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  • Federal Register: May 14, 2007 (Volume 72, Number 92)]

    [Notices]

    [Page 27091-27093]

    From the Federal Register Online via GPO Access [wais.access.gpo.gov]

    [DOCID:fr14my07-21]

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    COMMODITY FUTURES TRADING COMMISSION

    Proposal To Exempt the Trading and Clearing of Certain Credit Default Products Traded on the Chicago Board Options Exchange and Cleared Through the Options Clearing Corporation Pursuant to the Exemptive Authority in Sec. 4(c) of the Commodity Exchange Act

    AGENCY: Commodity Futures Trading Commission.

    ACTION: Notice of proposed order and request for comment.

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    SUMMARY: The Commodity Futures Trading Commission (``CFTC'' or the ``Commission'') is proposing to exempt the trading and clearing of certain credit default products that are proposed to be traded on the Chicago Board Options Exchange (``CBOE'') and cleared through the Options Clearing Corporation (``OCC'') from any applicable provisions of the Commodity Exchange Act (``CEA'').\1\ Authority for this exemption is found in Section 4(c) of the CEA.\2\

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    \1\ 7 U.S.C. 1 et seq.

    \2\ 7 U.S.C. 6(c).

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    DATES: Comments must be received on or before May 29, 2007.

    ADDRESSES: Comments may be submitted by any of the following methods:

    • Federal eRulemaking Portal: http://frwebgate.access.gpo.gov/cgi-bin/leaving.cgi?from=leavingFR.html&log=linklog&to=http://www.regulations.gov/

    http://frwebgate.access.gpo.gov/cgi-bin/leaving.cgi?from=leavingFR.html&log=linklog&to=http://frwebgate.access.gpo/cgi-bin/leaving. Follow the instructions

    for submitting comments.

    • E-mail: secretary@cftc.gov. Include ``OCC Clearing Credit

    Default Options'' in the subject line of the message.

    • Fax: 202-418-5521.

    • Mail: Send to Eileen A. Donovan, Acting Secretary,

    Commodity Futures Trading Commission, Three Lafayette Centre, 1155 21st

    Street, NW., Washington, DC 20581.

    • Courier: Same as mail above.

    All comments received will be posted without change to http://frwebgate.access.gpo.gov/cgi-bin/leaving.cgi?from=leavingFR.html&log=linklog&to=http://www.cftc.gov/

    .

    FOR FURTHER INFORMATION CONTACT: John C. Lawton, Deputy Director and

    Chief Counsel, 202-418-5480, jlawton@cftc.gov, and Robert B. Wasserman,

    Associate Director, 202-418-5092, rwasserman@cftc.gov, Division of

    Clearing and Intermediary Oversight, Commodity Futures Trading

    Commission, Three Lafayette Centre, 1151 21st Street, NW., Washington,

    DC 20581.

    SUPPLEMENTARY INFORMATION:

    I. Introduction

    The OCC is both a Derivatives Clearing Organization (``DCO'')

    registered pursuant to Section 5b of the CEA, 7 U.S.C. 7a-1, and a

    securities clearing agency registered pursuant to Section 17A of the

    Securities Exchange Act of 1934 (``1934 Act'').\3\ The CBOE is a

    national securities exchange registered as such under Section 6 of the

    1934 Act.\4\

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    \3\ 15 U.S.C. 78q-l.

    \4\ 15 U.S.C. 78f.

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    CBOE has filed with the Securities and Exchange Commission

    (``SEC'') proposed rule changes to provide for the listing and trading

    on CBOE of cash-settled, binary call options based on credit events in

    one or more debt securities.\5\ These options are referred to as Credit

    Default Options (``CDOs''), and would pay the holder a specified amount

    upon the occurrence, as determined by CBOE, of a ``Credit Event,''

    defined to mean an ``Event of Default'' on any debt security issued or

    guaranteed by a specified ``Reference Entity.''

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    \5\ See Release No. 34-55251, 72 FR 7091 (Feb. 14, 2007).

