[Federal Register Volume 64, Number 56 (Wednesday, March 24, 1999)]
[Proposed Rules]
[Pages 14159-14178]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 99-6829]
=======================================================================
-----------------------------------------------------------------------
COMMODITY FUTURES TRADING COMMISSION
17 CFR Parts 1 and 30
Access to Automated Boards of Trade
AGENCY: Commodity Futures Trading Commission.
ACTION: Proposed rules.
-----------------------------------------------------------------------
SUMMARY: On July 24, 1998, the Commodity Futures Trading Commission
(``CFTC'' or ``Commission'') published in the Federal Register a
``concept release'' seeking public comment on issues related to
permitting the use in the U.S. of automated trading systems providing
access to electronic boards of trade otherwise primarily operating
outside the U.S. Following its review of the comments received on the
concept release, the Commission has determined to propose new rules
concerning automated access to these boards of trade from within the
U.S. The Commission is proposing herein a new Rule 30.11 that would
establish a procedure for an electronic exchange operating primarily
outside the U.S. to petition the Commission for an order that would
permit use of automated trading systems that provide access to the
board of trade from within the U.S. without requiring the board of
trade to be designated as a U.S. contract market. If appropriate in
light of the information provided in a petition, the Commission would
issue an order under section 4(c) of the Commodity Exchange Act
(``Act'' or ``CEA'') that would allow a member of the petitioner board
of trade or an affiliate thereof to operate automated trading systems
that provide access to the board of trade in the U.S., subject to
specified conditions.
The Commission also is proposing a new Rule 1.71, which would apply
both to domestic and foreign firms. New Rule 1.71 would clarify that
U.S. customers and foreign futures and foreign options customers
wishing to trade on or subject to the rules of the automated trading
system of a U.S. contract market or on or subject to the rules of the
automated trading system of an exchange otherwise operating primarily
outside the U.S. may place orders via automated order routing systems,
provided that such systems meet certain minimum requirements and
provide certain safeguards such as automated checks for customer
trading or position limits and credit limits.
The rules proposed herein are focused on boards of trade with
automated order matching/execution, often referred to as ``electronic
exchanges,'' and do not address the use of order routing systems or
other communication devices that provide access to traditional open
outcry exchanges.
DATES: Comments must be received on or before April 23, 1999.
ADDRESSES: Comments on the proposed rules may be sent to Jean A. Webb,
Secretary of the Commission, Commodity Futures Trading Commission, 1155
21st Street, NW., Washington, DC 20581. In addition, comments may be
sent by facsimile transmission to facsimile number (202) 418-5521 or by
electronic mail to secretary@cftc.gov. Reference should be made to
``Access to Automated Boards of Trade.''
FOR FURTHER INFORMATION CONTACT: David M. Battan, Chief Counsel,
Lawrence B. Patent, Associate Chief Counsel, or Charles T. O'Brien,
Attorney Advisor, Division of Trading and Markets, Commodity Futures
Trading Commission, 1155 21st Street, NW., Washington, DC 20581.
Telephone (202) 418-5450.
SUPPLEMENTARY INFORMATION:
I. Introduction
Significant developments in technology in recent years have made
automated trading methods a significant addition or alternative to
traditional open outcry for trading commodity futures and option
products on or subject to the rules of foreign and domestic boards of
trade. In February 1996, the Commission's Division of Trading and
Markets (``Division'') issued a no-action letter to the Deutsche
Terminborse (``DTB'' or ``Eurex''), \1\ an automated international
futures and option exchange headquartered in Frankfurt, Germany, in
which the Division agreed, subject to certain conditions, not to
recommend enforcement action to the Commission if Eurex placed computer
terminals in the U.S. offices of its members for principal trading \2\
and, where the Eurex member
[[Page 14160]]
is also an FCM registered under the Act,\3\ for trading on behalf of
U.S. customers as well, without Eurex being designated as a U.S.
contract market (``Letter'').\4\ Since the Division's issuance of the
Letter, several other boards of trade that have heretofore operated
outside the U.S. have requested similar relief.
---------------------------------------------------------------------------
\1\ In June 1998, DTB changed its name to Eurex Deutschland
(``Eurex'').
\2\ A ``principal'' trade under Eurex rules is limited to a
trade made by a Eurex member for its own account. Eurex's definition
of ``principal'' is thus narrower than the definition of
``proprietary'' found in Commission Rule 1.3(y). A proprietary trade
under Commission rules includes not only transactions made by
futures commission merchants (``FCMs'') for their own accounts, but
also those made by certain affiliates and insiders of the FCM for
their respective accounts carried by the FCM.
\3\ 7 U.S.C. 1 et seq. (1994).
\4\ See CFTC Interpretative Letter No. 96-28, (1996-1997
Transfer Binder) Comm. Fut. L. Rep. (CCH) para. 26,669 (Feb. 29,
1996). For a thorough discussion of prior Division actions
concerning automated trading system use in the U.S., see the
Commission's concept release, discussed below. 63 FR 39779 (July 24,
1998).
---------------------------------------------------------------------------
In light of these requests, the Commission determined that it is
appropriate to address, through the Commission's rulemaking process,
the subject of the use in the U.S. of automated trading systems that
provide access to boards of trade whose primary operations otherwise
take place outside the U.S. The Commission began this process in July
1998 by publishing in the Federal Register a concept release seeking
public comment on a wide variety of questions concerning the use of
automated trading systems in the U.S. and on a possible regulatory
structure to address these questions. After reviewing the comments
received and engaging in discussions with industry participants, the
Commission has decided to propose rules that incorporate many of the
general principles set forth for comment in the concept release.
However, based upon the comments received and the Commission's further
consideration of the issues, the proposal contains a number of
refinements to the model set forth in the concept release.
The Commission's purpose in issuing these proposed rules is to
create a framework for addressing the regulatory issues that arise from
the increasing globalization of futures exchanges. The procedures set
forth herein are intended to provide an exemption from the contract
market designation requirement for boards of trade that are established
in a foreign country and that have historically operated solely within
that countries other than the U.S., but that as a result of a desire to
take advantage of technological advancements, now wish to make their
products accessible from within the U.S. via trading screens, the
Internet, or other automated trading systems. Boards of trade that are
accessible within the U.S. in this manner are not ``located outside the
U.S.'' for purposes of section 4(a) of the Act and might, accordingly,
be required to be designated as contract markets absent an exemption
under Section 4(c) of the Act.\5\ However, the Commission does not
believe that it would be appropriate to require these exchanges to be
designated as contract markets as long as they would be subject to
generally comparable regulation in their home countries. Exemption from
the contract market designation requirement and other related
requirements under the Act and Commission regulations would avoid
duplicative regulation, would encourage other countries to allow access
to the automated trading systems of U.S. exchanges and would encourage
global competition and open markets in the industry. The Commission
believes that the petition approach set forth below would provide the
Commission with the information necessary to identify those boards of
trade that would be ``located in the U.S.'' by virtue of being
accessible from within the U.S. via automated trading systems, but that
otherwise would continue to be primarily operated outside the U.S. The
Commission would exercise its power under section 4(c) of the Act to
exempt such boards of trade from regulation under the Act if the
requirements described below are satisfied. Further, the process
described herein is flexible enough that, if the locus of the board of
trade's activities is such that it should be subject to all
requirements of the Act and the Commission's regulations, if the board
of trade is not subject to a generally comparable regulatory structure,
or if the board of trade has been established and structured
purposefully to evade U.S. regulation, the Commission can require it to
become a designated contract market.
---------------------------------------------------------------------------
\5\ Section 4(a) of the Act states in relevant part:
* * *[I]t shall be unlawful for any person to offer to enter
into, to enter into, to execute, to confirm the execution of, or to
conduct any office or business anywhere in the U.S., its territories
or possessions, for the purpose of soliciting, or accepting any
order for, or otherwise dealing in, any transaction in, or in
connection with a contract for the purchase or sale of a commodity
for future delivery (other than a contract which is made on or
subject to the rules of a board of trade, exchange, or market
located outside the U.S., its territories or possessions) unless--
(1) such transaction is conducted on or subject to the rules of
a board of trade which has been designated by the Commission as a
``contract market'' for such commodity;
(2) such contract is executed or consummated by or through a
member of such contract market; and
(3) such contract is evidenced by a record in writing * * *.
Section 4(c) of the Act provides the Commission with authority
``by rule, regulation, or order'' to exempt ``any agreement,
contract or transaction'' from the requirements of Section 4(a) of
the act if the Commission determines that the exemption would be
consistent with the public interest, that the contracts would be
entered into solely by appropriate persons and that the exemption
would not have a material adverse effect on the ability of the
Commission or any contract market to discharge its regulatory or
self-regulatory duties under the Act. 7 U.S.C. 6(a) and 6(c) (1994).
---------------------------------------------------------------------------
In determining whether to exercise its section 4(c) exemptive
authority with respect to a particular petitioner, the Commission
believes that it is essential to its customer protection obligations
under the Act to ensure that certain general standards have been met.
Specifically, the Commission intends to ensure that: (1) The petitioner
is an established board of trade that wishes to place within the United
States an automated trading system permitting access to its products
but whose activities are otherwise primarily located in a particular
foreign country that has taken responsibility for regulation of the
petitioner; (2) the petitioner's home country has established a
regulatory scheme that is generally comparable to that in the U.S. and
provides basic protections for customers trading on markets and for the
integrity of the markets themselves; (3) except for certain incidental
contacts with the U.S., the petitioner is present in the U.S. only by
virtue of being accessible from within the U.S. via its automated
trading system; (4) the petitioner is willing to submit itself to the
jurisdiction of the Commission and the U.S. courts in connection with
its activities conducted under an exemptive order; (5) the petitioner's
automated trading system has been approved by the petitioner's home
country regulatory following a review of the system that applied the
standards set forth in the 1990 International Organisation of
Securities Commissions (``IOSCO'') report on screen-based trading
systems (as may be revised and updated from time-to-time) or
substantially similar standards; and (6) satisfactory information
sharing arrangements are in effect between the Commission and the
petitioner and the petitioner's regulatory authority. As discussed
further in the description of the petition procedure below, a
petitioner which satisfies these standards may be issued an order under
section 4(c) of the Act that exempts the petitioner from the contract
market designation requirements of section 4(a) of the Act and related
statutory and regulatory provisions.
II. The Concept Release
The July 1998 concept release raised general questions concerning,
among other things, how to define an
[[Page 14161]]
automated system that would be subject to Commission rules, how to
treat the use of automated order routing systems located in the U.S.
when they are employed to enter orders through a futures commission
merchant (``FCM'') (or through a firm exempt from registration pursuant
to Commission Rule 30.10, also referred to as a ``Rule 30.10 firm'')
\6\ for execution on a board of trade operated primarily outside the
U.S., and how to determine if a board of trade's activities in the U.S.
are such that it should be subject to all of the requirements of the
Act and the Commission's regulations. The concept release also set
forth for comment a possible regulatory approach that was intended to
promote discussion on the appropriate means to resolve these and
related issues.
---------------------------------------------------------------------------
\6\ Commission Rule 30.10 provides for a process whereby any
person affected by any requirement in the Commission's part 30 rules
may petition the Commission for an exemption from such requirement.
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 the U.S. for U.S. persons on non-U.S. boards of
trade without registering under the Act--based upon substituted
compliance with a foreign regulatory structure found comparable to
that administered by the Commission under the Act. In considering a
request from a foreign regulatory or self-regulatory authority for
Rule 30.10 comparability relief, the Commission considers, among
other things: (1) Registration, authorization or other form of
licensing, fitness review, or qualification of persons through whom
customer orders are solicited and accepted; (2) minimum financial
requirements for those persons that accept customer funds; (3)
minimum sales practice standards, including disclosure of risks and
the risk of transactions undertaken outside of the United States;
(4) procedures for auditing compliance with the requirements of the
regulatory program, including recordkeeping and reporting
requirements; (5) protection of customer funds from misapplication;
and (6) the existence of appropriate information-sharing agreements.
The Commission has issued orders to permit certain foreign firms
that have comparability relief under Rule 30.10 to engage in limited
marketing activities of foreign futures and option products from
locations within the United States. See orders of October 28, 1992,
57 FR 49644 (Nov. 3, 1992), and August 4, 1994, 59 FR 42156 (Aug.
17, 1994).
---------------------------------------------------------------------------
The Commission initially provided a 60-day comment period on the
concept release, through September 22, 1998. On September 18, 1998, the
Commission extended the comment period for fifteen days, through
October 7, 1998. The Commission received 31 comments on the release: 19
from futures exchanges, three from FCMs, two from futures trade
associations, two from commodity trading advisors (one of which is also
a registered commodity pool operator), one from a futures self-
regulatory authority, one from an exchange member and three from
foreign securities/futures regulatory authorities. In addition, the
Commission was aided significantly in the development of these proposed
rules by the work of the Commission's Global Markets Advisory Committee
which held two public meetings on these issues, as well as the
Committee's Working Group on Electronic Terminals which prepared a
report for the Commission on these issues. The Commission's Financial
Products Advisory Committee also held a public meeting at which these
issues were discussed.
In general, most commenters supported the Commission's effort to
develop uniform rules concerning the use from within the U.S. of
automated trading systems that provide access to boards of trade
operated primarily outside the U.S. For example, Her Majesty's (``HM'')
Treasury, the regulator that is authorized to grant foreign exchanges
the right to have their automated trading systems placed in the U.K.\7\
indicated in its comment letter that the approach set forth in the
concept release is similar to that applied by HM Treasury when
processing similar requests in the U.K. Other commenters, however, took
issue with various aspects of the possible regulatory approach set
forth in the concept release. Certain specific comments concerning the
approach set forth in the concept release and the issues related
thereto are discussed in the description of the proposed rules which
follows.
---------------------------------------------------------------------------
\7\ Specifically, HM Treasury is authorized to grant a foreign
exchange status as a ``recognized overseas investment exchange''
(``ROIE'') and to monitor ROIEs operating in the U.K. through
automated trading systems placed in the U.K. HM Treasury's
responsibilities with respect to ROIEs are to be transferred to the
Financial Services Authority (``FSA'') with the enactment of the
Financial Services and Markets Bill, which is anticipated to take
place some time toward the end of 1999.
---------------------------------------------------------------------------
The Commission believes that the rules proposed herein will
establish a regulatory approach that addresses the important issues
presented by the use of automated trading systems in the U.S. by boards
of trade otherwise operated primarily outside the U.S. in a manner that
will foster growth of the global marketplace while fulfilling the
Commission's obligations under the Act to protect U.S. customers and to
maintain the integrity and competitiveness of U.S. markets. The
Commission looks forward to the comments on the proposed rules herein
and will consider such comments carefully in adopting any final rules.
