[Federal Register Volume 60, Number 229 (Wednesday, November 29, 1995)]
[Notices]
[Pages 61277-61280]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 95-29152]
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SECURITIES AND EXCHANGE COMMISSION
[Release No. 34-36505; International Series Release No. 889; File No.
SR-Phlx-95-42]
Self-Regulatory Organizations; Order Approving a Proposed Rule
Change and Notice of Filing and Order Granting Accelerated Approval of
Amendment No. 2 to the Proposed Rule Change by the Philadelphia Stock
Exchange, Inc., to List and Trade 3D Foreign Currency Options on the
Japanese Yen
November 22, 1995.
I. Introduction
On June 14, 1995, the Philadelphia Stock Exchange, Inc. (``Phlx''
or ``Exchange'') filed a proposed rule change with the Securities and
Exchange Commission (``SEC'' or ``Commission''), pursuant to Section
19(b)(1) of the Securities Exchange Act of 1934 (``Act'')\1\ and Rule
19b-4 thereunder,\2\ to list and trade Dollar Denominated Delivery
(``3D'') foreign currency options (``FCOs'') on the Japanese yen. The
Exchange filed Amendment No. 1 to the proposal on July 7, 1995.\3\ The
Exchange filed Amendment No. 2 on November 8, 1995.\4\
\1\15 U.S.C. 78s(b)(1).
\2\17 CFR 240.19b-4.
\3\The Phlx submitted Amendment No. 1 to the Commission to make
certain technical corrections to the proposal. See Letter from
Michele Wiesbaum, Associate General Counsel, Phlx. to John Ayanian,
Attorney, Office of Market Supervision (``OMS''), Division of Market
Regulation (``Market Regulation''), Commission, dated July 7, 1995.
\4\The Phlx submitted Amendment No. 2 to the Commission to
explain its proposed provisions for calculating and disseminating
the settlement value for the 3D Japanese yen options. See Letter
from Michele Weisbaum, Associate General Counsel, Phlx, to John
Ayanian, Attorney, OMS, Market Regulation, Commission, dated
November 8, 1995 (``Amendment No. 2'').
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Notice of the proposal, and Amendment No. 1, was published for
comment and appeared in the Federal Register on August 11, 1995.\5\ No
comment letters were received on the proposed rule change. This order
approves the Exchange's proposal, as amended.
\5\See Securities Exchange Act Release No. 36062 (August 4,
1995), 60 FR 41140.
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II. Background
In March 1994, the Commission approved the listing and trading of
3D FCOs on the German mark.\6\ 3D FCOs are cash-settled, European-style
options issued by The Options Clearing Corporation (``OCC'') that allow
holders to receive U.S. dollars representing the difference between the
current foreign exchange spot price\7\ and the exercise price of the
option. Specifically, upon exercise of an in-the-money 3D FCO
structured as a call, the holder will receive, from OCC, U.S. dollars
representing the difference between the exercise strike price and the
closing settlement value of the 3D FCO contract multiplied by the
number of units of currency covered by the contract. For a 3D FCO
structured as a put, the holder will receive U.S. dollars representing
the excess of the exercise price over the closing settlement value of
the 3D FCO contract multiplied by the number of units of foreign
currency covered by the contract.
\6\See Securities Exchange Act Release No. 33732 (March 8,
1995), 59 FR 12023 (March 15, 1994).
\7\The ``spot price'' with respect to an option contract on a
foreign currency option contract means the price for the sale of one
foreign currency for another, quoted by various commercial banks in
the interbank foreign exchange market for the sale of a single unit
of such foreign currency for immediate delivery (which generally
means delivery within two business days following the date on which
the terms of such sale are agreed upon). See Phlx Rule 1000(b)(16).
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Unlike other Phlx-traded FCOs, 3D FCOs which are in-the-money by
any amount on the expiration date will be exercised automatically by
OCC. 3D FCOs which are out-of-the-money at expiration will expire
worthless.
