, in the first instance, the CP bears all of the loss arising from the assumption service.

The FIEA further provides that, if a clearing organization’s rules stipulate provisions on the

clearing deposit, the clearing organization has the right to receive payment from the clearing

deposit in preference over other creditors against a loss caused by the CP’s default. If the

clearing organization provides for methods of settlements in its rules, such methods continue in

effect under the Bankruptcy Act in the event of a default or insolvency of the CP.

In addition, you represent that the FIEA requires that a clearing organization may not

unjustly discriminate against any CP

it in preference over other creditors against a loss caused by the CP’s default. If the

clearing organization provides for methods of settlements in its rules, such methods continue in

effect under the Bankruptcy Act in the event of a default or insolvency of the CP.

In addition, you represent that the FIEA requires that a clearing organization may not

unjustly discriminate against any CP. A clearing organization also is required to be a stock

company and, therefore, must comply with certain governance requirements applicable to public

companies.

You represent that the FIEA authorizes the Commissioner of the FSA to order a clearing

organization to submit any reports or materials concerning its property or business to the FSA, to

inspect a clearing organization’s books and records, and to conduct an on-site inspection of the

clearing organization. You further represent that, upon a finding that a provision of the FIEA has

Paul M. Architzel, Esq.

Page 31

been violated, the Commissioner of the FSA is authorized to rescind a clearing organization’s

license, suspend the clearing organization from all or part of its business for a period of up to six

months, or dismiss any of the clearing organization’s officers. The Commissioner of the FSA

also has the power to order a clearing organization to take necessary measures for improving its

business operations.

Finally, you represent that the FSA participates with other regulators in determining

future best practices for clearing houses. For example, the FSA is an active participant in

IOSCO. The FSA’s Vice Commissioner for International Affairs is currently the Vice-Chairman

of the IOSCO Technical Committee.

VI

ng organization to take necessary measures for improving its

business operations.

Finally, you represent that the FSA participates with other regulators in determining

future best practices for clearing houses. For example, the FSA is an active participant in

IOSCO. The FSA’s Vice Commissioner for International Affairs is currently the Vice-Chairman

of the IOSCO Technical Committee.

VI.

OSE’S STATUS AS A SELF-REGULATORY ORGANIZATION (SRO)

Under the OSE’s Articles of Incorporation, TPs must abide by the FIEA and its related

laws and regulations, dispositions given by government agencies based thereon, the OSE’s own

Articles of Incorporation, Business Regulations, Brokerage Agreement Standards and other

rules, and fair and equitable principles of transactions. OSE operates self-regulatory programs

and represents that it has a comprehensive rule book requiring that TPs remain in compliance

with these requirements and that they, among other things: have adequate capital, employ sound

internal management and risk controls, establish transaction management systems, prevent unfair

trading, ensure fair pricing, investigate customer qualification, provide OSE with requested

information, submit to inspection by OSE staff and register representatives with OSE. In order

to carry out these functions, OSE has a staff of over 300 people and various self-regulatory

divisions.75

OSE rules prohibit TPs from acting “contrary to the fair and equitable principles of

transactions.” Such actions are defined in the rule as actions that “damage the credibility of OSE

or TPs of OSE, or are contrary to good faith in respect to OSE or TPs of the OSE” and include,

among others, interfering in or obstructing the business of OSE or its TPs or fraudulent,

dishonest or improper activities or gross negligence in administering transaction business.

Additionally, OSE has a general requirement that TPs make “best efforts” to preserve and

improve the function of the OSE markets

OSE, or are contrary to good faith in respect to OSE or TPs of the OSE” and include,

among others, interfering in or obstructing the business of OSE or its TPs or fraudulent,

dishonest or improper activities or gross negligence in administering transaction business.

Additionally, OSE has a general requirement that TPs make “best efforts” to preserve and

improve the function of the OSE markets. In addition to the rules and regulations already in

place, OSE may prescribe additional regulations in relation to the efficient operation of OSE

markets. In fulfilling its self-regulatory obligations, OSE conducts real-time and post-trading

surveillance and, as discussed below, has the authority to impose sanctions and discipline TPs for

violations.