III. The Proposed Rules
A. Definitions
Proposed Rules 30.11(a) (1) and (2) distinguish between two major
types of automated trading systems and establish two mutually exclusive
definitions, ``direct execution system'' (``DES'') and ``automated
order routing system'' (``AORS''). As explained more fully below, DES
is a term that encompasses any system that allows entry of orders from
within the U.S. for an automated board of trade, except those systems
that satisfy the definition of AORS. AORSs generally are systems on
which customers or their representatives would submit orders through an
FMC or rule 30.10 firm for automated execution, although the definition
covers every system on which an order is transmitted to another party
and then transmitted to an automated board of trade. It should be noted
that the definitions of DES and AORS, and these rules generally, only
apply in the context of automated or ``electronic'' boards of trade
where orders are matched and executed at the board of trade without
substantial human intervention. Order routing or other devices that are
used to enter or to communicate trades to be executed on traditional
open outcry exchanges are not within the ambit of these rules.\8\ If
one exchange organization operates both an electronic exchange and an
open outcry exchange, the proposed rules would apply to the former but
not to the latter. The Commission wishes to emphasize that the
definitions of DES and AORS are structured so that every device, system
or software upon which orders for products traded on boards of trade
can be entered from within the U.S. for any electronic exchange would
fall into one or the other category.\9\
---------------------------------------------------------------------------
\8\ The definitions of DES and AORS apply to systems that access
boards of trade where trade execution takes place ``without
substantial human intervention.'' See proposed Rules 30.11(a)(1) and
1.3(tt) (emphasis added). The word ``substantial'' is included to
make clear that an automated or electronic exchange cannot evade the
application of these rules by inserting clerical or trivial human
action into the trade matching/execution process. Execution on
traditional open outcry exchanges involves substantial human
intervention and, as noted above, is beyond the scope of these
rules.
\9\ A determination as to whether a system is a DES or an AORS
is not dependent on who designs, maintains or provides the system.
That a particular system implementation uses third-party hardware,
networks or services will not prevent it from being a DES or AORS.
---------------------------------------------------------------------------
It should be noted further that, while those rules provide
standards for exemptive relief to certain boards of trade with respect
to their exchange-traded products, these rules do not sanction the
trading of off-exchange products, nor do they alter, restrict or
[[Page 14162]]
expand the coverage of existing Commission exemptions for particular
classes of products. For example, an illegal off-exchange futures
product that is traded in violation of the Act may not lawfully be
traded via an AORS, even if such AORS satisfies the requirements of the
proposed rules. Likewise, a product that has been exempted from
relevant provisions of the Act need not satisfy the requirements of
these rules unless the Commission rule or order exempting the product
so indicates.\10\
---------------------------------------------------------------------------
\10\ For example, the Commission could decide in the future that
a particular class of products should be exempt from some Commission
regulations, but that, to the extent such class of products will be
traded through automated trading systems, these proposed rules
should apply.
---------------------------------------------------------------------------
Paragraph (a)(1) of proposed Rule 30.11 defines a DES as any system
of computers, software or other devices that allows the entry of orders
for products traded on a board of trade's computer or other automated
device where, without substantial human intervention, trade matching or
execution takes place. One common example of a DES is a board of
trade's proprietary computer terminal (e.g., a dedicated Eurex computer
terminal where members place orders that are then executed in the
exchange's matching system). However, the term DES would also include
any other device that currently is being used or may be used in the
future to provide access to a board of trade's automated matching
engine. Such devices might include, for example, computer software that
facilitates access via a personal computer or other electronic device,
an automated telephonic system that is connected, or can be used to
connect, to the main computer of a board of trade primarily operated
outside the U.S. for order matching and execution, and direct Internet
access to such a board of trade through a personal computer, telephone
or similar device. Thus, for example, if a board of trade that is
otherwise primarily operated outside the U.S. were to provide its
members in the U.S. with personal identification numbers or passwords
that permitted such members to access and to place orders on the board
of trade via an automated telephone system or Internet connection, the
board of trade would be covered by the proposed rules.
Paragraph (a)(2) of proposed Rule 30.11 defines AORS. This term is
defined by reference to a definition that is being proposed herein to
be added as new Rule 1.3(tt).\11\ Proposed rule 1.3(tt) in turn would
define an AORS as any system of computers, software or other devices
that allows entry of orders through another party for transmission to a
board of trade's computer or other automated device where, without
substantial human intervenion, trade matching or execution takes place.
The Commission anticipates that the most common form of an AORS will be
computer software that is provided by an FCM (or Rule 30.10 firm) to
customers, foreign futures and options customers, or their
representatives such as CTAs to enter orders on a board of trade or on
several boards of trade. This rule is intended to cover an AORS used by
any person for trading on a designated contract market's automated
system, whether the person, his or her representative or the AORS is
located in the U.S. or outside of the U.S. The AORS in these
circumstances must provide for trading through an FCM. The rule also is
intended to cover trading by a person located in the U.S. on a board of
trade that otherwise primarily is operated outside the U.S. and that
has received a Commission exemptive order under these rules or whose
products are accessible as part of an automated trading system pursuant
to rules of a designated contract market that have been submitted to
the Commission and are in effect pursuant to section 5a(a)(12)(A) of
the Act and Rule 1.41 (hereinafter referred to as a ``linked
exchange''). The AORS in the latter circumstances must provide for
trading through an FCM or a Rule 30.10 firm.
---------------------------------------------------------------------------
\11\ Since this term and the requirements applicable thereto
would, as recommended by some commenters, apply uniformly and not
only to boards of trade primarily operated outside the U.S., the
Commission is proposing to define AORS in a new paragraph (tt) of
Commission Rule 1.3, which contains the Commission's general
definitions.
---------------------------------------------------------------------------
Rule 30.10 firms may not solicit or accept orders from U.S. persons
for trading on designated contract markets, and these proposed rules
are not intended to affect that prohibition. Under these rules,
however, Rule 30.10 firms would be authorized to solicit or accept
orders from U.S. customers for products traded on automated boards of
trade that obtain a Commission order under these rules or products
traded on linked exchanges. To this end, the Commission is proposing
Rule 30.11(g), which would deem products traded on a board of trade
that received a Commission order or on a linked exchange to be foreign
futures or foreign options, notwithstanding the board of trade's or
linked exchange's presence in the U.S.\12\ Further, these rules would
not expand the boards of trade for which a Rule 30.10 firm may solicit
or accept orders beyond those provided in the relevant Commission order
issued under rule 30.10 and any confirmation thereof for a particular
firm. Thus, if the Commission's order issued under Rule 30.10 permits a
firm to solicit or accept orders for products traded on boards of trade
in its home country and Countries B and C (but not Country D), the
restriction on soliciting or accepting orders for products traded on a
board of trade in Country D would remain in effect even if the Country
D board of trade were to obtain a section 4(c) exemption order in
accordance with Rule 30.11.
---------------------------------------------------------------------------
\12\ Consistent with current regulations regarding linked
exchanges, Rule 30.10 firms could handle U.S. customer orders for
products traded on the linked exchange but not for products traded
on the designated contract market to which that exchange is linked.
---------------------------------------------------------------------------
The proposed rules would not permit customer use of DESs; however,
they would allow customers and their representatives to obtain AORSs
and to enter orders via those AORSs. Under the proposal, a customer
order for a contract traded on or subject to the rules of an exempted
board of trade under proposed Rule 30.11 or a linked exchange that is
made via an AORS would be required to be made through a registered FCM
or through a Rule 30.10 firm.
The Commission requested comment as to whether it should consider
imposing any requirements that would enable it to ensure that board of
trade members who would have DESs are bona fide members (i.e. to ensure
that petitioning boards of trade do not create membership categories
that do not meaningfully differentiate between traditional ``members''
and ``customers'').\13\ In response to this request, one commenter
suggested that the Commission should require information concerning a
board of trade's membership standards and closely examine those
standards to ensure that they are meaningful. Another commenter stated,
among other things, that the Commission should not impose formal limits
on exchange membership qualifications and that no limitations should be
imposed as long as a board of trade primarily operated outside the U.S.
does not have special membership categories (i.e., as long as all
members have the same rights and obligations).
---------------------------------------------------------------------------
\13\ 63 FR at 39787.
---------------------------------------------------------------------------
The Commission has determined to require that petitioners under the
proposed rule provide information concerning their membership rules and
classes. The information should include any financial requirements
(e.g., net worth requirements and fees for
[[Page 14163]]
membership) as well as any experience or professional requirements or
certifications established by the board of trade. The Commission's
proposed rules require that, for customer protection purposes, the
trades of U.S. customers on automated trading systems must be
intermediated by an FCM or by a Rule 30.10 firm. Accordingly, the
Commission wishes to ensure that access to DESs is limited to commodity
professionals and large sophisticated users trading their proprietary
accounts. The Commission would review the information received
concerning a petitioner's membership requirements with a view toward
ensuring that the petitioner's membership criteria did not provide a
means for avoidance of intermediation for U.S. retail investors. In the
event that the commission concluded form the information received that
U.S. retail customers could be ``members'' under a particular
petitioner's rules and could, therefore, have access to DESs if the
Commission were to issue a section 4(c) exemption order to the
petitioner, the Commission could refuse to issue such an order or could
condition its order accordingly. In the latter regard, the Commission
could take into account relevant market structures and financial
protections and controls that potentially could serve the same customer
protection objectives as professional intermediation.
As technology continues to evolve, the available means to provide
direct access from within the U.S. to boards of trade otherwise
primarily operating outside the U.S. undoubtedly will further develop.
By using broad definitions, the Commission hopes to creates a
regulatory approach that provides a flexible means to incorporate the
changing nature of technology. The Commission has no desire to dictate
particular technology choices to market participants, nor does it wish
to restrict innovation, and these rules were crafted accordingly.
B. The Petition Procedure
The Commission's proposal would establish a uniform procedure to
enable a board of trade that primarily is operating outside the U.S. to
request a Commission order that would permit access, via DESs or AORSs,
to the board of trade's products from within the U.S. without requiring
the board of trade to be designated as a U.S. contract market. The
Commission wishes to emphasize that the proposed rules would not alter
a board of trade's obligations to: (a) Receive a no-action position
from the Commission prior to authorizing the offer or sale of any stock
index futures or options contracts in the U.S. or (b) have any foreign
government debt obligation first designated as an ``exempt security''
by the Securities and Exchange Commission (``SEC'') before authorizing
the offer or sale of any futures contract or option thereon in the U.S.
The approach set forth for discussion in the concept release
envisioned a two-step procedure. Under this approach, a board of trade
that primarily is operated outside the U.S. would first petition the
Commission for an order that would permit the use of automated trading
systems in the U.S. to facilitate trading of the board of trade's
products without requiring the board of trade to receive U.S. contract
market designation. Next, if the Commission issued an exemptive order
to a particular board of trade, a member of that board of trade or an
affiliate thereof would be able to make a written request to the
National Futures Association (``NFA'') for confirmation to operate
under the order.\14\
---------------------------------------------------------------------------
\14\ 62 FR 47792, 47795 (Sept. 11, 1997)
---------------------------------------------------------------------------
The concept of a confirmation process was derived from the
procedure currently required of Eurex members for their compliance with
the Letter. Pursuant to this procedure, if a Eurex member located in
the U.S. wishes to install a Eurex terminal in its office, Eurex must
make a written filing to the NFA on behalf of that member, including
certain information and declarations.
The potential approach set forth in the concept release suggested
the possibility of codifying confirmation process similar to that from
the Eurex Letter. Although the Commission received few comments
regarding the confirmation process, upon reconsideration of this
procedure the Commission has determined that such a process is
unnecessary. A a simpler alter-native to this procedure, the proposed
rules would require only that, as a condition to any section 4(c)
exemption order, a board of trade primarily operating outside the U.S.
must maintain and provide to the Commission's on a quarterly basis, and
at any other time upon request of a Commission representative, a
current list that includes (1) the names and main business addresses in
the U.S. of its members and affiliates thereof that have DESs in the
U.S. indicating which of such persons allow their customers to use
AORSs, and (2) the names and main business addresses of its members and
affiliates thereof that allow their U.S. customers to use AORSs but who
do not have DESs in the U.S.\15\ Thus, under the proposed rules, after
the Commission issues an exemption order,\16\ any member, or affiliate
thereof,\17\ of the petitioner may take advantage of the Commission's
order immediately.\18\ Additionally, as discussed below in Section III.
B. 3. concerning the use of AORSs, after the Commission issues an order
under these rules, any FCM or Rule 30.10 firm may provide U.S.
customers with AORSs that provide access to the products of the board
of trade that received the Commission order provided that the AORS
meets certain minimal requirements and contains certain safeguards.\19\
---------------------------------------------------------------------------
\15\ See proposed Rule 30.11(d)(3)(iii).
\16\ Proposed Rule 30.3(c) makes clear that a board of trade
that primarily operates outside the U.S. that is accessible from a
DES in the U.S. must be designated as a U.S. contract market unless
it has received a section 4(c) exemption order under Rule 30.11. The
Commission believes that this rule is necessary to ensure its
ability to enforce proposed Rule 30.11 adequately.
\17\ Proposed Rule 30.11(a)(3) defines an affiliate of a board
of trade member for purposes of the rule as: (1) A person that owns
50% or more of a member (e.g., a board of trade member's parent
company with an ownership interest in the board of trade member of
50% or more); (2) a person owned 50% or more by a member (e.g., a
board of trade member's 50%-or-more-owned subsidiary); or (3) a
person that is owned by a third person that also owns 50% or more of
a member (e.g., a member's sister company where both the member and
the sister company are owned 50% or more by a third person).
\18\ Because any person who solicits or accepts orders and funds
related thereto from U.S. customers for trading pursuant to a
Commission order under Rule 30.11 must be registered as an FCM or
operate pursuant to an order of exemption under Rule 30.10, the
Commission would have appropriate means to discipline such a person
for any violation of the Act or rules thereunder relating to the
operation of board of trade DESs or AORSs in the U.S.
\19\ Proposed Rule 30.3(d) would provide that, except as
provided in Rule 30.11, it shall be unlawful for any person to
solicit or accept orders for, or to accept money, securities or
property in connection with the purchase or sale of, foreign futures
or foreign options by a foreign futures or options customer that are
placed via an AORS (as defined in proposed Rule 30.11(a)(2) by
reference to proposed Rule 1.3(tt)) unless the board of trade
through which the transaction will be executed has been designated
as a contract market under section 5 of the Act. As noted above
proposed Rule 30.11 is not intended to allow Rule 30.10 firms to
solicit or to accept orders from U.S. customers to be placed on a
U.S. contract Market. To obviate any limitations on the use of AORS
by Rule 30.10 firms, Rule 30.11(g) would deem products traded on a
board of trade that received a Commission order under Rule 30.11 to
be foreign futures or foreign options.