German 3D FCOs were originally listed with one-week and two-week
expirations to provide a hedging vehicle to sophisticated retail
customers, portfolio managers and multi-national corporations which
needed to hedge their short term foreign currency exposure and also to
banks which needed to hedge the risks associated with trading in the
forward and cash markets. The Commission recently approved the Phlx's
proposal to list German 3D FCO contracts with longer term expirations
up to twelve months.\8\
\8\See Securities Exchange Act Release No. 35756 (May 24, 1995),
60 FR 28638 (June 1, 1995).
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III. Description of the Proposal
The Exchange is now proposing to list and trade 3D FCOs on the
Japanese yen (U.S. dollar/Japanese yen) (``3D JY Options''). The
contract size will be 6,250,000 yen, the same as physically settled
Japanese yen contract. Pursuant to Phlx Rule 1012(a)(ii), the contracts
will be listed with expirations at one week and two weeks and one, two,
three, six and nine months (twelve month options will not be listed at
this time but will be permitted under Phlx rules). The options will be
on the March, June, September, December cycle and no month end or long
term expirations will be listed. The expiration date for the
consecutive and cycle month options will be the Monday preceding the
third Wednesday of each month. The Exchange expects that the symbols
for these options will be as follows:
XJA first Monday of month expiration
XJB second Monday of month expiration
XJC third Monday of month expiration
XJD fourth Monday of month expiration
XJE fifth Monday of month expiration
XJS settlement symbol
The 1, 2, 3, 6 and 9 month options will be listed with the symbol
XJB or XJC depending on whether expiration will be the second or third
Monday of that month and will carry that symbol to expiration. For
example, a ``Sept 1995'' option which would expire on Monday September
18, would be listed as an XJC Sept 95 call whereas the ``Nov 1995''
option which would expire on Monday, November 13, would be listed as an
XJB Nov 95 call.
Similar to the 3D German mark contracts, the Exchange proposes that
a series of 3D JY Options will trade during normal trading hours for
foreign currency options, specifically, 2:30 a.m. to 2:30 p.m. E.T.
Monday through Friday. The expiring FCO contract will cease trading at
10:30 a.m. and expire at 11:59 p.m. on its expiration Monday, unless
such Monday is an Exchange holiday or an Exchange designated bank
holiday, when, under Phlx Rule 1000(b)(21), ``Expiration date,'' as
amended, the 3D FCO will expire at 11:59 p.m. on the preceding business
date (ordinarily a Friday).
Accordingly, on Exchange holidays and Exchange designated bank
holidays, the expiring 3D FCOs will cease trading at 10:30 a.m. on the
preceding business day. In addition, when Monday is an exchange
holiday, new series will be listed on the following Tuesday at 2:30
a.m. E.T. as opposed to the normal Monday morning listing.
The closing settlement value, which will be disseminated through
the Options Price Reporting Authority (``OPRA''), will be determined by
a designated agent(s) of the Exchange under Phlx Rule 1057, ``3D
(Dollar Denomination Delivery) Foreign Currency Option Closing
Settlement
[[Page 61278]]
Value.'' Pursuant to Phlx Rule 1057, at 10:30 a.m. (E.T.), on every
expiration date for 3D FCOs, the market information vendor(s), acting
as the Exchange's designated agent will determine the final settlement
value. The Exchange has retained Reuters to calculate the settlement
value which the Exchange disseminates.\9\
\9\See Amendment No. 2, supra note 4.
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The market information vendor(s) will collect a bid and offer
quotation, from 10 a.m. (E.T.) until 10:30 a.m. (E.T.), for the current
Japanese yen spot price from the quotations submitted by 15 interbank
foreign participants, which the designated agent will select randomly
from a list created by the Phlx of at least 25 active interbank foreign
exchange market participants.\10\ After discarding the five highest
offers and five lowest bids, the designated agent will arithmetically
average the remaining ten bids and ten offers to arrive at a closing
settlement value. This value will be calculated and sent to the Phlx
every 30 seconds until 10:30 a.m. when the designated agent will
determine the final settlement value. At that time, the settlement
value will be automatically entered into the Phlx's systems, and then
the Phlx disseminates it to OPRA and the OCC for entry into the OCC
clearing systems.
\10\The Phlx will select the list of interbank market
participants by evaluating the number of times each contributor
supplies Japanese yen spot quotes to the market information
vendor(s) on Monday mornings between 10 a.m. and 10:30 a.m. The pool
of quote contributors will be reviewed monthly based on these
criteria and substitutions will be made, if necessary. If at any
time an interbank market participant ceases to distribute Japanese
yen spot quotes or is no longer in the business of making Japanese
yen markets, that entity will be replaced. Currently, there are 40
interbank market participants on the list which show bid and offer
quotations. Telephone conversation between Michele Weisbaum,
Associate General Counsel, Phlx, and John Ayanian, Attorney, OMS,
Market Regulation, Commission, on November 15, 1995.