OSE requires its TPs to report to the Exchange in a number of instances. These include

activities relating to the authorization or registration to conduct business; issues relating to its

process for managing risks of loss; matters relating to suspensions or resumption of business;

75 In addition to the Self-Regulation Committee, OSE has a Disciplinary Committee and a Listing Committee as

advisory committees to the Self-Regulation Committee, and a number of self-regulatory divisions such as the Self-

Regulation Administration Division, the Participant Affairs Division, the Market Surveillance Division and the

Listing Administration Division.

75 In addition to the Self-Regulation Committee, OSE has a Disciplinary Committee and a Listing Committee as

advisory committees to the Self-Regulation Committee, and a number of self-regulatory divisions such as the Self-

Regulation Administration Division, the Participant Affairs Division, the Market Surveillance Division and the

Listing Administration Division.

Paul M. Architzel, Esq.

Page 32

issues relating to bankruptcy or insolvency, or the decline of the capital ratio below 140%; when

it takes various corporate actions, such as actions affecting voting rights or a change in

ownership; when it is subject to questioning, inspection, visit or disciplinary action pursuant to

laws or regulations and when it learns that an act in violation of law and regulations or of the

Exchange’s rules has occurred.

In addition to its authority to discipline TPs for violative conduct, OSE has the authority

to address market irregularities. OSE may control trading, for example, by temporarily changing

the trading hours prescribed, suspending trading totally or partially, holding a trading session, or

cancelling or suspending transactions. OSE also has the authority to take emergency actions,

under which, if it considers there is an urgent need, it may impose necessary and appropriate

regulations relating to the business of TPs. Additionally, OSE may stipulate new conditions for

the settlement of contracts if it determines that the settlement of such contracts has become

impossible or extremely difficult due to a natural disaster, extreme change in the economic

situation, supply shortage, or any other event beyond the control of OSE.

A.

Market and Trade Surveillance

OSE carries out its self-regulatory obligations, in part, through the conduct of real-time

and post-trading surveillance

ts if it determines that the settlement of such contracts has become

impossible or extremely difficult due to a natural disaster, extreme change in the economic

situation, supply shortage, or any other event beyond the control of OSE.

A.

Market and Trade Surveillance

OSE carries out its self-regulatory obligations, in part, through the conduct of real-time

and post-trading surveillance. OSE has full-time staff members engaged in the real-time

surveillance of futures and options trading on the OSE and additional full-time staff members

responsible to carry out post-trade surveillance of futures and options trading. In both real-time

and post-trading surveillance, the criteria that result in opening a staff inquiry are formally

established in staff guidelines.

In conducting its surveillance of the market, staff makes use of electronic data analysis

systems to examine market movements associated with particular trades or to uncover suspicious

trading patterns. The activities to be investigated include suspected insider trading, market

manipulation and other conduct that appears to violate the laws and regulations thereunder. With

respect to possible market manipulation, an investigation may be opened when there appear to be

any unusual movements in price and/or trading volume or when there appears to be unusual

trading activity apparently relating to a published report or public information or based upon

information provided by the public. For insider trading, an investigation may be opened when

there appears to be unusual trading activity apparently relating to an entity’s publication of

material facts, which are required to be published under the FIEA.

In the course of the investigation, staff, among other things, analyzes the movement of

the price and trading volume, investigates whether the trading activities are concentrated on a

specific TP, and determines whether the case is serious enough to open a more detailed

investigation, referred to as an examination

ation of

material facts, which are required to be published under the FIEA.

In the course of the investigation, staff, among other things, analyzes the movement of

the price and trading volume, investigates whether the trading activities are concentrated on a

specific TP, and determines whether the case is serious enough to open a more detailed

investigation, referred to as an examination. If an examination is opened, staff will, among other

things, inquire about and analyze the process of acceptance and execution of orders and the

details of the customer and investigate whether corporate insiders have made trades. Ultimately,

staff determines whether unfair or inadequate conduct has taken place and decides whether to

recommend disciplinary action. If OSE finds the conduct being examined to be contrary to laws,

regulations or Exchange rules, OSE takes disciplinary actions, after a hearing, by resolution of

Paul M. Architzel, Esq.

Page 33

the Self-Regulation Committee.76 OSE reports conduct considered to be unfair, inappropriate or

inadequate to the Securities and Exchange Surveillance Commission (SESC).77

B.

