Futures and options on futures based on broad-based security indexes are under the exclusive jurisdiction of the CFTC. This is in contrast to security futures products, including futures on narrow-based security indexes, which are subject to the joint jurisdiction of the CFTC and the Securities and Exchange Commission.
Specifically, Section 2(a)(1)(C)(iv) of the Commodity Exchange Act (CEA), 7 USC 2(a)(1)(C)(iv), generally prohibits any person from offering or selling a futures contract based on a security index in the U.S., except as otherwise permitted under the CEA, including Section 2(a)(1)(C)(ii) of the CEA, 7 USC 2(a)(1)(C)(ii). By its terms Section 2(a)(1)(c)(iv) of the CEA applies to futures contracts on security indexes traded on both domestic and foreign boards of trade.
Section 2(a)(1)(C)(ii) of the CEA sets forth three criteria to govern the trading of futures contracts on a group or index of securities on designated contract markets:
1. the contract must provide for cash settlement;
2. the contract must not be readily susceptible to manipulation or to being used to manipulate any underlying security; and
3. the group or index of securities must not constitute a narrow-based security index.
The CEA does not explicitly address the standards to be applied to a foreign security index futures contract traded on a foreign board of trade. The CFTC has applied the three criteria noted above in evaluating requests by foreign boards of trade to allow the offer and sale within the U.S. of their foreign security index futures contracts when those foreign boards of trade do not seek designation as a contract to trade those products. When requested by a foreign board of trade, the Commission will certify foreign broad-based security index futures contracts that meet the requirements specified in Section 2(a)(1)(C)(ii) of the CEA.
In the analysis of a request for certification a foreign security index futures contract traded on a foreign board of trade, the CFTC’s Division of Market Oversight evaluates the foreign security index futures contract to ensure that it complies with the three criteria of Section 2(a)(1)(C)(ii) of the CEA. In addition, because broad-based security index futures contracts are cash settled, the Division of Market Oversight also evaluates the contract to ensure that the contract terms and conditions relating to cash settlement are consistent with the Commission’s Appendix C to part 38. For cash settled contracts, Appendix C to part 38 requires that the cash price series be not readily susceptible to manipulation, and be accurate, reliable, highly regarded by industry/market agents, and fully reflective of the economic and commercial conditions. In addition, to the extent possible, the cash settlement price should be based on cash price series that are publicly available and available on a timely basis for purposes of calculating the cash settlement price at the expiration of a commodity contract.
In making its determination, the Division of Market Oversight considers the design and maintenance of the index, the method of index calculation, the nature of the component security prices used to calculate the index, the breadth and frequency of index dissemination, and any other relevant factors.
In considering the susceptibility of an index to manipulation, the Division of Market Oversight examines several factors, including the structure of the primary and secondary markets for the component equities, the liquidity of the component stocks, the method of index calculation, the total capitalization of stocks underlying the index, the number, weighting and capitalization of individual stocks in the index, and the existence of surveillance sharing agreements between the board of trade and the securities exchange(s) on which the underlying securities are traded.
To verify that an index is not narrow-based, the Division of Market Oversight considers the number and weighting of the component securities and the value of average daily trading volume of the lowest weighted quartile of securities. Under the CEA, a security index is narrow-based if it meets any one of the following criteria:
1. the index is composed of fewer than ten securities;
2. any single security comprises more than 30 percent of the total index weight;
3. the five largest securities comprise more than 60 percent of the total index weight; or
4. the lowest-weighted securities that together account for 25 percent of the total weight of the index have an aggregate dollar value of average daily trading volume of less than U.S. $30 million (or U.S. $50 million if the index includes fewer than 15 securities).
Pursuant to Commission Regulation 30.13, a foreign board of trade seeking Commission certification of a futures contract on a non-narrow based foreign security index traded on that foreign board of trade should electronically submit to the Secretary of the CFTC’s , in English:
1. The terms and conditions of the contract and all other relevant rules of the exchange and, if applicable, of the exchange on which the underlying securities are traded, which have an effect on the overall trading of the contract, including circuit breakers, price limits, position limits, or other controls on trading;
2. Surveillance agreements between the foreign board of trade and the exchange(s) on which the underlying securities are traded;
3. Assurances from the foreign board of trade of its ability and willingness to share information with the Commission, either directly or indirectly;
4. When applicable, information regarding foreign blocking statutes and their impact on the ability of U.S. government agencies to obtain information concerning the trading of such contracts;
5. Information and data denoted in U.S. dollars (and the conversion date and exchange rate(s) used) relating to:
a. The method of computation, availability, and timeliness of the index;
b. The total capitalization, number of stocks (including the number of unaffiliated issuers if different from the number of stocks), and weighting of the stocks by capitalization and, if applicable, by price in the index as well as the combined weighting of the five highest-weighted stocks in the index;
c. Procedures and criteria for selection of individual securities for inclusion in, or removal from, the index, how often the index is regularly reviewed, and any procedures for changes in the index between regularly scheduled reviews;
d. Method of calculation of the cash settlement price and the timing of its public release;
e. Average daily volume of trading, measured by share turnover and dollar value, in each of the underlying securities for a six-month period of time and, separately, the dollar value of the average daily trading volume of the securities comprising the lowest weighted 25 percent of the index for the past six calendar months, calculated pursuant to CFTC Regulation 41.11; and
f. If applicable, average daily futures trading volume;
1. A statement that the index is not a narrow-based security index as defined in Section 1a(35) of the CEA, 7 USC 1a(35), and the analysis supporting that statement; and
2. When applicable, a request to make the futures contract available for trading in accordance with the terms and conditions of, and through the electronic trading devices identified in, the Foreign Trading System No-Action letter that the foreign board of trade received from Commission staff and a certification from the foreign board of trade that it is in compliance with the terms and conditions of that no-action letter.