---------------------------------------------------------------------------
This release is not intended to alter Commission Rule 30.4 that
requires, generally, that a foreign firm be a registered FCM or a Rule
30.10 firm if it solicits or accepts orders for or involving any
foreign futures contract or foreign options transaction and, in
connection therewith, accepts money, securities or property to margin,
guarantee or secure any trades or contracts that result therefrom
[[Page 14164]]
(including where the U.S. person is a nonclearing member of an exempt
board of trade trading solely for its own account).\20\ The Commission
also wishes to make clear that the Commission's issuance of a Rule
30.11 order would not affect the Commission's ability to bring
appropriate actions for fraud or manipulation, nor would it alter the
obligations of the board of trade that received the order, its members,
FCMs or any other persons under applicable provisions of the Act or the
Commission's regulations, except as specifically provided in these
rules or in a section 4(c) exemption order. For example, an FCM who
solicits or accepts orders from U.S. customers for trading on a board
of trade exempted under proposed Rule 30.11 or on a linked exchange
would remain responsible for complying with the risk disclosure
requirements set forth in Rule 30.6 regarding, among other things, the
risks associated with trading foreign futures or foreign options
contracts.\21\
---------------------------------------------------------------------------
\20\ Commission staff have interpreted this rule to provide an
exception if (1) the foreign firm is either a member of the relevant
board of trade or is a foreign affiliate of a registered FCM and its
sole contact with a U.S. customer is that it carries the FCM's
customer omnibus account or (2) the foreign firm solely carries
accounts on behalf of U.S. customers that are proprietary accounts
(as defined in Rule 1.3(y)) of the foreign firm. See CFTC
Interpretative Letter No. 87-7, Comm. Fut. L. Rep. (CCH)
para.23,972, (Nov. 17, 1987), and CFTC Interpretative Letter No. 88-
15, Comm. Fut. L. Rep. (CCH) para.24,296 (August 10, 1998).
\21\ Rule 30.6 refers to Rule 1.55 which requires, among other
things, that an FCM provide a risk disclosure statement to each of
its customers that provides certain disclosures regarding the risks
associated with trading in commodity futures contracts. Paragraphs
(b) (7) and (8) of Rule 1.55 contain required language specifically
related to risks concerning trading in foreign futures and foreign
options. In particular, paragraph (b)(7) requires disclosure that,
because ``[n]o domestic organization regulates the activities of a
foreign exchange . . .'', customers who trade on these exchanges may
not be afforded the same protections (e.g., protections regarding
the safety of margin funds) that may apply to domestic transactions.
Rules 4.24 and 4.34 require similar risk disclosure language to be
provided by commodity pool operators and commodity trading advisors
to their customers if the offered pool may trade in foreign futures
or foreign options contracts or the offered trading program permits
the trading of foreign futures or foreign option. See also Rule
30.6, as proposed to be amended by 64 FR 1566 (Jan. 11, 1999).
---------------------------------------------------------------------------
1. Application Procedure
Paragraph (b) of proposed Rule 30.11 establishes the petition
procedure discussed above, whereby a board of trade may petition the
Commission for an exemption order under section 4(c) of the Act. Such
an order would enable DESs or AORSs that provide access to the board of
trade's products to be used in the U.S. without requiring the board of
trade to be designated as a contract market.
The approach set forth in the concept release requested comments on
six general categories of information that could be included in a
petition by a board of trade: (1) General information concerning the
petitioner and its products; (2) information concerning the
petitioner's rules and regulations, the laws and regulations in effect
in the petitioner's home country, and the methods for monitoring
compliance therewith; (3) information related to the board of trade's
technological system and standards; (4) financial and accounting
information; (5) information concerning the ability of U.S. contract
markets to operate in the petitioner's home country; and (6)
information concerning the petitioner's U.S. activities and presence.
The concept release suggested that this information would be used to
determine whether a board of trade that is subject to regulation by a
foreign regulator and whose primary locus of operations is aboard
should be exempt from contract market designation requirements if it
places automated trading systems in the U.S. accessing such board of
trade.
Commenters generally agreed that the Commission has a legitimate
regulatory interest in examining automated boards of trade that are
primarily operated abroad, but that nonetheless wish to have a presence
in the U.S. by becoming accessible from within the U.S. via computer
screens or other automated trading systems. However, some commenters
took issue with certain of the specific information included in the
categories above, generally based upon concerns regarding the
information's relevance or based upon concerns that collection of the
information would be unnecessarily duplicative or burdensome. In light
of the comments received and the Commissions's own assessment of the
information that it believes would be necessary in reviewing a board of
trade's petition, the proposed rules provide for a modified set of
information that would be required in a petition. Additionally, the
proposed rules contain certain provisions that are intended to
eliminate the filing of duplicative information.
a. General Approach
At the outset, the Commission wishes to reiterate its general view
that it supports technological innovation and does not wish to make it
unduly burdensome for U.S. customers to access global future and option
markets. The Commission does believe, however, that in order to make
the determinations required before it can issue an order under section
4(c) of the Act concerning the public interest, customer protection and
its ability to discharge its regulatory duties, the Commission has an
obligation to obtain and to review certain basic information. This
basic information relates to, among other things, a board of trade's
regulatory structure, its automated trading systems, and the extent of
its contacts and operations in the U.S. Likewise, in an era where fully
computerized exchanges are becoming common, the Commission has an
interest in ensuring that operators of these exchanges are not using
developments in technology and global communications to evade U.S.
regulatory requirements.
Generally, as noted above, section 4(a) of the Act requires that
futures and option contracts offered or sold in the U.S. be: (1) Traded
on or subject to the rules of a designated contract market; (2)
executed or consummated by or through a member of such contract market;
and (3) evidenced by a written record that includes the date, the
parties and their addresses, the property covered and its price, and
the delivery terms. An exception from these requirements is provided
for contracts that are made on or subject to the rules of a board of
trade located outside of the U.S. or for which the Commission has
granted an exemption from the section 4(a) requirements pursuant to
section 4(c) of the Act. The Commission believes that, if contracts of
a board of trade otherwise primarily operated outside of the U.S. are
accessible from within the U.S. via a DES or an AORS, the board of
trade is no longer ``located outside of the U.S.'' for purposes of
section 4(a) of the Act. The Commission also believes, however, that
regulating boards of trade that satisfy the requirements set forth
below would be largely duplicative of their home country regulations
and unnecessary. Thus, the Commission proposes to establish an
exemption process.
Proposed Rule 30.11 would establish a framework for the
consideration of petitions for exemption pursuant to section 4(c) of
the Act for boards of trade otherwise primarily located outside of the
U.S. section 4(c) of the Act requires the Commission to make certain
determinations prior to granting an exemption thereunder. In the
context of a petition under Rule 30.11, the Commission would be
required to determine that: (1) The requirements of Section 4(a) of the
Act should not apply to the contracts for which the exemption is
requested and the exemption would be consistent with the public
interest and the purposes of the Act; (2) the
[[Page 14165]]
contracts will be entered into solely between appropriate persons; and
(3) the contracts will not have a material adverse effect on the
ability of the Commission or any contract market to discharge its
regulatory or self-regulatory duties under the Act. As noted above, the
standards that will guide the Commission in determining whether a
petitioner meets the requirements under section 4(c) of the Act are
that: (1) The petitioner is an established board of trade that wishes
to place within the United States an automated trading system
permitting access to its products but whose activities are otherwise
primarily located in a particular foreign country that has taken
responsibility for regulation of the petitioner; (2) the petitioner's
home country has established a regulatory scheme that is generally
comparable to that in the U.S. and provides basic protections for
customers trading on markets and for the integrity of the markets
themselves; (3) except for certain incidental contacts with the U.S.
the petitioner is present in the U.S. only by virtue of being
accessible from within the U.S. via its automated trading system; (4)
the petitioner is willing to submit itself to the jurisdiction of the
Commission and the U.S. courts in connection with its activities
conducted under an exemptive order; (5) the petitioner's automated
trading system has been approved by the petitioner's home country
regulator following a review of the system that applied the standards
set forth in the 1990 International Organization of Securities
Commissions (``IOSCO'') report on screen-based trading systems (as may
be revised and updated from time-to-time) or substantially similar
standards; and (6) satisfactory information sharing arrangements are in
effect between the Commission and the petitioner and petitioner's
regulatory authority.
b. Statutory Standards for Exemptive Relief under Section 4(c)
As noted above, section 4(c) of the act provides the Commission
with authority ``by rule, regulation or order'' to exempt ``any
agreement, contract or transaction'' from any of the requirements of
section 4(a) of the Act, if the Commission determines that the
exemption would be consistent with the public interest and that the
contracts would be entered into solely by appropriate persons and would
not have a material adverse effect on the ability of the Commission or
any contract market to discharge its regulatory or self-regulatory
duties under the Act.
As discussed more fully below, the Commission has crafted standards
to apply in evaluating exemptive petitions under the proposed rules
that will enable it to make the requisite findings under section 4(c)
if appropriate. If a petitioner is subject to a regulatory structure in
its home jurisdiction that the Commission finds to be generally
comparable to that in the U.S. in terms of protecting customers and the
integrity of markets, as well as meeting IOSCO standards or similar
standards for screen-based trading, and finds that the regulator in
that other jurisdiction monitors and enforces compliance with that
regulatory structure, the Commission appropriately can determine that
automated trading by U.S. customers pursuant to that foreign regulatory
structure is consistent with the public interest and the purposes of
that Act. the Commission appropriately could permit anyone who can
participate in contract market transactions to be deemed to be an
``appropriate person'' for such automated trading and thus to be
eligible to participate in the petitioner's markets. Further, the
various provisions that the Commission would establish under Rule 30.11
with regard to information sharing arrangements (access to books and
records, notice of enforcement or disciplinary actions and notice of
default, insolvency or bankruptcy), the petitioner's appointment of an
agent for service of process and consent to U.S. jurisdiction, the
Commission's retention of antifraud authority concerning these
transactions, as well as the limitations on the petitioner's U.S.
presence to DESs or AORSs that provide access to its products and
incidental U.S. contacts, would provide a basis for the Commission to
determine that granting the petition would not have a material adverse
effect on the ability of the Commission or any contract market to
discharge its regulatory duties under the Act. A more detailed
description of the requirements for a petition follows.
c. Foreign Regulatory Requirements
The Commission believes that the establishment of automate trading
systems in the U.S. that provide rapid and proximate access to boards
of trade otherwise primarily located outside the U.S. will cause a
fundamental change in the nature of global trading and raise
substantial issues regarding the regulation of increasingly
international or multinational exchanges. Thus, the Commission believes
that one essential factor in determining whether an automated board of
trade that wishes to establish trading systems in the U.S. should be
exempt from contract market designation is whether such board of trade
is subject to a bona fide regulatory system i.e., a structure that is
generally comparable to that in the U.S. in terms of customer
protections and market integrity and that is adequately monitored and
supervised by a foreign futures authority.
To assist the Commission in making the required determinations
under Section 4(c) of the Act and the judgments concerning the general
standards set forth above, the Commission is proposing that a
petitioners submit certain information. With respect to whether the
petitioner is an established board of trade primarily operating outside
the U.S., the petitioners would be required to include the following
basic business information: (1) The address of the petitioner's main
business office and the name, address, telephone number, facsimile
number and electronic mail address of a person to contact for
additional information concerning the petition; (2) the petitioner's
articles of association, constitution, or other similar organizational
documents along with the date and place of its establishment; (3) the
name and address of the petitioner's home country regulatory; and (4) a
complete description of the contracts that initially would be traded
through DESs and/or AORSs located in the U.S.\22\
---------------------------------------------------------------------------
\22\ Proposed Rule 30.11(b)(2)(i)-(iii).
---------------------------------------------------------------------------
In order for a petitioner to be eligible for an exemption,
petitioner's home country regulatory regime should be generally
comparable to that in the U.S. in providing for: (A) Prohibition of
fraud, abuse and market manipulation relating to trading on the
petitioner's markets; (B) recordkeeping and reporting by the
petitioners and its members; (C) fitness standards for intermediaries
operating on petitioner's markets, members or others; (D) financial
standards for the petitioner's members; (E) protection of customer
funds, including procedures in the event of a clearing member's default
or insolvency; (F) trade practice standards; (G) rule review or general
review of board of trade operations by its regulatory authority; (H)
surveillance, compliance, and enforcement mechanisms employed by the
board of trade and its regulatory authority to ensure compliance with
their rules and regulations; and (I) regulatory oversight of clearing
facilities.\23\ Information concerning the petitioner's rules,
including its membership rules, the laws and regulations of the home
[[Page 14166]]
country applicable to the petitions and its operations, and the
mechanisms available for ensuring compliance with all such rules, laws
and regulations should be provided in the petition. The Commission
would review such information in order to determine whether it is
consistent with the public interest, customer protection and its
ability to discharge its regulatory duties to issue an order under
section 4(c) of the Act to permit U.S. customer access to petitioner's
products from automated systems within the U.S.
---------------------------------------------------------------------------
\23\ Proposed Rule 30.11(b)(2)(iv)-(vi).
---------------------------------------------------------------------------
In response to the Commission's request for comment concerning ways
to avoid the filing of unnecessarily duplicative information with the
Commission, several commenters argued that, if a petitioner or its
regulator has received an exemption from the Commission pursuant to
Commission Rule 30.10, the petitioner should not be required to submit
duplicative information to the Commission. The Commission agrees that,
if a petitioner or a regulatory authority that governs the petitioner
has received an exemption under Rule 30.30, the Commission may already
have received much of the information referred to above. Accordingly,
the proposed rules provide that, in such a case, a petitioner would not
be required to submit its organizational documents, its current rules,
and the information concerning the regulatory scheme in the
petitioner's home country, if such information was provided to the
Commission as a basis for the Rule 30.10 exemptive order and remains
the same in all material respects and if the petitioner provides a
statement in its petition to this effect that also specifies the
date(s) the information was provided and the name of the petitioner who
received the Rule 30.10 order.\24\ Such a petitioner, however, would be
required to provide all other information set forth in the rules unless
a particular provision of the rules provides to the contrary. It should
be noted that it is only where the information as to a particular board
of trade's regulatory and self-regulatory program has previously been
provided to the Commission under Rule 30.10 that a petitioner under
Rule 30.11 need not provide all required information. Only where
provision of information would, in fact, be duplicative may a
petitioner rely on information provided in a prior Rule 30.10
application.\25\
---------------------------------------------------------------------------
\24\ See proviso to proposed Rule 30.11(b)(2)(vi).