Exchange Authority to Address Violative Conduct

OSE, in order to fulfill its self-regulatory functions, has the authority to take disciplinary

actions over TPs. OSE may impose fines, order suspensions from or limitations to trading,

revoke a party’s trading qualification, or issue a formal reprimand. OSE may also issue

warnings against actions that are contrary to the laws and regulations. When OSE finds that a

TP’s internal control system is deficient, it may issue a warning requesting that the TP take

corrective action or, as a disciplinary action, it may require the TP to do so. If OSE deems it

necessary, it may require the TP to submit periodic improvement reports with respect to the

measures taken

ue

warnings against actions that are contrary to the laws and regulations. When OSE finds that a

TP’s internal control system is deficient, it may issue a warning requesting that the TP take

corrective action or, as a disciplinary action, it may require the TP to do so. If OSE deems it

necessary, it may require the TP to submit periodic improvement reports with respect to the

measures taken.

OSE may also take action in the event that, based on the business or financial status of a

TP, OSE considers that there is a danger that a violation of the laws and regulations will arise.

OSE has the authority to conduct an inspection of the TP and, if the findings of the inspection

warrant, issue warnings or take disciplinary action. In addition, if it considers that the business

or financial condition of a TP is inappropriate in light of the objectives of OSE or the operation

of the OSE markets, OSE may recommend that the TP take specified corrective measures.

C.

Regulatory Supervision and Oversight

The Prime Minister has supervisory authority over all financial instruments exchanges in

Japan and is authorized to grant licenses to such exchanges and to approve changes in their

Articles of Incorporation, Business Regulations, or Brokerage Agreement Standards and the

listing of securities issued by financial instruments exchanges or derivatives contracts on such

securities. The Prime Minister has delegated these powers, other than the authority to grant

licenses to financial instruments exchanges, to the Commissioner of the FSA.

The FSA is responsible for ensuring the stability of Japan’s financial system and for

protecting investors by, among other things, establishing rules for trading in financial

instruments markets, inspecting and supervising market participants and related parties, such as

financial instruments exchanges, and surveying compliance of rules in financial instruments

markets and for facilitating financial services

onsible for ensuring the stability of Japan’s financial system and for

protecting investors by, among other things, establishing rules for trading in financial

instruments markets, inspecting and supervising market participants and related parties, such as

financial instruments exchanges, and surveying compliance of rules in financial instruments

markets and for facilitating financial services. The FSA has an authorized staff of up to 150878

and is organized into six major components: the Administrative Law Judge, the Planning and

Coordination Bureau, the Inspection Bureau, the Supervisory Bureau, the SESC and the Certified

Public Accountants and Auditing Oversight Board.

76 The Self-Regulation Committee has been delegated authority by the Board to make decisions on matters

relating to the self-regulatory operations of OSE pursuant to the Articles of Incorporation of OSE, and in accordance

with the FIEA.

77 The SESC, as discussed below, is the component of the FSA which oversees the financial instruments markets.

78 The staff number represents the 2010 fiscal year.

Paul M. Architzel, Esq.

Page 34

The SESC, its authority expanded by implementation of the FIEA, oversees the financial

instruments markets. The SESC has a staff of 697 (384 in the main SESC office and 313 in local

offices) and is directed by a Chairman and two Commissioners appointed by the Prime Minister

with the consent of both houses of the National Diet of Japan.79 To encourage their

independence when exercising their authority, these officials cannot be dismissed against their

will during their three year terms

nts markets. The SESC has a staff of 697 (384 in the main SESC office and 313 in local

offices) and is directed by a Chairman and two Commissioners appointed by the Prime Minister

with the consent of both houses of the National Diet of Japan.79 To encourage their

independence when exercising their authority, these officials cannot be dismissed against their

will during their three year terms. The SESC’s Executive Bureau is composed of five

independent divisions: the Coordination Division, the Market Surveillance Division, the

Inspection Division, the Civil Penalties Investigation and Disclosure Documents Inspection

Division and the Investigation Division.80

The SESC conducts the following: daily market surveillance; inspections of market

participants and related parties; investigations into criminal cases and accusation thereof;

compliance reviews of market intermediaries; examinations of disclosure documents; and

investigations into acts suspected to have compromised the fairness of financial instruments

trading. The SESC monitors financial instruments markets every day and may require financial

instruments business operators to submit detailed reports or materials related to any specific

transactions. Where it is convinced after an investigation that further action is appropriate, the

SESC may recommend administrative disciplinary actions or file formal complaints with the

public prosecutors. Additionally, the SESC is empowered to file motions with the court for

prohibition or suspension of acts violating the FIEA.