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The Exchange represents that there are two Reuters terminals within
the Exchange Regulatory Services area which calculate the settlement
value and both are connected to a digital feed. If one terminal has a
complication with any 30 second calculation, the other terminal takes
over. If there is a communication problem between Reuters and the
Exchange, the Exchange can telephone Reuter's New York office to have
the value provided verbally, as it is also calculated on a terminal in
New York. In the event of a broad based shut down of Reuters, the
Exchange would directly contact a group of banks and ask for their
current spot quote, and calculate the settlement value using the same
methodology as described above. Additionally, if the Reuters program
does not generate enough quotes during an inactive period, the Exchange
can add quotes from the Reuters international page which shows bank
quotes other than the predetermined set of 40 in the normal
program.\11\
\11\See Amendment No. 2, supra note 4.
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The position limits and exercise limits for the 3D JY Options will
be the same as the position and exercise limit for the physically
settled Japanese yen contracts pursuant to Phlx Rule 1001\12\ and Rule
1002 and positions in the 3D JY Options will be aggregated with
positions in the physically settled Japanese yen contracts. The Phlx
proposes to initially list exercise strike prices for each expiration
around the current spot price and new strikes may be added during the
life of the option in accordance with Phlx Rule 1012 at half-cent
intervals for the one and two weeks and 3 near term months and at one
cent intervals for the six and nine month options.\13\
\12\Position and exercise limits on the Japanese yen are 100,000
contracts on either side of the market, however, the Phlx has
recently proposed to raise this limit to 200,000 contracts. This
proposal is currently under review at the Commission. See Securities
Exchange Act Release No. 35688 (May 8, 1995), 60 FR 26062 (May 16,
1995).
\13\The Phlx represents that it has adequate systems capacity to
process quotations and trades in the proposed 3D JY Options. See
Letter from William H. Morgan, Vice President, Trading Systems,
Phlx, to Michael Walinskas, Branch Chief, OMS, Market Regulation,
Commission, dated November 17, 1995.
The Commission notes that trading of 3D JY Options is contingent
upon the Commission's receipt of the Options Price Reporting
Authority's representation that it has adequate systems capacity to
process quotations and trades in the proposed 3D JY Options.
Telephone Conservation between Michele Weisbaum, Associate General
Counsel, Phlx, and John Ayanian, Attorney, OMS, Market Regulation,
Commission, on November 22, 1995.
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The 3D JY Options will trade in accordance with the rules governing
all Phlx FCOs, including sales practice rules and floor trading rules.
For example, Phlx Rule 1014, ``Obligations and Restrictions Applicable
to Specialists and Registered Options Traders'' provides that bid/ask
differentials for 3D FCOs shall be determined by reference to the
underlying foreign currency. Further, 3D JY Options will not be subject
to customized trading pursuant to Phlx Rule 1069.
The 3D JY Options will have the same customer margin requirements
as are provided for the existing Japanese yen FCOs pursuant to Phlx
Rule 722, ``Margin Accounts.'' Specifically, for any put or call on 3D
options which are issued, guaranteed or carried ``short'' in a
customer's account, the required margin shall be 100% of the options
premium plus 4% of the value of the underlying contract less any out-
of-the-money account, with an adjustment for out-of-the-money options
to be not less than 100% of the options premium plus \3/4\% of the
underlying contract margin within five days following the date on which
a customer enters into a 3D FCO position and within two days if the
option has two weeks or less to expiration.
The Exchange believes that the proposed rule change is consistent
with Section 6 of the Act, in general, and furthers the objectives of
Section 6(b)(5), in particular, in that it is designed to promote just
and equitable principles of trade, prevent fraudulent and manipulative
acts and practices, as well as to protect investors and the public
interest by providing foreign currency option users who do not
necessarily need to exchange currency at settlement with an alternative
cash settled foreign currency option with corresponding expirations.
IV. Commission Finding and Conclusions
The Commission finds that the proposed rule change is consistent
with the requirements of the Act and the rules and regulations
thereunder applicable to a national securities exchange, and, in
particular, the requirements of Section 6(b)(5) of the Act.\14\
Specifically, the Commission believes that the Exchange's proposal is
designed to provide investors with an adequate means to hedge foreign
currency portfolios and cash flows from short-term market risk, thereby
facilitating transactions in FCOs and providing investors with greater
flexibility to tailor foreign currency options positions to satisfy
their investment objectives.\15\
\14\15 U.S.C. 78f(b)(5).
\15\Pursuant to Section 6(b)(5) of the Act the Commission must
predicate approval of exchange trading for new products upon a
finding that the introduction of the product is in the public
interest. Such a finding would be difficult with respect to a
product that served no investment hedging or other economic
function, because any benefits that might be derived by market
participants would likely be outweighed by the potential for
manipulation, diminished public confidence in the integrity of the
markets, and other valid regulatory concerns.