\25\ If a petitioner is aware that another board of trade in its
home jurisdiction has recently provided information to the
Commission in a petition that, in fact, duplicates specific
information that would be required in the petitioner's petition, the
petitioner may, in its petition, request that it not be required to
include such duplicative information.
---------------------------------------------------------------------------
The Commission wishes to emphasize that it remains very concerned
about, and committed to, the protection of the positions and funds of
U.S. customers who trade on boards of trade whose primary locus of
operations is outside the U.S. Any U.S. customer who trades on such
boards of trade may face additional risks, as various Commission-
mandated risk disclosure statements make clear. There may also be an
impact even on customers who do not themselves trade on such boards of
trade, but have their accounts carried at FCMs that clear trades for
other customers who do. The recent financial failure of Griffin Trading
Company has heightened the Commission's concern in this area. Although
the Commission recognizes that the events leading to Griffin's
insolvency began on automated trading systems outside of the U.S., the
Commission believes that this incident should serve as a reminder of
the importance of establishing and enforcing trading and credit limits,
rules to address the insolvency of intermediaries, and methods to
transfer accounts of non-defaulting customers when there is a customer
default. The protection of customer funds remains one of the
Commission's major goals in its regulatory regime.
In light of the issues raised by the failure of Griffin, the
Commission is considering the appropriateness of adopting a provision,
in connection with its rules concerning automated trading systems, that
would require that the automated order matching/execution system of
contract markets, linked exchanges or boards of trade operating
pursuant to proposed Rule 30.11 exemption orders have the ability to
provide pre-execution credit and trading or position limit screening.
The Commission's intention would be to insure that DESs could not be
used to execute trades in violation of give-up or clearing agreements
with credit and trading or positions limits. (This is to be
distinguished from the trading or credit checks performed by FCMs' or
Rule 30.10 firms' AORSs.) The Commission is not including such a
requirement in these proposed rules, but requests comment on the
appropriateness of such a requirement.
d. Technological Systems and Standards
The Commission's concept release also requested comment concerning
what information should be requested regarding the technological
systems and standards related to a petitioner's automated trading
systems. The concept release suggested that this information could
include a discussion of the petitioner's order processing system and
its system integrity and architecture. Commenters varied in their
suggested approaches to this issue. One commenter stated that
petitioners should be required to provide information concerning their
home country regulator's technological standards and suggested, by
example, that a petitioner be required to specify whether such
regulator has adopted the principles for screen-based trading set forth
by IOSCO.\26\ Another commenter suggested that the Commission's rules
should not require any review or inquiry concerning the technological
features of a petitioner's systems unless special circumstances warrant
such attention. This commenter stated further that, if the home country
regulator has satisfied itself that a trading system meets or surpasses
the standards set forth by IOSCO in its report, no purpose is served by
the Commission requiring any further demonstration of compliance by the
petitioner.
---------------------------------------------------------------------------
\26\ These principles address the following topics:
1. Compliance with applicable legal standards, regulatory
policies, and/or market custom or practice where relevant;
2. The equitable availability of accurate and timely trade and
quotation information;
3. The order execution algorithm used by the system;
4. Technical operation of the system that is equitable to all
market participants;
5. Periodic objective risk assessment of the system and system
interfaces;
6. Procedures to ensure the competence, integrity, and authority
of system users and to ensure fair access to the system;
7. Consideration of any additional risk management exposures
pertinent to the system;
8. Mechanisms to ensure that the information necessary to
conduct adequate surveillance of the system for supervisory and
enforcement purposes is available;
9. Adequacy of risk disclosure, including system liability; and
10. Procedures to ensure that the system sponsor, providers, and
users are aware of, and will be responsive to, relevant regulatory
authorities.
See IOSCO report entitled ``Screen-Based Trading Systems for
Derivative Products'' (June 1990).
---------------------------------------------------------------------------
The Commission believes it is generally appropriate to respect the
judgment of home country regulators in these matters and does not wish
to conduct a de novo review of the technological decisions made by
petitioning boards of trade. However, the Commission also believes that
it has an obligation to assure that any system that will be accessed
from within the U.S. is sufficiently sound (e.g., its architecture is
sufficient to handle reliably the type and volume of transactions
reasonably anticipated) and secure and provides fair access to U.S.
[[Page 14167]]
customers on a nondiscriminatory basis (i.e., U.S. customers are not
placed at a competitive disadvantage to others trading on the system).
These assurances are necessary in order for the Commission to determine
that issuance of a section 4(c) exemption order would not be contrary
to the public interest, would serve to ensure protection of U.S.
customers and would not adversely affect the Commission's ability to
discharge its regulatory duties.
To address these concerns and the recommendations of commenters,
the proposed rules would require that a petitioner state in detail in
its petition the extent to which a technical review of the system at
issue was performed by its home country regulator and identify the
standards applied in that review. The petitioner would include a copy
of any order or certification received from its home country regulator
as a result of such review. If the home country regulator based its
approval on a review conducted by a third-party, the petitioner should
so indicate and discuss the qualifications of the party that performed
the review and the standards applied.
The petition would also be required to include a general
description of the automated trading system operated by the board of
trade, including at a minimum a general description of the architecture
and security features of the system, information as to the length of
time the particular system has been operating and a history of
significant system failures or interruptions.\27\ Depending upon the
nature of the technical review performed and the information received
concerning the system's operating history, the Commission would
determine what additional inquiry, if any, by the Commission is
necessary and appropriate in reviewing the petitioner's request. The
Commission adopted the IOSCO 1990 Principles on Screen-Based Trading as
a formal Commission statement of regulatory policy and would use the
IOSCO principles as guidelines for its review to determine whether the
petitioner's automated system technology is sufficient to permit the
Commission to issue a section 4(c) exemption order.\28\ In this regard,
the petitioner would be required to describe any differences between
the IOSCO principles and those that were used to perform the technical
review.
---------------------------------------------------------------------------
\27\ See proposed rule 30.11(b)(2)(viii).
\28\ 55 FR 48670 (Nov. 21, 1990). IOSCO is currently undertaking
a study to review the principles set forth in its 1990 report in
light of new technological developments.
---------------------------------------------------------------------------
To the extent that the information to be provided to the Commission
would be the same for several boards of trade using a shared computer
or for a board of trade that lists its products on another board of
trade's automated trading system, only one of the boards of trade using
the system or making its products available on such system in the U.S.
would be required to provide the information regarding technological
systems and standards. If a petitioner shares a computer system or
platform with another board of trade that has not sought an exemption
order and the petitioner has relied on the system analysis performed by
the other board of trade's home country regulator, it would not be
sufficient for the petitioner simply to state that it relied on such
analysis. Rather, the petitioner would be responsible for obtaining and
providing the Commission with information concerning the analysis
performed by the other board of trade's home country regulator and for
describing whether such analysis was consistent with the IOSCO
principles. Additionally, if a board of trade does not include all or a
portion of the information regarding the type of review that was
performed on its system because the information has been or is being
provided by another board of trade, the petitioner must include a
statement to that effect in its petition and must identify the board of
trade that has provided or is providing the information.
e. U.S. Activities
Another possible information requirement outlined in the concept
release concerned the petitioner's activities in the U.S. The concept
release requested comment on whether to require a petitioner to provide
information concerning its marketing, education, promotional or other
activities in the U.S. including the address of, and number of persons
employed by, any office maintained by the petitioner in the U.S., and
the extent to which the board of trade makes information available on
the Internet that may be relvevant to U.S. customers who wish to trade
its products. Additionally, if the petitioner maintains a warehouse in
the U.S. for any futures contracts that could involve physical delivery
of the underlying commodity, the concept release suggested that the
petitioner should provide the address for such warehouse and the stocks
contain as of the date of the petition.
Commenters generally agreed that the Commission has a legitimate
interest in obtaining information to determine whether a board of
trade's presence in the United States is more than incidental such that
the board of trade should be required to obtain contract market
designation. The Commission has determined to propose generally the
submission of the information discussed in the concept release
concerning a petitioner's U.S. activities.\29\ To qualify for an
exemption order, petitioner's management, back office operations, order
matching/execution facilities and clearing facilities would have to be
located outside the U.S., as would all or the vast majority of its
personnel. The presence of an office or offices in the U.S. might or
might not be deemed to be incidental contact, depending on the size,
purpose, and activities conducted by the office(s). The Commission will
evaluate this issue based on the facts described in the petition.
---------------------------------------------------------------------------
\29\ See proposed Rule 30.11(b)(2)(ix)-(xi).
---------------------------------------------------------------------------
One commenter questioned the relevance of information concerning
the address of warehouses in the U.S. and the stocks available at such
warehouses. The Commission believes that the location of the underlying
cash market and delivery points with respect to products traded through
U.S.-located automated trading systems is a pertinent factor in
examining the nature and extent of an exchange's activities in the U.S.
Presence in the U.S. of some warehouse facilities would not itself
render a petitioner ineligible for relief under these rules.
Eligibility would depend on the nature of petitioner's U.S. activities
taken as a whole.\30\
---------------------------------------------------------------------------
\30\ The proposed rules require petitioners to identify the
addresses of any warehouses maintained in the U.S. for delivery of
underlying commodities, but not to specify the stocks on hand at
such warehouses. If a petition is granted, an exempted exchange must
respond to any Commission requests for information about such
stocks. See proposed Rule 30.11(d)(8).
---------------------------------------------------------------------------
f. Rules Concerning Access by U.S. Exchanges to Foreign Markets
The concept release also requested comment on whether the
Commission should require that the petitioner provide a statement from
the regulatory authority in its home country with primary
responsibility for oversight of the petitioner as to whether such
regulator or any other body in that country imposes any restrictions or
regulations regarding: (1) The placement or operation of U.S. exchange
automated trading systems in the country; (2) the types of products
permitted to be traded on such systems; and (3) the sale of U.S.
exchange products, generally. If any such restrictions or regulations
existed, the concept release suggested that the statement include a
description of the restrictions or regulations, copies of any relevant
statutes or other relevant legal
[[Page 14168]]
materials and a description of the application process, if any,
required for a U.S. exchange and its members to place automated trading
systems and/or to sell products in the petitioner's home country.
Commenters generally were in favor of the Commission's collection
of the information described above as a means of ensuring electronic
access to markets globally. Commenters differed, however, regarding the
role such information should have in the Commission's ultimate
determination as to whether it should issue an order. Several
commenters stated that an order should not be issued to a board of
trade primarily located outside the U.S. unless similar electronic
access is made available to U.S. exchanges by the board of trade's home
country regulator. Other commenters warned that the Commission should
not use the request for information concerning the electronic access
rules of the petitioner's home country as a means to require, as a
prerequisite to issuing an order, that a particular regulatory
framework for allowing U.S. exchanges to place automated trading
systems in the foreign jurisdiction be in effect in a foreign
jurisdiction. Two commenters believed that the Commission should
collect information concerning a foreign jurisdiction's rules and
policies vis-a-vis a U.S. contract market's ability to place automated
trading systems in the foreign jurisdiction, but should not deny
electronic access to a board of trade solely on the basis that its home
jurisdiction excludes the systems of U.S. exchanges. Rather, these
commenters believed that the information should be considered as one
element in the Commission's assessment of the entire petition. Another
commenter stated its view that the issue of reciprocity should not be a
significant factor in the Commission's determination as to whether to
issue an exemption order because financial institutions in a country
that does not provide electronic access ultimately will be harmed by
such a policy, thus effectively forcing the country into developing
regulations permitting access. One commenter also noted that any
Commission regulations must be consistent with U.S. obligations under
the General Agreement on Trade in Services (``GATS'') and any
applicable annexes thereto.
With respect to the GATS, Commission staff have held discussions
with staff of the U.S. Department of Treasury (``Treasury'') and the
Office of the U.S. Trade Representative (``USTR'') on this issue.
Treasury and USTR staff have expressed to Commission staff their view
that the Commission may not condition granting an order on reciprocity
by the petitioner's home country without violating U.S. legal
obligations under the GATS and North American Free Trade Agreement
(NAFTA). Indeed, they have expressed concern that even a request for
information such as that set forth in the concept release and described
above might raise questions relating to U.S. obligations under the GATS
and NAFTA.
In light of Treasury's and USTR's view regarding U.S. legal
obligations under the GATS and NAFTA, the Commission is not now
proposing to impose a requirement that a particular partitioner's home
country jurisdiction extend reciprocity to U.S. exchanges' automated
trading systems, even though it had intended to do so. The Commission
would welcome comment on this issue. Even if U.S. international
obligations prevent the Commission from requiring reciprocity, the
Commission strongly supports a policy of open and free access to global
markets and is committed to aiding U.S. exchanges in gaining the right
to place electronic systems in foreign jurisdictions. The Commission
encourages any U.S. exchange that believes that it is being wrongfully
prevented from placing its automated trading systems in foreign
jurisdiction to inform the Commission of this concern. The Commission
will work with the exchange, with the foreign jurisdiction, and with
Treasury and/or USTR as appropriate to open such jurisdiction to U.S.
exchanges and to resolve any dispute over unfair restrictions placed on
U.S. exchanges.
g. Financial Information and Volume Data
The concept release requested comment on a requirement to include
in a petition the petitioner's most recent annual financial statements
and the total trading volume, on a contract-by-contract basis and in
the aggregate, for its most recent year and most recent quarter (or
other period if data is not maintained on an annual and quarterly
basis). Based upon the concerns of commenters regarding the relevance
of the financial statements, the fact that the Commission does not
require similar statements from contract markets and the fact that the
Commission will review the minimum financial standards and clearing
facility oversight in the petitioner's home country, the Commission has
determined not to require financial statements from the petitioner in
the proposed rules. Neither will the Commission require volume figures
in a petition under Proposed Rule 30.11. The proposed rules, however,
would require certain basic U.S. volume data to be reported to the
Commission on a quarterly basis as a condition of a section 4(c)
exemption order.\31\
---------------------------------------------------------------------------
\31\ See discussion of conditions of an order in Section
III.B.2., below.