D.

Prohibition of Abusive Market Activities

The FIEA prohibits trading activities that harm market fairness. These include, among

others, spreading false rumors, engaging in insider trading, engaging in market manipulation, and

engaging in misleading or false transactions

ly, the SESC is empowered to file motions with the court for

prohibition or suspension of acts violating the FIEA.

D.

Prohibition of Abusive Market Activities

The FIEA prohibits trading activities that harm market fairness. These include, among

others, spreading false rumors, engaging in insider trading, engaging in market manipulation, and

engaging in misleading or false transactions. If the FIEA’s provisions on unfair trading activities

are considered to be violated, the SESC may recommend to the Prime Minister and the

Commissioner of the FSA that an order to pay administrative penalties be issued. In addition,

the SESC works closely with SROs, particularly self-regulatory departments at financial

instruments exchanges. The SESC and SROs share information regarding market oversight and

surveillance on issues such as insider trading and transaction management. Additionally, the

SESC is authorized to conduct inspections of the SROs to determine if they are carrying out their

self-regulatory duties and properly sanctioning their TPs for violations of their rules.

The SESC may submit to the Prime Minister, the Commissioner of the FSA or the

Minister of Finance policy proposals, based on the results of SESC market surveillance,

inspections or investigations that are considered necessary to ensure fairness in financial

instruments transactions or investor protection. For example, if current laws and regulations

were found to be insufficient, the SESC would propose reviewing those laws and regulations by

presenting specific facts and problems with such laws and regulations.

79 The staff number represents the 2010 fiscal year, which is from April 1 to the following March 31.

80 The English language web site of the SESC is located at: http://www.fsa.go.jp/sesc/english/index.htm.

and regulations

were found to be insufficient, the SESC would propose reviewing those laws and regulations by

presenting specific facts and problems with such laws and regulations.

79 The staff number represents the 2010 fiscal year, which is from April 1 to the following March 31.

80 The English language web site of the SESC is located at: http://www.fsa.go.jp/sesc/english/index.htm.

Paul M. Architzel, Esq.

Page 35

One of the strongest tools for supervisory enforcement is the Prime Minister’s ability to

order the financial instruments exchange to dismiss any officer of such an exchange that has

violated laws and regulations, the exchange’s Articles of Incorporation, or the disposition of any

government agency. This also applies to officers of SROs and to members of self-regulatory

committees. In addition, the Prime Minister may order a financial instruments exchange, its

subsidiary company, or a party that received entrustment of business from the exchange, to

produce any information or materials that will be helpful in understanding the operation of its

business or its property. This includes inspection authority with respect to operation of the

exchange or intermediation business.

Finally, the Prime Minister may order financial instruments exchange to make specific

improvements in its operations, rescind its license, or take other disciplinary action. For

example, under the FIEA, the Prime Minister may suspend a financial instruments exchange’s

license for failing to exercise its powers or taking any other necessary measures for enforcing the

obligations of its TPs that are in violation of any law or regulation, or for committing an act

contrary to the fair and equitable principles of transactions

icense, or take other disciplinary action. For

example, under the FIEA, the Prime Minister may suspend a financial instruments exchange’s

license for failing to exercise its powers or taking any other necessary measures for enforcing the

obligations of its TPs that are in violation of any law or regulation, or for committing an act

contrary to the fair and equitable principles of transactions. In addition, if it is found to be

necessary and appropriate for the public interest or protection of investors, the Prime Minister

may require a financial instruments exchange to undertake certain supervisory measures with

regard to compliance with applicable law and regulations.

VII.

INFORMATION-SHARING

As described more fully below, the Commission and its staff will be entitled to receive

sufficient information regarding OSE, the J-GATE and OSE’s market participants directly from

OSE pursuant to the terms and conditions of the direct access no-action relief granted herein and

existing information-sharing agreements. OSE is a signatory to the Exchange International

Information Sharing Memorandum of Understanding and Agreement dated March 15, 1996, a

framework for over 60 futures exchanges and clearing organizations worldwide to share

information relevant to managing global market emergencies.