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The Commission believes that the Phlx's proposal will help to
promote the maintenance of a fair and orderly market by extending the
benefits of a listed currency market to an instrument designed to meet
the investment needs of Japanese currency market participants. The
attributes of the Exchange's markets versus the OTC market for short-
term FCOs include, but are not limited to, a regulated market
[[Page 61279]]
center, an auction market, with posted market quotations and
transaction reporting, standardized contract specifications, parameters
and procedures and procedures for clearance and settlement, and the
guarantee of the OCC.
The trading of 3D JY Options, generally, however, raises several
issues, including issues related to pricing and settlement value,
customer protection, surveillance, and market impact. For the reasons
discussed below, the Commission believes that the Phlx has adequately
addressed these issues.
A. Pricing and Settlement Value
The Commission believes that the methodology described above in
Phlx Rule 1057 and Amendment No. 2 for calculating the settlement value
of 3D JY Options is designed to provide an accurate reflection of the
foreign currency spot price. The Commission also believes that the
Phlx's procedures and the competitive nature of the spot market for
foreign currencies should help to ensure that the settlement values for
3D FCO contracts will accurately reflect the spot price for foreign
currencies. Moreover, the Commission believes that the Phlx's
procedures should guard against unreliable or manipulated quotes.
Finally, as noted above, the Phlx has established adequate back-up
mechanisms to ensure the settlement value calculation will be available
on a timely basis.
B. Customer Protection
The Commission believes that a regulatory system designed to
protect public customers must be in place before the trading of
sophisticated financial instruments, such as 3D JY Options, can
commence on a national securities exchange. Under paragraph (b) of Phlx
Rule 1024, members will be prohibited from accepting a customer order
to purchase or write a 3D FCO unless such customer's account has been
specially approved in writing by a designated Foreign Currency Options
principal of the member for transactions in 3D FCOs. Exchange Rule 1026
is designed to ensure that options, including 3D FCOs, will be sold
only to customers capable of evaluating and bearing the risks
associated with trading in the instruments. Finally, under Exchange
Rule 1027, members will be permitted to exercise discretionary power
with respect to trading 3D FCOs in a customer's account only if the
member has received prior written authorization from the customer and
the account has been accepted in writing by a designated Foreign
Currency Options Principal. In addition, under Exchange Rule 1027, the
Foreign Currency Options Principal or a Registered Options Principal
must approve and initial each discretionary 3D FCO on the day the order
is entered.
The Commission notes that the trading of standardized exchange-
traded options occurs in an environment that is designed to ensure,
among other things, that: (1) The special risks of options are
disclosed to public customers; (2) only investors capable of evaluating
and bearing the risks of options trading are engaged in such trading;
and (3) special compliance procedures are applicable to options
accounts. Accordingly, because the 3D JY Options will be subject to the
same regulatory regime as the other 3D FCOs currently traded on the
Phlx, the Commission believes that adequate safeguards are in place to
ensure the protection of investors in 3D JY Options.
C. Surveillance
The Commission notes that the Phlx will integrate 3D JY Options
into existing Phlx market surveillance programs. The Commission
believes that existing FCO surveillance procedures should enable the
Exchange to conduct, deter, as well as detect, trading abuses involving
the 3D JY Options market and the markets for the underlying Japanese
yen. In light of the design of the 3D JY Options contracts and the
developed market for foreign currencies, the Commission believes that
the markets for the 3D JY Options will not be readily susceptible to
manipulation.
D. Position and Exercise Limits and Margin Requirements
As noted above, 3D JY Options will be aggregated with other
existing contracts on the same underlying currency for position and
exercise limit purposes. The Commission believes that aggregation of 3D
FCOs with existing contracts on the same underlying currency for
position and exercise limit purposes will reduce concerns regarding
manipulations or disruptions of the markets for 3D FCOs, other currency
options, and the underlying currencies, while at the same time not
hampering the depth and liquidity of the marekt for 3D FCOs.