---------------------------------------------------------------------------
h. Information Sharing
The prevention of fraud and the protection of U.S. customers,
including customer funds, remain major goals of the Commission's
regulatory scheme. The Commission's ability to access information
regarding trading by persons located in the U.S. that is conducted on a
board of trade exempted under proposed Rule 30.11 is essential to
achieving these goals. The concept release requested comment on a
requirement that a petitioner identify any information sharing
arrangement in effect among the relevant regulatory authorities and the
Commission, including information concerning any blocking statutes or
data protection laws in effect in the petitioner's home country that
might impair the Commission's ability to obtain information under such
arrangements. The commission has determined that the existence of
satisfactory information sharing arrangements between the petitioner
and the petitioner's regulator and the Commission is an essential
prerequisite for an exemptive order under the proposed rules. Under
such arrangements, the Commission and the petitioner and the
petitioner's regulatory authority would agree to cooperate with respect
to inquiries concerning trading on the petitioner's markets that
affects U.S. persons or markets. Relevant information to be provided
under such arrangements may include, without limitation, trade
confirmation data, data necessary to trace funds related to trading
futures and option products subject to regulation in the petitioner's
home country, position data, data on a firm's standing to do business
in the petitioner's home country, and a firm's financial condition.
Mechanisms for cooperating with the Commission and the NFA in
inquiries, compliance matters, investigations and enforcement
proceedings must be established in the information sharing
arrangements. Failure to maintain satisfactory information sharing
arrangements could result in revocation of the Commission's order.
Proposed Rule 30.11(d)(8) also provides that the Commission may seek
information directly from the petitioner to evaluate the petitioner's
continued eligibility for or compliance with the
[[Page 14169]]
conditions of a section 4(c) exemption or for any other reason.
i. Arrangements Among Multiple Exchanges
The Commission envisions that its proposed rules would apply not
only with respect to individual boards of trade that primarily are
operated outside the U.S., but also in circumstances where the products
of multiple boards of trade are traded through a single system. In such
a case, each board of trade whose products would be made available
through U.S.-located automated trading systems generally would be
required to comply with the requirements set forth in the proposed
rules. For example, if two or more boards of trade share the same
system and each wishes to place DESs in the U.S. for its members' (or
members' affiliates') use, each would be required to receive an order
from the Commission prior to such placement. Similarly, if the products
of one or more boards of trade are available through the DES of another
board of trade, each board of trade whose products would be available
in the U.S. through such DES would be required to receive a section
4(c) exemption order. With respect to AORSs that provide U.S. customers
with access to the products of multiple boards of trade, each board of
trade whose products would be available through such device or software
would have to comply with the rules and receive a section 4(c)
exemption order before an FCM or a Rule 30.10 firm could allow its
customers to enter trades on the board of trade via an AORS. In the
examples discussed above, a petition to the Commission under the
proposed rules could be made individually by each board of trade or
jointly, provided that the Commission received all required information
under the proposed rules with respect to each board of trade whose
products would be made available electronically from within the U.S.
In addition to the foregoing, the Commission appreciates that some
boards of trade currently allow automated trading of their products
from within the U.S. through mutual arrangements with designated
contract markets or may in the future do so. In these cases, the
arrangements are submitted to the Commission for its prior review as
rule changes of the contract market. Because the Commission thus has
the opportunity to examine each such arrangement, the proposed rules
carve out an exception that would allow a board of trade primarily
operating outside the U.S. to have its products traded through
automated trading systems located in the U.S. without obtaining
contract market designation and without receiving a section 4(c)
exemption order if (1) the board of trade has entered into an
electronic trading arrangement with a designated contract market which
is submitted to the Commission for review and is in effect as a rule of
the contract market and (2) the products of the board of trade that are
traded in the U.S. through such trading systems are traded in
accordance with such an arrangement. However, a board of trade that has
entered into an electronic trading arrangement with a designated
contract market would be required to receive a Commission order
pursuant to these proposed rules if the board of trade planned to allow
automated access to its products in any manner that would fall outside
the arrangement with a U.S. contract market that has been submitted to
the Commission for review.
The Commission wishes to emphasize that, although a ``linked
exchange'' would not be required to comply with these proposed rules if
access to its products via automated trading systems from within the
U.S. is limited to the terms of an arrangement with a designated
contract market, a designated contract market that enters into such a
linkage arrangement must submit a rule(s) describing the arrangement
and the attendant rights and responsibilities of all parties involved
in the arrangement to the Commission for approval. In reviewing such a
rule submission, the Commission has applied and will continue to apply
substantially the same standards as set forth herein modified as
appropriate based on the exact nature of the linkage arrangement. Among
other things, the Commission seeks assurances from the designated
contract market that the arrangement will conform with the principles
for screen-based trading set forth by IOSCO \32\ and evaluates what
role the U.S. contract market would have in securing its members'
compliance with the rules of the board of trade operating primarily
outside the U.S. Additionally, the Commission will ensure that any
rule(s) it reviews includes language requiring such a board of trade to
subject itself to the jurisdiction of the Commission and U.S. courts
regarding its activities under the linkage arrangement.
---------------------------------------------------------------------------
\32\ See supra note 26.
---------------------------------------------------------------------------
j. Public Availability of Petitions
The concept release asked for comment on whether petitions received
should routinely be published in the Federal Register for public
comment. After reviewing the comments and in light of the nature of the
petition process that would be established by the proposed rules, the
Commission believes that, as a general matter, it would be beneficial
to provide public notice of petitions. Accordingly, pursuant to section
4(c) of the Act, paragraph (e) of proposed Rule 30.11 provides that the
Commission will publish a ``notice of availability'' in the Federal
Register upon receipt of any petition. The notice of availability would
contain a general description of the information discussed in the
petition and the exemption sought by the petitioner. Interested parties
would thus be aware of each petition and would have the opportunity to
request information concerning the petition from the Secretariat of the
Commission. The proposed rule further provides that the Commission may,
upon the request of a petitioner, limit the public availability of
information included in its petition if the Commission determines that
such information constitutes a trade secret or that public disclosure
would result in material competitive harm to the petitioner.
2. Conditions of an Order
If all standards for exemptive relief are met, exemptive orders
under proposed Rule 30.11 would be issued subject to certain
conditions. The concept release set forth a number of potential
conditions that would be included in each Commission order. The
Commission believes that it generally would be helpful to go further
and provide in its rules a list of conditions that will apply
automatically to each Commission order, unless a particular order
indicates otherwise. In light of the comments received on the concept
release, the Commission is proposing conditions that vary in certain
respects from those discussed in the concept release. These conditions
are intended to aid the Commission to fulfill certain basic goals of
its rulemaking: (1) To ensure protections for U.S. customers and (2) to
ensure that the Commission has ongoing access to data to ensure the
continued appropriateness of the Commission's 4(c) exemption order. The
conditions that are proposed to be included automatically in each
Commission order are as follows:
1. Only memebers of the board of trade that received a
Commission exemptive order and their affiliates may have access to
DESs, and the board of trade will not provide, and will take
reasonable steps to prevent third parties from providing DESs to any
other persons;
[[Page 14170]]
2. Unless otherwise exempt from registration, any member or
affiliate thereof that solicits or accepts orders for, or accepts
money, securities or property in connection with the purchase or
sale of, foreign futures or foreign options by a foreign futures or
foreign options customer via a DES or an AORS must be a registered
FCM or a Rule 30.10 firm;
3. The board of trade that received the exemptive order must
notify the Commission in writing within 30 calendar days of (a) any
material changes in the information provided in its petition to the
Commission and any changes in its rules or in the laws or rules of
its home country that may have a material impact on the order, (b)
any known violation by a member (or its affiliate) of the
Commission's order; and (c) any disciplinary action taken against a
member (or its affiliate that involves any market manipulation,
fraud, deceit or conversion or that results in the member's
suspension or expulsion \33\ and that involves the use of a DES or
an AORS in the U.S., provided, however, that the board of trade must
notify the Commission at least ten business days prior to allowing
any new products (i.e., products other than those discussed in its
petition) to be traded through DESs or AORSs located in the U.S. and
within 24 hours of any significant system failure or interruption or
a member's default, insolvency or bankruptcy; \34\
---------------------------------------------------------------------------
\33\ See, e.g., Rule 1.63(a)(6)(ii) (defining disciplinary
offense for purposes of the Commission's rule concerning service on
SRO governing boards by persons with disciplinary histories to
include any violation of SRO rules that involves fraud, deceit or
conversion or results in suspension or expulsion).
\34\ Although the proposed rules would require that the
Commission be notified if a board of trade operating under an
exemption order intends to allow automated access to new products
through DESs or AORSs located in the U.S., the proposed rules
generally would not require any type of pre-approval process.
However, as previously noted, the proposed rules would not alter a
board of trade's obligations: (a) To receive a no-action position
from the Commission prior to engaging in the offer or sale of any
stock index futures or option contracts in the U.S. or (b) to have
any foreign government debt obligation designated as an ``exempt
security'' by the SEC before engaging in the offer or sale of any
futures contract or option thereon in the U.S. section 2(a)(1)(B)(v)
of the Act states generally that no person shall offer or enter into
a contract of sale for future delivery of any security except an
``exempt security'' under Section 3 of the Securities Act of 1933 or
section 3(a)(12) of the Securities Exchange Act of 1934.
---------------------------------------------------------------------------
4. Satisfactory information sharing arrangements must remain in
effect between the Commission and the petitioner and the
petitioner's regulatory authority;
5. The board of trade that received the order must provide to
the Comission, on a quarterly basis and at any other time upon the
request of a Commission representative, a current list that (a)
identifies and provides the main business addresses in the United
States for those of its members and affiliates thereof that have
DESs in the United States and indicates which of such members and
affiliates thereof allow the use of AORSs by foreign futures and
foreign options customers and (b) identifies and provides the main
business addresses for those of its members and affiliates thereof
that allow the use of AORSs by foreign futures and foreign options
customers, but who do not have DESs in the U.S.;
6. Prior to operating pursuant to the Commission order, the
board of trade that received the order must file with the
Commission, and maintain thereafter as long as it operates pursuant
to the order, a valid and binding appointment of an agent for
service of process in the United States, pursuant to which such
agent is authorized to accept delivery and service of communications
issued by or on behalf of the Commission, the Department of Justice,
any member of the board of trade or affiliate of such member, or any
foreign futures or foreign options customer. Service or delivery of
any communication issued by or on behalf of any of the foregoing,
pursuant to such appointment, shall constitute valid and effective
service or delivery.
7. Prior to operating pursuant to the Commission order, the
board of trade that received the order must file with the Commission
a written representation, executed by someone with authority to bind
the board of trade, stating that, as long as the board of trade
operates pursuant to the order, the board of trade irrevocably
agrees to and submits to the jurisdiction of the Commission and
state and federal courts in the United States with respect to the
board of trade's activities conducted under the exemption order; and
8. The board of trade that received the order must provide the
Commission with quarterly reports indicating with respect to each
contract available to be traded from within the U.S. via DESs or
AORSs (a) the total volume originating from DESs or AORSs located in
the U.S. and (b) the total worldwide trade volume on the board of
trade. If applicable, the board of trade also must provide reports
upon request indicating the stocks held at any warehouse maintained
by it in the U.S. for products that require physical delivery.
A significant issue raised in the concept release concerned the
extent to which the Commission should look to the volume of a
petitioner's contracts transacted by U.S. persons in determining
whether such petitioner should be issued an exemption order under these
proposed rules. The majority (although not all) of the commenters on
this issue believed that the Commission should not use a volume test as
the sole means to determine whether a board of trade should be eligible
for a Commission order. Commenters varied, however, in their views as
to the extent, if any, to which U.S. volume data should play a role in
this determination. The Commission agrees with those commenters who
suggested that adopting a particular percentage of volume within the
U.S. beyond which a board of trade would be required to receive
contract market designation could serve to inhibit the development of
new products that might appeal to U.S. users and could prove difficult
to manage because volume potentially can vary greatly from one
reporting period to the next. Thus, the Commission is not proposing any
fixed percentage. However, the Commission believes that trade volume
from within the U.S. is relevant in assessing whether a board of
trade's contacts in the U.S. are so extensive that it should be
required to be designated as a contract market and that a quarterely
report that indicates a board of trade's volume of U.S. transactions in
each contract and the total number of transactions worldwide in each
contract would be beneficial to the Commission in obtaining a complete
picture of the board of trade's U.S. activities. Accordingly, the
Commission has determined to include in its proposal a periodic U.S.
volume reporting requirement that would be included as a condition to
each order issued under the proposed rules. The Commission believes
that the volume data that would be required under the proposed rules,
while relevant and helpful to the Commission, should not impose a
significant burden. Specifically, as noted above, the proposed rules
would require that a board of trade that received a Commission order
provide a report to the Commission on a quarterly basis that indicates
the total volume in each of its contracts that originates from
automated trading systems in the U.S. (whether from DESs or AORSs) and
the total volume of transactions in such contracts worldwide (including
the U.S.). This information would be provided for each contract traded
on DESs or AORSs from within the U.S.
Another issue raised in the concept release concerned a potential
requirement for a biennial on-site review of the operations of members
(and their affiliates) operating in the U.S. under a Commission order.
The Commission has determined not to require a separate on-site review.
As one commenter pointed out, any member or affiliate thereof that uses
a DES to trade on behalf of U.S. customers pursuant to a Commission
issued order would have to be registered as an FCM and would be subject
to periodic audits by the Commission and its designated self-regulatory
organization (``DSRO'') (i.e., U.S. contract market or NFA). The
Commission does not believe that it is necessary to require an
additional review under these rules. Rather, it anticipates that the
DSRO's audit procedures would be extended to encompass a review of
compliance with the Commission's new rules, and orders
[[Page 14171]]
issued thereunder, when adopted and issued.
The Commission wishes to make clear that the above list of
conditions that will automatically apply under the proposal would not
necessarily be exhaustive. For clarity's sake, each order likely would
reiterate the conditions that are imposed automatically by the rules.
However, as the rules state, the ``default'' or automatic conditions
would apply even if not contained in an order, unless explicitly
excluded therefrom. Additionally, a petitioner must include in its
petition a written statement in which it consents to or agrees to
comply with each of the conditions should the Commission issue the
petitioner a Rule 30.11 exemption order.\35\ Thus, consent or agreement
to comply with the conditions also would be a prerequisite to the
Commission's issuance of an order under these rules.
---------------------------------------------------------------------------
\35\ See proposed rule 30.11(b)(2)(xii).
---------------------------------------------------------------------------
The Commission would be free to subject any order to other
conditions that the Commission believes to be necessary or appropriate.