With respect to government to government information sharing, you represent that the

Japanese regulatory authorities have recognized the need for securities regulators to share

information on cross-border securities activities, and Japan values international information

sharing agreements. In 2002, the FSA, the U.S. Securities and Exchange Commission (SEC) and

the CFTC signed a Statement of Intent (SOI) Concerning Cooperation, Consultation and the

Exchange of Information, which established a framework for information sharing and facilitated

cooperation in investigations of potential unfair cross-border securities activities

n values international information

sharing agreements. In 2002, the FSA, the U.S. Securities and Exchange Commission (SEC) and

the CFTC signed a Statement of Intent (SOI) Concerning Cooperation, Consultation and the

Exchange of Information, which established a framework for information sharing and facilitated

cooperation in investigations of potential unfair cross-border securities activities. The SOI was

supported by Notes Verbale, which stated the views the governments share concerning sharing

information. In 2006, the FSA and the CFTC signed a document amending the SOI to cover

financial derivatives transactions. The SOI now covers both securities derivatives and financial

derivatives. Under the new framework, the FSA, SEC and CFTC will, upon request, exchange

information regarding financial derivatives markets, including information on financial futures.

In addition, in February 2008, the FSA signed the IOSCO Multilateral Memorandum of

Understanding concerning Consultation and Cooperation and the Exchange of Information

Paul M. Architzel, Esq.

Page 36

(MMOU), a multilateral framework which facilitates information exchanges among securities

regulators around the world. Japan underwent a thorough screening process by IOSCO with

regard to its legislation concerning information exchange, and IOSCO determined that Japan has

the legal ability to undertake the information exchange requirements. By letter dated February

17, 2011, the FSA confirmed that the MMOU and SOI would extend to information requested by

the Commission or any Division thereof in connection with trades and activities by TPs of OSE

under any direct access no-action relief granted by the CFTC, or any division thereof, with

regard to the placement or approval in the U.S. of electronic facilities providing access to OSE.81

VIII

ed February

17, 2011, the FSA confirmed that the MMOU and SOI would extend to information requested by

the Commission or any Division thereof in connection with trades and activities by TPs of OSE

under any direct access no-action relief granted by the CFTC, or any division thereof, with

regard to the placement or approval in the U.S. of electronic facilities providing access to OSE.81

VIII. CONCLUSION

Consistent with the Commission's Policy Statement and the June 2 Order, the Division

has reviewed and considered OSE's no-action request and the information and documentation

forwarded to the Division in support thereof. Among other things, the materials furnished by

OSE indicate that OSE and its TPs are subject to oversight in Japan by a regulatory regime that is

based upon regulatory objectives that generally are comparable to those in the U.S.; that the

regulatory regime provides basic protections for customers trading on OSE’s market and for the

integrity of the market itself; that OSE and its regulatory authority employ surveillance,

compliance and enforcement mechanisms designed to ensure compliance with statutes and

OSE’s and the regulatory authority’s rules and regulations; that OSE adheres to the IOSCO

Principles; and that adequate information-sharing arrangements applicable to the activities of

OSE are in place.82

Based specifically upon these and other representations made by OSE in support of its

no-action request, the Division has determined that granting no-action relief to OSE and its TPs

would not be contrary to the public interest. Accordingly, subject to compliance with the terms

and conditions stated herein, the Division will not recommend that the Commission institute

enforcement action against OSE or its TPs located in the U.S. that have been authorized to

directly access the J-GATE solely based upon OSE’s failure to obtain contract market

designation or DTEF registration pursuant to Sections 5 or 5a, respectively, of the CEA if:

1

t to compliance with the terms

and conditions stated herein, the Division will not recommend that the Commission institute

enforcement action against OSE or its TPs located in the U.S. that have been authorized to

directly access the J-GATE solely based upon OSE’s failure to obtain contract market

designation or DTEF registration pursuant to Sections 5 or 5a, respectively, of the CEA if:

1.

OSE TPs trade for their own accounts through the J-GATE (which includes for purposes

of this and all subsequent paragraphs, J-NET market transactions which are effectuated through

J-GATE) in the U.S.;

2.

OSE TPs who are registered with the CFTC as FCMs or who are Rule 30.10 Firms

submit orders from or on behalf of U.S. customers to the J-GATE for execution;

81 Letter from Takashi Nagaoka, Director for International Financial Markets, FSA, to Richard Shilts, Director,

Division of Market Oversight, Commo

This text is long and has been trimmed here. Open the source document for the complete record.