The Commission believes the proposed margin levels for 3D FCO
contracts, which are consistent with the margin levels for the Phlx's
other FCOs, will result in adequate coverage of contract obligations
and are designed to preclude the systemic risks arising from
excessively low margin levels. As noted above, the margin requirement
on any put and call 3D FCO issued, guaranteed or carried ``short'' in a
customer's account shall be 100% of the option premium plus 4% of the
value of the underlying contract less any out-of-the money amount, with
an adjustment for out-of-the money options to be not less than 100% of
the option premium plus \3/4\% of the underlying contract value. The
Phlx plans to collect margin within five days following the date on
which a customer enters into a 3D FCO position and within two days if
the option has two weeks or less to expiration. The Phlx has indicated
that the proposed margin would cover the historical volatility over the
preceding three years of the Japanese yen over a five-day period with a
97.50% level of confidence.\16\ Accordingly, the Commission believes
that the Phlx's propsoed margin level will result in adequate coverage
for 3D JY Options. Because the volatility of foreign currencies can
change significantly, the Commission expects the Phlx to monitor the
adequacy of margin levels for 3D JY Options to ensure that the required
margin remains appropriate in view of the volatility of the underlying
instrument.\17\
\16\Telephone conversation between Michele Weisbaum, Associate
General Counsel, Phlx, and John Ayanian, Attorney, OMS, Market
Regulation, Commission, on November 22, 1995.
\17\In this regard, the Commission would view coverage of less
than 97.50% as problematic. If coverage should fall below this
level, the Exchange will immediately notify the Commission's
Division of Market Regulation.
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E. Market Impact
The Commission believes that the listing and trading of 3D JY
Options will not adversely affect the spot or derivative foreign
currenly markets. First, the Commission notes that the interbank
foreign currency spot market is an extremely large, diverse market
comprised of banks and other financial institutions worldwide. That
market is supplemented by equally deep and liquid markets for
standardized options and futures on foreign currencies and options on
those futures. There is also an active OTC market for FCOs.
Further, as noted above, the Phlx applies its existing FCO
surveillance procedures to the 3D FCOs, which should enable the
Exchange to conduct, deter, as well as detect, trading abuses involving
the 3D JY Options market and the markets for the underlying Japanese
yen.
F. Conclusion and Accelerated Approval of Amendment No. 2
Based on the above, the Commission believes that the proposed rule
change is consistent with the requirements of the Act and the rules and
regulations
[[Page 61280]]
thereunder applicable to a national securities exchange, and, in
particular, the requirements of Section 6(b)(5) of the Act.\18\
Additionally, the Commission notes that implementation of this proposed
rule change is contingent upon the Commission's receipt of OPRA's
representation that it has adequate systems capacity to process
quotations and trades in the proposed 3D JY Options.\19\
\18\15 U.S.C. 78f(b)(5).
\19\See supra note 13.
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The Commission finds good cause for approving Amendment No. 2 to
the proposed rule change prior to the thirtieth day after the date of
publication of the notice thereof in the Federal Register. In Amendment
No. 2, the Phlx represented that the provisions for calculating and
disseminating the settlement value for the 3D Japanese yen options will
be exactly the same as used for the 3D German mark options. The
Commission believes that because the provisions for calculating and
disseminating the settlement value for the 3D Japanese yen options will
be exactly the same as used for the 3D German mark options, and contain
adequate back-up procedures in case of system failure or other
problems, no new regulatory issues are raised. Accordingly, the
Commission believes that it is consistent with Sections 6(b)(5) and
19(b)(2) of the Act to approve Amendment No. 2 to the Phlx proposal on
an accelerated basis.
V. Solicitation of Comments
Interested persons are invited to submit written data, views and
arguments concerning Phlx Amendment No. 2. Persons making written
submissions should file six copies thereof with the Secretary,
Securities and Exchange Commission, 450 Fifth Street, NW., Washington,
DC 20549. Copies of the submission, all subsequent amendments, all
written statements with respect to the proposed rule change that are
filed with the Commission, and all written communications relating to
the proposed rule change between the Commission and any person, other
than those that may be withheld from the public in accordance with the
provisions of 5 U.S.C. 552, will be available for inspection and
copying at the Commission's Public Reference Section, 450 Fifth Street,
NW., Washington, DC 20549. Copies of such filing will also be available
for inspection and copying at the principal office of the Phlx. All
submissions should refer to SR-Phlx-95-42 and should be submitted by
December 20, 1995.
It is therefore ordered, pursuant to Section 19(b)(2) of the
Act,\20\ that the proposed rule change (File No. SR-phlx-95-42), as
amended, is approved.
\20\15 U.S.C. 78s(b)(2).
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For the Commission, by the Division of Market Regulation,
pursuant to delegated authority.\21\
\21\17 CFR 200.30-3(a)(12).
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Margaret H. McFarland,
Deputy Secretary.
[FR Doc. 95-29152 Filed 11-28-95; 8:45 am]
BILLING CODE 8010-01-M