In addition, under paragraph (f) of proposed Rule 30.11, the Commission
would retain the authority to condition further, modify, suspend,
terminate or otherwise restrict the terms of an order as they apply
either to a specific person operating thereunder or to the order in its
entirety. The Commission might determine to take such action, for
example, if the Commission found that the board of trade that received
the order, or an entity operating in the U.S. based on the order,
materially violated a stated condition of the order, that the
activities, operations and trading of the board of trade that received
the order no longer justified the order, or that continuation of the
order otherwise would be contrary to the Act, public policy or the
public interest.
3. Rules Concerning Automated Order Routing Systems
a. AORS Definition
As noted above, the Commission is proposing to adopt a definition
of the term ``automated order routing system'' in a new paragraph (tt)
of Commission Rule 1.3, which contains the Commission's general
definitions and thus would apply to U.S. designated contract markets in
addition to boards of trade granted a Commission order under proposed
Rule 30.11 and linked exchanges. The definition of an AORS is any
system of computers, software or other devices that allows entry of
orders through another party for transmission to a board of trade's
computer or other automated device where, without substantial human
intervention, trade matching or excution takes place. ``Entry of
orders'' for an AORS could be via a screen-based or other automated
system. A customer who telephones an order to an employee of an FCM or
Rule 30.10 firm would not be entering an order for purposes of these
rules, and the AORS definition would not apply. The definition of AORS
and the requirements relating thereto would apply to orders for and
customer or foreign futures or options customer, although order entry
itself could be made by the customer or by a person designated by the
customer to enter orders on its behalf, e.g., a CTA.
As described more fully below, under Proposed Rule 1.71(a), if a
customer or foreign futures or foreign options customer uses an AORS to
transmit an order to an FCM or Rule 30.10 firm, such AORS must be a
``qualified'' AORS and satisfy certain minimum requirements specified
in proposed rule 1.71(b). Further, under proposed rule 30.3 (d), AORSs
can only be used to access designated contract markets, boards of trade
that have received an exemption under Proposed Rule 30.11 or linked
exchanges.
The qualification requirements of Proposed Rule 1.71 do not apply
to orders transmitted via an AORS if such orders are proprietary orders
of the receiving firm, of if they are transmitted by a registered FCM
to another firm for any proprietary account or customer omnibus account
of the FCM. Systems transmitting such orders still fall within the
definition of AORS, however, and therefore Proposed Rule 30.3(d)
requires that such orders be directed to a contract market, a Rule
30.11 exempt board of trade or a linked exchange.
There are a number of possible permutations in how a particular
order may be transmitted from a customer or an FCM for eventual
execution on an automated board of trade, and it is important to
examine each step of a particular transaction to determine what
requirements apply. For example, if a customer telephoned an order to
an employee of a U.S. FCM, who then entered the order into a system
linked directly to an automated board of trade of which it was member,
the second step of the transaction would involve the use of a DES, and
under proposed Rule 30.3(c), the board of trade for which the order was
placed must be a designated contract market, a Rule 30.11 exempt board
of trade, or a linked exchange. If the same customer used a system that
satisfied the definition of an AORS to send an order to an FCM (or Rule
30.10 firm) for transmission to an automated board of trade, such AORS
would have to be a qualified AORS and satisfy the requirements of
Proposed rule 1.71(b). Under proposed Rule 30.3(d), the board of trade
for which the order was placed would have to be a designated contract
market, a Rule 30.11 exempt board of trade, or a linked exchange.
If a foreign futures options customer telephoned an order to an
employee of an FCM and the FCM, using its customer omnibus account,
were to take the order and transmit it electronically to another FCM, a
Rule 30.10 firm or a firm otherwise exempt from registration as an FCM
\36\ for transmission into an automated board of trade, transmission of
the order from the customer's FCM through the other firm for execution
would constitute use of an AORS. Accordingly, under proposed Rule
30.3(d), the board of trade for which the order was placed must be a
Rule 30.11 exempt board of trade or a linked exchange. The AORS used by
the customer's FCM in this example would not have to be a qualified
AORS that meets the credit check and other requirements of proposed
Rule 1.71, however, because its use was by an FCM for a customer
omnibus account.
---------------------------------------------------------------------------
\36\ See supra note 20.
---------------------------------------------------------------------------
Where a non-clearing member of a board of trade operating under a
Rule 30.11 exemption order or of a linked exchange uses an automated
device directly to access the board of trade's automated order matching
engine and there is a post-trade give-up for clearing to an FCM or a
Rule 30.10 firm, this would be treated as use of a DES rather than an
AORS under the proposed rules. The requirements of proposed Rule 1.71
therefore would not apply.\37\ However, an FCM or Rule 30.10 firm must
bear in mind that, if the non-clearing member used an automated device
to route an order through the FCM or Rule 30.10 firm prior to the
order's transmission to the matching/execution engine of the board of
trade, this would be treated as use of an AORS by the non-clearing
member customer, and the AORS therefore would have to be a qualified
AORS and to satisfy the requirements of proposed Rule 1.71, unless the
non-clearing member is itself an FCM or has a proprietary relationship
to the FCM receiving the order.
---------------------------------------------------------------------------
\37\ The firm carrying the account generally would have to be a
registered FCM or Rule 30.10 firm.
---------------------------------------------------------------------------
b. Requirements for Qualified AORSs
Proposed Rule 1.71 would set forth very basic standards that must
be met by a qualified AORS. If these minimum requirements are
satisfied, there would
[[Page 14172]]
be no restriction upon the type of customer that could use the AORS,
e.g., no minimum net worth standards, and no restrictions upon the type
of data that may be displayed to the customer. The AORS must be limited
to exchange trading only, either on a designated contract market, an
exchange linked to such a contract market or a board of trade that
receives an exemption order in accordance with proposed Rule 30.11.\38\
---------------------------------------------------------------------------
\38\ An AORS could also provide access to trading in cash
markets, securities markets, or CEA-exempt hybrid markets, if such
trading is consistent with all applicable laws and regulations.
Trading of swaps via AORSs would not be permissible under the
current Commission exemption for swaps, which prohibits the use of
multilateral transaction execution facilities for swaps trading,
see, e.g., Rule 35.2(d), and thus would not be permissible under
proposed Rule 1.71.
---------------------------------------------------------------------------
A qualified AORS may only provide access for a customer or a
foreign futures or foreign options customer to products that can
lawfully be offered to or entered into by U.S. persons. Thus, for
example, if there were a futures contract traded on a board of trade
with a Rule 30.11 exemption order (or a linked exchange) involving a
foreign stock index or a foreign government's sovereign debt
instruments that had not received the requisite clearances, the futures
contract could not lawfully be offered or sold to U.S. persons. The FCM
(or Rule 30.10 firm, as applicable) should also exercise due diligence
to verify that use of an AORS is permissible under, and undertaken in
accordance with, the rules of the relevant contract market, board of
trade that received a Rule 30.11 exemption order, or linked exchange.
For trading through an FCM, a qualified AORS would be required to
provide all information required by Commission Rule 1.35(a-1)(1)
concerning identification of customer orders, except that order-related
times would have to be captured to the nearest second. The proposed
requirement for timing to the nearest second is consistent with the
Commission's previous advisory concerning recordkeeping requirements
for electronic order-routing systems.\39\
---------------------------------------------------------------------------
\39\ 62 FR 7675, at 7677 (Feb. 20, 1997).
---------------------------------------------------------------------------
The Commission believes that the use of AORSs may be beneficial for
customers and FCMs in terms of convenience and efficiency. However,
these systems are not infallible or without serious risk. The
Commission is concerned that, due to the speed and the uninterrupted
nature of an automated device, an error, if one should occur, could be
very large in magnitude and impact and thus potentially could pose a
significant risk to customers, to the integrity of the FCM and to the
marketplace in general if the AORS does not contain appropriate
safeguards. Commission Rule 1.16 requires, among other things, that an
FCM have in place appropriate internal accounting controls and
procedures for safeguarding customer and firm assets.\40\ However, that
rule does not prescribe specific controls that must be in place. The
Commission believe that it is appropriate to mandate that certain
specific, minimum controls be present in any qualified AORS. These
minimum safeguards do not supplant or replace an FCM's duties under
Rules 1.16 and 166.3 and other applicable regulations, concerning
proper internal controls and supervision of employees and accounts.
Rather, they are minimum standards that should be implemented in
addition to other appropriate controls employed by FCMs regarding
AORSs.
---------------------------------------------------------------------------
\40\ In particular, Rule 1.16(d)(1) requires that the scope of
the FCM's annual audit, review of the accounting system and
procedures for safeguarding customer and firm assets be ``sufficient
to provide reasonable assurance that any material inadequacies
existing at the date of the examination in (i) the accounting
system, (ii) the internal accounting controls, and (iii) the
procedures for safeguarding customer and firm assets . . . will be
discovered.'' A material inadequacy is defined generally in Rule
1.16(d)(2) to include, among others, ``any conditions which
contributed substantially to or, if appropriate corrective action is
not taken, could reasonably be expected to . . . (r)esult in
material financial loss(.)'' See also, Commission Rule 166.3, which
governs an FCM's general supervisory duty with respect to handling
of accounts.
---------------------------------------------------------------------------
Proposed Rule 1.71(b)(3) requires generally that an FCM or Rule
30.10 firm take reasonable steps to ensure that its system is and
remains sound and secure and generally fit for its intended purpose.
Proposed Rule 1.71(b)(5) provides that a qualified AORS must contain at
a minimum checks that verify that any credit and trading or position
limits for the account (as established by the FCM or Rule 30.10 firm)
are not exceeded.\41\ Such checking could be performed manually or by
the system itself on an automated basis. If these checks are automated,
the FCM or Rule 30.10 firm must implement proper internal controls to
ensure that limits appropriate to each customer or foreign futures or
foreign options customer, as determined by personnel authorized to set
such limits, are properly input into the AORS and updated as
appropriate. The Commission is also proposing, in proposed Rule
1.71(b)(6) and (b)(7), that a qualified AORS must provide: (1) An FCM
or Rule 30.10 firm, on a unilateral and immediate basis, with the
capability to block use of an AORS if, for example, the firm determines
that its security or the security of any contract market, linked
exchange or board of trade operating pursuant to a Rule 30.11 exemption
order may be adversely affected by use of the AORS and (2) reasonable
precautions to ensure against unauthorized access, unauthorized trading
and unauthorized disclosure of customer or foreign futures or foreign
options customer orders \42\ and to provide overall integrity and
security of the AORS.
---------------------------------------------------------------------------
\41\ This proposed rule is consistent with conditions currently
placed on customers of the CME who may transmit Globex orders to
FCMs via the Internet. By letter to the CME dated August 14, 1997,
the Division, under authority delegated by the Commission in Rule
1.41(a)(3), informed the CME that its proposal to permit customers
to transmit Globex orders to FCMs via the Internet did not require
Commission approval under section 5a(a)(12) of the Act. Under CME's
proposal, customers do not have direct access to Globex. Rather, the
proposal permits CME clearing members to accept customer orders via
the Internet. After receipt of a customer order, the order is
transmitted to Globex via the clearing member's order routing system
and CME's computer-to-computer interface (``CTCI''), which enables a
clearing member to upload and download orders between the member's
order routing system and Globex. A CME clearing member may use CME's
CTCI only if (1) the member's order routing system contains
automated credit controls or position limits or (2) customer orders
received by a member through its order routing system are subject to
manual review and processing by a clearing member employee prior to
being entered into a Globex terminal.
\42\ See Commission Rule 155.3(b)(1).
---------------------------------------------------------------------------
With respect to recordkeeping, the Commission is proposing that a
qualified AORS must enable an FCM to download trade history on each
order entered through the system on a daily basis and otherwise to
maintain records related to such orders in accordance with Commission
Rule 1.31.\43\ To assure system integrity and appropriate trade data,
any and all modifications to or cancellations of an order must be
recorded. In addition, the Commission is proposing to require an FCM to
maintain a record of accounts for which it will accept or transmit for
execution orders that have been entered through an AORS. This record
shall also include the name of any person designated by a customer or a
foreign futures or foreign options customer to exercise control over
the trading decisions for the account and shall be maintained in
accordance with Commission Rule 1.31.\44\ A Rule 30.10 firm should
maintain records in accordance with the
[[Page 14173]]
requirements of its home country regulator, which would then be
available to Commission or NFA representatives under appropriate
information sharing arrangements.
---------------------------------------------------------------------------
\43\ See proposed Rule 1.71(b)(8).
\44\ Proposed Rule 1.71(c). The records of third-party account
controllers, like all books and records required to be kept by the
Act or rules thereunder, must be readily accessible during the first
two years of the required five-year retention period under Rule
1.31. Commission staff have sometimes experienced difficulty in
obtaining this information on existing accounts. Such information is
required by Rule 1.37 and is generally maintained by FCMs, but
sometimes the manner of maintenance improperly makes ready retrieval
difficult.
---------------------------------------------------------------------------
As discussed above, proposed Rule 1.71 is intended to establish
minimum requirements with respect to the use and the soundness of an
AORS. The Commission believes that these basic, common sense
requirements likely would be adopted by any responsible FCM or Rule
30.10 firm, even in the absence of Commission action. Indeed, the
Commission anticipates that AORSs may contain protections more
elaborate than those required under the proposed rules. Depending on
the nature of the system, compliance with existing Commission Rules
1.16 and 166.3 may require more stringent internal controls and
protections to be in effect. The Commission requests comments as to
whether any additional specific prudential standards should be included
in the Commission's rules concerning the use of AORSs.
Certain commenters noted that rules pertaining to AORSs should
apply universally. The Commission agrees with that position and is
therefore proposing to add to Commission Rule 30.3 a new paragraph (e)
to provide that, notwithstanding the terms of any prior Rule 30.10
order, it shall be unlawful for a Rule 30.10 firm to accept or transmit
for execution an order from a foreign futures or foreign options
customer through an AORS unless the system satisfies the requirements
of proposed Rule 1.71(a), as appropriate for a Rule 30.10 firm. This
provision would apply to existing Rule 30.10 firms irrespective of what
may have been stated in an earlier Commission order under Rule 30.10.
With respect to the disclosure of risk that an FCM must provide to
a customer or a foreign futures of foreign options customer using an
AORS, the Commission notes that Rule 1.55, certain provisions of which
are referred to above, provides in paragraph (g) thereof that any
specific requirements set forth therein do ``not relieve (an FCM) from
any other disclosure obligation it may have under applicable law.''
Therefore, although the Commission is not proposing any specific risk
disclosure language applicable to an AORS or a DES, just as it has not
done so for contract market automated trading systems, the Commission
believes that FCMs must disclose material risks about these systems.
Designated contract markets have developed risk disclosure statements
for their automated trading systems that FCMs provide to customers
using those systems, and comparable risk disclosures would be necessary
and appropriate as to AORSs and DESs.
The Commission notes that there have been discussions between
Commission staff and a joint industry-NFA committee concerning a
generic electronic trading and order routing systems disclosure
statement, which is proposed to replace the contract market-specific
disclosure statements with the understanding that customers would
always be entitled to further information about a particular system
upon request or about particular material risks not otherwise covered
by the generic disclosure statement. In determining whether a
petitioner's regulatory structure is generally comparable to the U.S.
structure with respect to customer protection and prohibition of fraud
and abuse, the Commission would review the petitioner's risk
disclosures pertaining to its automated trading systems in light of
those prepared by designated contract markets for their systems and any
generic disclosure statement ulitmately developed in discussions
between Commission staff and the industry-NFA committee discussed
above. The Commission requests comment concerning any specific
disclosure provisions that should be set forth in Commission rules.
The Commission also notes that proposed Rule 1.71 would not apply
in a situation where the customer is outside the U.S. and trades on a
Rule 30.11 exempt board of trade or foreign board of trade, but the
trade is given up for clearance after execution to an FCM. The focus of
Rule 1.71 is to assure that there is a sound automated system that will
be secure and provide for credit and trading or position limit checks
prior to execution, and the Commission does not believe that the above
situation would allow pre-screening by the FCM. Of course, the
Commission expects that an FCM will maintain appropriate internal
controls and supervision with respect to any account that it clears in
accordance with existing Rules 1.16 and 166.3.
The Commission is not proposing to apply the AORS definition or
Rule 1.71 to order routing for open outcry execution. The Commission
intends that these proposals would not alter its prior advisory
referred to above or impact on efforts of contract markets using open
outcry execution to enhance the automation of order flow.
4. Interim Procedures
Several commenters have requested that the Commission grant interim
relief to allow automated access from within the U.S. to boards of
trade primarily operated outside the U.S. in anticipation of the
Commission's final rules. The Commission appreciates the importance of
the issues involved in this rulemaking, but does not believe that it is
appropriate to grant interim relief either before the Commission's
adoption of final rules or pending the Commission's review of a board
of trade's petition. Interested boards of trade should feel free,
however, to begin a dialogue now with Commission staff to help expedite
their preparation and submission of a petition following the
Commission's adoption of final rules.
IV. Related Matters
A. Regulatory Flexibility Act
The Regulatory Flexibility Act (``RFA''), 5 U.S.C. 601-611 (1994),
requires that agencies, in proposing rules, consider the impact of
those rules on small businesses. The proposed rules discussed herein
would affect boards of trade, their members or members' affiliates and
FCMs. Many board of trade members and affiliates thereof will be FCMs.
The commission previously has determined that, based upon the fiduciary
nature of the FCM/customer relationships, as well as the requirement
that FCMs meet minimum financial requirements, FCMs should be excluded
from the definition of small entity.\45\ With respect to potentially
affected entities that are not FCMs, such entities must be board of
trade members or their affiliates, which generally have financial
requirements comparable to FCMs. On that basis, these entities should
not be considered ``small.'' Boards of trade likely to seek electronic
access to their products from within the U.S. are similar in nature to
designated contract markets, and the Commission has excluded contract
markets from the definition of small entity.\46\ Accordingly, on behalf
of the Commission, the Chairperson certifies that this proposed rule
will not have a significant economic impact on a substantial number of
small entities. Moreover, this proposal provides an alternative to the
contract market designation process and to compliance with the law and
rules related to contract markets and, in that respect, is less
burdensome than that currently in place. Nevertheless, we invite
comments regarding the applicability of the FRA to these proposed
rules.
---------------------------------------------------------------------------
\45\ FR 18618-18621 (April 30, 1982).
\46\ Id.
---------------------------------------------------------------------------
B. Paperwork Reduction Act
When publishing proposed rules, the Paperwork Reduction Act of 1995
(Pub.
[[Page 14174]]
L. 104-13 (May 13, 1995)) imposes certain requirements on federal
agencies (including the Commission) in connection with their conducting
or sponsoring any collection of information as defined by the Paperwork
Reduction Act. In compliance with the Act, the Commission, through
these rule proposals, solicits comments to:
(1) Evaluate whether the proposed collection of information is
necessary for the proper performance of the functions of the agency,
including the validity of the methodology and assumptions used; (2)
evaluate the accuracy of the agency's estimate of the burden of the
proposed collection of information including the validity of the
methodology and assumptions used; (3) enhance the quality, utility,
and clarity of the information to be collected; and (4) minimize the
burden of the collection of the information on those who are to
respond, including through the use of appropriate automated,
electronic, mechanical, or other technological collection techniques
or other forms of information technology, e.g., permitting
electronic submission of responses.
The Commission has submitted these proposed rules and their
associated information collection requirements to the Office of
Management and Budget. The burden associated with this entire
collection (3038-0023), including these proposed rules, is as follows:
Average Burden Hours Per Response: 39.36003.
Number of Respondents: 73,640.
Frequency of Response: On occasion.
The burden associated with this specific proposed rule, is as
follows:
Average Burden Hours Per Response: 21.25003.
Number of Respondents: 140.
Frequency of Response: On occasion and quarterly.
Persons wishing to comment on the estimated paperwork burden
associated with these proposed rules should contact Desk Officer,
Office of Management and Budget, Room 10202, NEOB, Washington, DC 20503
(202) 395-7340. Copies of the information collection submission to OMB
are available from the CFTC Clearance Officer, 1155 21st Street, NW.,
Washington, DC 20581, (202) 418-5160.
List of Subjects
17 CFR Part 1
Commodity futures; Automated order routing system.
17 CFR Part 30
Commodity futures; Foreign futures and foreign options.
In consideration of the foregoing, and pursuant to the authority
contained in the Commodity Exchange Act, and in particular, sections
2(a)91)(A), 4, 4c and 8a thereof, 7 U.S.C. 2, 6, 6c and 12a, the
Commission hereby proposes to amend parts 1 and 30 of chapter I of
title 17 of the code of Federal Regulations as follows:
PART I--GENERAL REGULATIONS UDNER THE COMMODITY EXCHANGE ACT
1. The authority citation ofr part 1 continues to read as follows:
Authority: 7 U.S.C. 1a, 2, 2a, 4, 4a, 6, 6a, 6b, 6c, 6d, 6e, 6f,
6g, 6h, 6i, 6k, 6l, 6m, 6n, 6o, 6p, 7, 7a, 7b, 8, 9, 12, 12a, 12c,
13a, 13a-1, 16, 16a, 19, 21, 23 and 24.
2. Section 1.3 is proposed to be amended by adding paragraph (tt)
to read as follows:
Sec. 1.3 Definitions.
* * * * *
(tt) Automated order routing system. This term means any system of
computers, software or other devices that allows entry of orders
through another party for transmission to a board of trade's computer
or other automated device where, without substantial human
intervention, trade matching or execution takes place.
3. Section 1.71 is proposed to be added to read as follows:
Sec. 1.71 Automated order routing system.
(a) It shall be unlawful for a firm registered or required to be
registered as a futures commission merchant or a firm exempt from such
registration under Sec. 30.10 of this chapter to accept or transmit for
execution an order from or on behalf of a customer (other than an owner
or holder of a proprietary account as defined in Sec. 1.3(y)) or a
foreign futures or foreign options customer (as defined in Sec. 30.1(c)
of this chapter) that has been entered through an automated order
routing system, whether the system is operated, maintained or provided
to the customer or the foreign futures or foreign options customer by
the futures commission merchant, a firm exempt from such registration
under Sec. 30.10 of this chapter or by another person, unless the
automated order routing system is a qualified automated order routing
system: Provided, however that the requirements of this section shall
not apply to orders received by a firm registered or required to be
registered as a futures commission merchant or a firm exempt from such
registration under Sec. 30.10 of this chapter from a registered futures
commission merchant for that futures commission merchant's customer
omnibus accounts or proprietary accounts.
(b) To be a qualified automated order routing system, such
automated order routing system shall provide that:
(1) Access is limited to:
(i) Trading conducted on or subject to the rules of a designated
contract market, through a registered futures commission merchant;
(ii) Trading conducted on or subject to the rules of a board of
trade to which the Commission has issued an exemption order under
section 4(c) of the Act following the board of trade's submission of a
petition in accordance with Sec. 30.11 of this chapter; or
(iii) Trading conducted on a board of trade the products of which
are accessible as part of an automated trading system operated pursuant
to specific rules regarding the particular linkage arrangement that
have been submitted by a designated contract market to the Commission
and are in effect pursuant to section 5a(a)(12)(A) of the Act and
Sec. 1.41 and which is otherwise primarily operating outside the United
States.
(2) Access is limited to products that can be lawfully offered and
sold in the United States;
(3) The futures commission merchant or firm exempt from such
registration under Sec. 30.10 of this chapter takes reasonable steps to
ensure that the system is and remains sound and secure and fit for the
purpose for which it is intended;
(4) For futures commission merchants, information required by
Sec. 1.35(a-1)(1) is recorded in accordance with that paragraph, except
that order-related times must be captured to the nearest second;
(5) It is designed and operated consistent with the duty of the
futures commission merchant or firm exempt from such registration under
Sec. 30.10 of this chapter to maintain proper internal controls and
supervision over the handling of customer accounts. This must include,
but is not limited to, credit and trading or position limit checks that
are performed, either by a natural person or by the system itself,
prior to the order's execution. If such credit and trading or position
limit checks are automated, the futures commission merchant or firm
exempt from such registration under Sec. 30.10 of this chapter shall
implement proper internal controls to ensure that limits appropriate to
each customer or foreign futures or foreign options customer as
determined by personnel of the futures commission merchant or the firm
exempt from such registration under Sec. 30.10 of this chapter
authorized to set such limits are properly input into the
[[Page 14175]]
automated order routing system and updated as appropriate;
(6) The futures commission merchant or firm exempt from such
registration under Sec. 30.10 of this chapter has the capability on a
unilateral and immediate basis to block any customer's or foreign
futures or foreign options customers' use of an automated order routing
system where necessary or appropriate to safeguard the futures
commission merchant or firm exempt from registration under Sec. 30.10,
customer accounts or the stability or security of any designated
contract market or any board of trade referred to in paragraphs
(b)(1)(ii) and (iii) of this section; or for any other appropriate
reason;
(7) There are reasonable safeguards to ensure against unauthorized
access, unauthorized trading, and unauthorized disclosure of customer
or foreign futures or foreign options customer orders and to provide
overall integrity and security of the automated order routing system;
and
(8) For a futures commission merchant, that the futures commission
merchant has the capability to download trade history on each order
entered through an automated order routing system on a daily basis and
otherwise to maintain records related to such orders in accordance with
Sec. 1.31.
((c)(1) A futures commission merchant shall maintain in accordance
with Sec. 1.31 a record of those accounts of customers or foreign
futures or foreign options customers for which the futures commission
merchant will accept or transmit for execution orders that have been
entered through an automated order routing system. This record shall
also include the name of any person designated by the customer or
foreign futures or foreign options customer to exercise control over
the trading decisions for the account, which shall be readily
accessible during the first two years of the required five-year
retention period under Sec. 1.31.
(2) A firm that is exempt from registration as a futures Medicare
pursuant to an order granted by the Commission under Sec. 30.10 of this
chapter shall maintain in accordance with the recordkeeping
requirements of its home country regulator a record of those accounts
of foreign futures or foreign options customers for which the firm will
accept or transmit for execution orders that have been entered through
an automated order routing system. This record shall also include the
name of any person designated by the foreign futures or foreign options
customer to exercise control over the trading decisions for the account
and shall be made available upon the request of any Commission
representative.
PART 30--FOREIGN OPTIONS AND FOREIGN FUTURES TRANSACTIONS
4. The authority citation for part 30 continues to read as follows:
Authority: 7 U.S.C. 2, 4, 6, 6c, and 12a.
5. Section 30.3 is proposed to be amended by adding paragraphs (c)-
(e) to read as follows:
Sec. 30.3 prohibited transactions.
* * * * *
(c) Except as otherwise provided in Sec. 30.11, it shall be
unlawful to use or to provide to any person in the United States a
direct execution system (as defined in Sec. 30.11(a)(1)) for the
purpose of facilitating the execution of transactions in foreign
futures or foreign options unless the board of trade to which the
direct execution system provides access has been designated as a
contract market under section 5 of the Act.
(d) Except as otherwise provided in Sec. 30.11, it shall be
unlawful for any person to solicit or accept orders for, or to accept
money, securities or property in connection with, the purchase or sale
of foreign futures or foreign options by a foreign futures or options
customer that are entered via an automated order routing system (as
defined in Sec. 30.11(a)(2)) unless the board of trade through which
the transaction is to be executed has been designated as a contract
market under section 5 of the Act.
(e) notwithstanding the terms of any prior Commission order issued
under Sec. 30.10, it shall be unlawful for a firm operating pursuant to
a confirmation of a Commission order issued under Sec. 30.10 to accept
or transmit for execution an order from a foreign futures or foreign
options customer through an automated order routing system unless the
applicable requirements of Sec. 1.71 of this chapter are satisfied.
Sec. 30.11 [Redesignated as Sec. 30.12]
6. Section 30.11 is redesignated as Sec. 30.12 and a new Sec. 30.11
is added to read as follows:
Sec. 30.11 Access from the United States to automated trading systems
of a board of trade whose primary locus of regulation and operations is
otherwise outside the United States.
(a) Definitions: For purposes of this section:
(1) Direct execution system means any system of computers, software
or other devices that allows entry of orders for products traded on a
board of trade's computer or other automated device where, without
substantial human intervention, trade matching or execution takes
place: Provided, however, that this term shall not include an automated
order routing system as that term is defined in Sec. 1.3(tt) of this
chapter.
(2) Automated order routing system means automated order routing
system as defined in Sec. 1.3(tt) of this chapter.
(3) An affiliate of a member of a board of trade for purposes of
this rule means any person that:
(i) Owns 50% or more of a member;
(ii) Is owned 50% or more by the member; or
(iii) Is owned 50% or more by a third person that also owns 50% or
more of the member.
(4) Proprietary account means proprietary account as defined in
Sec. 1.3(y) of this chapter.
(b)(1) Upon the submission of a petition for exemption by a board
of trade in accordance with this section, the Commission may issue an
exemption order to the board of trade if the Commission determines
that:
(i) The petitioner is an established board of trade that wishes to
place within the United States an automated trading system permitting
access to trading its products but whose activities are otherwise
primarily located in a particular foreign country that has taken
responsibility for regulation of the petitioner;
(ii) The petitioner's home country has established a regulatory
scheme that is generally comparable to that in the U.S. and provides
basic protections for customers trading on markets and for the
integrity of the markets themselves;
(iii) Except for certain incidental contacts with the U.S., the
petitioner would be present in the U.S. only by virtue of being
accessible from within the U.S. via its automated trading system;
(iv) The petitioner is willing to submit itself to the jurisdiction
of the Commission and the U.S. courts in connection with its activities
conducted under an exemptive order;
(v) The petitioner's automated trading system has been approved by
the petitioner's home country regulator following a review of the
system that applied the standards set forth in the 1990 International
Organisation of Securities Commissions report on screen-based trading
systems (as may be revised and updated from time-to-time) or
substantially similar standards; and
(vi) Satisfactory information sharing arrangements are in effect
between the Commission and the petitioner and the petitioner's
regulatory authority.
[[Page 14176]]
(2) A petition of a board of trade made pursuant to this section
should be filed with the Secretary of the Commission and must contain
the following information, in English:
(i) The address of the petitioner's main business office and the
name, address, telephone number, facsimile number and electronic mail
address of a person to contact for additional information concerning
the petition;
(ii) The petitioner's articles of association, constitution, or
other similar organizational documents along with the date and place of
its establishment;
(iii) A complete description of the contracts that initially will
be traded through direct execution systems and/or automated order
routing systems located in the United States;
(iv) The petitioner's current rules including all rules for members
and users, which may be attached as an Appendix to the petition, and
shall include a description of membership requirements and classes and
distinctions between customer and proprietary trading;
(v) The address of the office responsible for monitoring compliance
with the petitioner's rules and the supervisory arrangements for
monitoring compliance with the rules insofar as the rules apply to
activities conducted in the United States, as well as the name and
address of the petitioner's home country regulator;
(vi) A description of the regulatory structure established in the
petitioner's home country, including, without limitation, a description
of the regulatory authority to which the petitioner is subject under
the laws of such country, the status of the petitioner under those
laws, and the applicable statutory and regulatory requirements
established by law or by the regulatory authority that govern the
operation of futures and options trading in the petitioner's home
country, including, without limitation, applicable regulations or
requirements concerning:
(A) Prohibition of fraud, abuse and market manipulation relating to
trading on petitioner's markets;
(B) Recordkeeping and reporting by the petitioner or its members;
(C) Fitness standards for intermediaries operating on petitioner's
markets, members, or others;
(D) Financial standards for the petitioner's members;
(E) Protection of customer funds, including procedures in the event
of a clearing member's default, insolvency or bankruptcy;
(F) Trade practice standards;
(G) Rule review or general review of board of trade operations by
its regulatory authority;
(H) Surveillance, compliance, and enforcement mechanisms employed
by the board of trade and its regulatory authority to ensure compliance
with their rules and regulations; and
(I) Regulatory oversight of clearing facilities; Provided, however,
that if the petitioner or the regulatory authority that governs the
petitioner has received an order of exemption, for trading on the
petitioning board of trade, from the Commission under Sec. 30.10 and
the information required by paragraphs (b)(2) (ii), (iv) and (vi) of
this section was provided to the Commission in the petition for such
order and has not changed materially from the date of the Commission's
order, the petitioner may, in lieu of furnishing the information
otherwise required under paragraphs (b)(2) (ii), (iv) and (vi) of this
section, make a statement to such effect which shall specify the
date(s) the information was provided to the Commission and the name of
the petitioner who received an order from the Commission under
Sec. 30.10;
(vii) Information sharing arrangements in effect between the board
of trade and the regulatory authority in the petitioner's home country
and the Commission, including information concerning any blocking
statutes or data protection laws in effect in the petitioner's home
country that might impair the Commission's ability to obtain
information in accordance with such an arrangement;
(viii) A general description of the order matching/execution system
and any direct execution system, software or devices operated by the
board of trade, including, at a minimum, a general description of the
architecture and security features of the systems, a statement as to
the length of time such systems have been operating, a complete history
of any significant system failures or interruptions, and a discussion
of the nature of any technical review of the board of trade's order
matching/execution system or direct execution system performed by the
board of trade's home country regulator, including a copy of any order
or certification received and any discrepancies between the standard of
review and the principles for screen-based trading set forth by the
International Organisation of Securities Commissions: Provided,
however, that if the information required by this paragraph has been
provided to the Commission, or will be provided to the Commission
contemporaneously with the board of trade's petition, by another board
of trade whose products trade through the same direct execution system
or automated order routing system as the petitioner, the petitioner
must so state and must identify the board of trade that has or will
provide the Commission with the required information and need not
itself provide the information required under this paragraph, but will
remain responsible for the provision of such information by the other
board of trade;
(ix) A description of all activities engaged in by the board of
trade or its employees, agents or representatives in the United States,
including, but not limited to, activities in connection with marketing,
education or otherwise promoting the board of trade's business or
products;
(x) The address of, and a description of activities engaged in by,
any office of the board of trade located in the United States and the
number of personnel employed or retained by the board of trade in the
United States, including the number of personnel in each such office;
(xi) If the petitioner lists for trading any futures contracts that
involve physical delivery of the underlying commodity and warehouses in
connection with such delivery are located in the United States, its
territories or possessions, the address of any such warehouses;
(xii) A written statement in which the petitioner consents to or
agrees to comply with each of the conditions listed in paragraph (d) of
this section; and
(xiii) Any further information that the Commission or its
representatives request.
(c) To the extent that the products of multiple boards of trade are
to be traded from the same direct execution system or automated order
routing system, each board of trade whose products will be made
available from such systems located in the United States must, either
individually or jointly, submit a petition in accordance with this
section: Provided, however, that a board of trade's products may be
offered through direct execution systems or automated order routing
systems located in the United States and need not submit a petition to
the Commission under this section or be designated as a contract market
under section 5 of the Act if its products are accessible as part of an
electronic trading system operated pursuant to specific rules regarding
the particular linkage arrangement that have been submitted by a
designated contract market to the Commission for review and are in
effect under section 5a of the Act.
[[Page 14177]]
(d) The Commission may issue an order under section 4(c) of the Act
and the provisions of this section subject to such terms and conditions
as the Commission may find appropriate: Provided, however, that any
order issued to a board of trade under this section will be subject to
the following conditions at a minimum, unless otherwise specified in
the order by the Commission:
(1) Only members of the board of trade and affiliates thereof will
have access to direct execution systems, and the board of trade will
not provide, and will take reasonable steps to prevent third parties
from providing, direct execution systems to persons other than members
and their affiliates;
(2) Unless otherwise exempt from registration, any member or
affiliate thereof that solicits or accepts orders for, or accepts
money, securities or property in connection with the purchase or sale
of foreign futures or foreign options by a foreign futures or foreign
options customer via an automated order routing system, or that
transmits the order of a foreign futures or foreign options customer
via a direct execution system, must be a registered futures commission
merchant or a firm exempt from such registration pursuant to an order
granted under Sec. 30.10;
(3) The board of trade will submit the following information to the
Commission on at least a quarterly basis:
(i) For each contract available to be traded through direct
execution systems and automated order routing systems located in the
United States, the total trade volume originating from such systems
located in the United States; and
(ii) For each contract available to be traded through direct
execution systems and automated order routing systems located in the
United States, the board of trade's total worldwide trade volume, from
any source;
(iii) A current list that:
(A) Identifies and provides the main business addresses in the
United States for those of its members and affiliates thereof that have
direct execution systems in the United States and indicates which of
such members and affiliates thereof allow the use of automated order
routing systems for foreign futures and foreign options customers; and
(B) Identifies and provides the main business addresses for those
of its members and affiliates thereof that allow the use of automated
order routing systems by foreign futures and foreign options customers,
but who do not have direct execution systems in the United States:
Provided, however, that the board of trade will additionally provide a
current list to a Commission representative at any time upon request;
(4) The board of trade will provide the Commission with written
notice within 30 calendar days of:
(i) Any material change to any information provided in its petition
to the commission for a section 4(c) exemption order under this
section: Provided, however, that the board of trade will notify the
Commission in writing:
(A) At least ten business days prior to offering any products not
listed in its initial petition to be traded through direct execution
systems or automated order routing systems located in the United States
and;
(B) Within 24 hours of any significant system failure or
interruption or a member's default, insolvency or bankruptcy;
(ii) A change in any laws or rules in the board of trade's home
country relevant to futures or options, including rules of the board of
trade itself, that may have a material impact on the order;
(iii) Any known violation of any obligations under the order
committed by a member of the board of trade or an affiliate thereof
operating in the United States under the order; and
(iv) Any disciplinary action taken against a member of the board of
trade or an affiliate thereof operating in the United States under the
order that involves any market manipulation, fraud, deceit or
conversion or that results in suspension or expulsion and that involves
the use of a direct execution system or an automated order system in
the United States;
(5) Satisfactory information sharing arrangements must remain in
effect between the board of trade and the board of trade's regulatory
authority and the Commission;
(6) Prior to operating pursuant to the section 4(c) exemption
order, the board of trade must file with the Commission, and maintain
thereafter as long as the board of trade operates pursuant to the
order, a valid and binding appointment of an agent for service of
process in the United States, pursuant to which such agent is
authorized to accept delivery and service of communications issued by
or on behalf of the Commission, the Department of Justice, any board of
trade member or affiliate of such member, or any foreign futures or
foreign options customer. Service or delivery of any communication
issued by or on behalf of any of the foregoing to the appointed agent
shall constitute valid and effective service or delivery; and
(7) Prior to operating pursuant to the section 4(c) exemption
order, the board of trade must file with the Commission a written
representation, executed by someone with authority to bind the board of
trade, that, as long as the board of trade operates pursuant to the
order, the board of trade irrevocably agrees to and submits to the
jurisdiction of the Commission and state and federal courts in the
United States with respect to the board of trade's activities conducted
under the section 4(c) exemption order;
(8) The Commission, in its discretion, may require other
information of the board of trade to evaluate its continued eligibility
for or compliance with conditions of a section 4(c) exemption order, or
for any other reason. The Commission may require the board of trade to
provide information regarding the stocks held at any warehouse
maintained by the board of trade in the U.S. for products that require
physical delivery.
(e) The Commission shall publish in the Federal Register a notice
of availability of each petition received under paragraph (b) of this
section for the purpose of providing notice to the public. Interested
parties may request a copy of the petition or relevant parts thereof
from the Secretary of the Commission: Provided, however, that the
Commission may limit the public availability of any information
received from the petitioner if the petitioner submits a written
request to limit disclosure contemporaneously with the petition and the
Commission determines that the information sought to be restricted
constitutes a trade secret or that public disclosure of the information
would result in material competitive harm to the petitioner.
(f) The Commission may, as it deems appropriate, condition, modify,
suspend, terminate, or otherwise restrict the terms of an order issued
under section 4(c) of the Act in accordance with this section if the
Commission determines that a board of trade that has received a section
4(c) exemption order in accordance with this section is in material
violation of any term or condition of the order, or this section that
the continued effectiveness of the order would be contrary to public
policy or the public interest, or that circumstances otherwise do not
warrant continuation of the order as issued. The Commission may take
such action with respect to the order in its entirety or with respect
to a specific person or persons operating thereunder.
(g) Any trading conducted on or subject to the rules of a board of
trade
[[Page 14178]]
that has received a section 4(c) exemption order in accordance with
this section or a board of trade the products of which are accessible
as part of an automated trading system operated pursuant to specific
rules regarding the particular linkage arrangement that have been
submitted by a designated contract market to the Commission and are in
effect pursuant to section 5a(a)(12)(A) of the Act and Sec. 1.41 of
this chapter and which otherwise operates primarily outside the United
States shall be deemed to involve the trading of foreign futures or
foreign options, as appropriate, under the definitions of Sec. 30.1(a)
and (b) and under any provisions that refer to those definitions. A
person located in the United States, its territories or possessions
engaged in such trading shall be deemed to be a foreign futures or
foreign options customer under Sec. 30.1(c).
Issued in Washington, DC on March 16, 1999 by the Commission.
Jean A. Webb,
Secretary of the Commission.
Commissioner Barbara P. Holum joining in the concurring opinions of
Commissioners Spears and Newsome.
Dated: March 16, 1999.
Commissioner Barbara P. Holum.
Concurring Opinion of Commissioner David D. Spears--Proposed Rules
Concerning Access to Automated Boards of Trade
I have significant reservations about the complexity of the
proposed rules. I believe the elaborate regulatory system this proposal
envisions could impose unnecessary burdens on US FCMs and could be
cited by foreign regulators as justification for imposing unnecessarily
restrictive requirements on US exchanges. However, I also recognize
that the Commission needs to act as quickly as possible to address
issues relating to access to foreign boards of trade from within the
US. Further delay in issuing proposed rules to allow for additional
revisions or refinements in the proposal would be a disservice to those
affected by the proposal. The investing public and the futures industry
have every right to expect this agency to act expeditiously in bringing
legal certainty to this area. Therefore, I have voted to issue the
proposed rules in the form presented. However, I would urge commenters
to review the proposal carefully with an eye toward suggesting
revisions that would make the rules simpler without detracting from
adequate customer protection or the fair and even-handed treatment of
all affected parties.
Concurring Opinion of Commissioner James E. Newsome--Proposed Rules
Concerning Automated Trading System Use in the United States
I respectfully concur in the issuance of the proposed rules
concerning automated trading system use in the United States. I agree
that the proposal should be released for public comment, but I do not
agree with the approach detailed therein, for the reasons stated below.
My concerns are twofold: first, I believe that the proposal is
overly regulatory in approach, and secondly, I believe that there are
troublesome jurisdictional issues inherent in the proposed regulation,
specifically, the use of the Commodity Exchange Act's Sec. 4(c)
exemptive authority and the possible conflict with the Act's Sec. 4(b)
jursidictional limitations. I do not believe that the proposal
appropriately mitigates the competitive concerns of our domestic
exchangers, and, indeed, may well exacerbate the issue of inequitable
regulatory treatment. Moreover, I believe that there are unnecessary
additional burdens included in this proposal that would negatively
affect the futures commission merchant community.
Given the widespread interest in this issue and the unfortunate
delay in its release, I support moving forward expeditiously and giving
the public another opportunity to comment on the proposal. However, I
strongly urge interested parties to comment particularly on the issues
I have mentioned, as well as alternative methods of addressing this
issue, including, for example, the use of no-action procedures or the
CEA's Part 30 Regulations.
Dated: March 15, 1999.
James E. Newsome,
Commissioner.
[FR Doc. 99-6829 Filed 3-23-99; 8:45 am]
BILLING CODE 6351-01-M