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    CBOE has also filed with the SEC proposed rule changes to provide

    for the listing and trading on CBOE of Credit Default Basket Options

    (``CDBOs'').\6\ These are similar in concept to CDOs, except that a

    CDBO covers more than one Reference Entity, and for each Basket

    Component (that is, a single Reference Entity) a notional value (a

    fraction of the aggregate Notional Face Value of the basket) and a

    recovery rate is specified. Upon the occurrence of a Credit Event

    involving a particular Reference Entity, the payout to the holder is

    equal to the product of (a) The Notional Face Value of that Basket

    Component multiplied by (b) one minus the recovery rate specified in

    advance for that Basket Component. CDBOs may be of the multiple-payout

    variety, or of the single-payout variety, where a payout occurs only

    the first time a Credit Event is confirmed with respect to a Reference

    Entity prior to expiration.

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    \6\ See SR-CBOE-2007-026.

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    OCC has filed with the CFTC, pursuant to Section 5c(c) of the CEA

    and Commission Regulations 39.4(a) and 40.5 thereunder,\7\ requests for

    approval of rules and rule amendments that would enable OCC to clear

    and settle these CDOs and CDBOs in its capacity as a registered

    securities clearing agency (and not in its capacity

    [[Page 27092]]

    as a DCO).\8\ Section 5c(c)(3) provides that the CFTC must approve any

    such rules and rule amendments submitted for approval unless it finds

    that the rules or rule amendments would violate the CEA.

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    \7\ 7 U.S.C. 7a-2(c), 17 CFR 39.4(a), 40.5.

    \8\ See SR-OCC-2007-01 A-1; SR-OCC-2007-06. OCC has filed

    identical proposed rule changes with the SEC.

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    The request for approval concerning the CDO product was filed

    effective March 8, 2007. On April 23, 2007, the review period was

    extended pursuant to Regulation 40.5(c) until June 6, 2007, on the

    ground that the CDOs ``raise novel or complex issues, including the

    nature of the contract, that require additional time for review.'' The

    request for approval concerning the CDBO product was filed effective

    April 23, 2007, and absent an extension the review period is scheduled

    to run until June 7, 2007.

    II. Section 4(c) of the Commodity Exchange Act

    Section 4(c)(1) of the CEA empowers the CFTC to ``promote

    responsible economic or financial innovation and fair competition'' by

    exempting any transaction or class of transactions from any of the

    provisions of the CEA (subject to exceptions not relevant here) where

    the Commission determines that the exemption would be consistent with

    the public interest.\9\ The Commission may grant such an exemption by

    rule, regulation or order, after notice and opportunity for hearing,

    and may do so on application of any person or on its own initiative.

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    \9\ Section 4(c)(1) of the CEA, 7 U.S.C. 6(c)(1), provides that:

    In order to promote responsible economic or financial innovation

    and fair competition, the Commission by rule, regulation, or order,

    after notice and opportunity for hearing, may (on its own initiative

    or on application of any person, including any board of trade

    designated or registered as a contract market or derivatives

    transaction execution facility for transactions for future delivery

    in any commodity under section 7 of this title) exempt any

    agreement, contract, or transaction (or class thereof) that is

    otherwise subject to subsection (a) of this section (including any

    person or class of persons offering, entering into, rendering advice

    or rendering other services with respect to, the agreement,

    contract, or transaction), either unconditionally or on stated terms

    or conditions or for stated periods and either retroactively or

    prospectively, or both, from any of the requirements of subsection

    (a) of this section, or from any other provision of this chapter

    (except subparagraphs (c)(ii) and (D) of section 2(a)(1) of this

    title, except that the Commission and the Securities and Exchange

    Commission may by rule, regulation, or order jointly exclude any

    agreement, contract, or transaction from section 2(a)(1)(D) of this

    title), if the Commission determines that the exemption would be

    consistent with the public interest.

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    In enacting Section 4(c), Congress noted that the goal of the

    provision ``is to give the Commission a means of providing certainty

    and stability to existing and emerging markets so that financial

    innovation and market development can proceed in an effective and

    competitive manner.'' \10\ Permitting the CDOs and CDBOs to trade on

    CBOE and be cleared on OCC as discussed above may foster both financial

    innovation and competition. The CFTC believes that the venue or venues

    for trading and clearing of instruments such as CDOs and CDBOs should

    be determined by the competitive forces of the market, particularly

    where any potential venue would be subject to federal regulatory

    oversight. The CFTC is requesting comment on whether it should exempt

    CDOs and CDBOs, as described above, that are traded on CBOE and cleared

    through OCC, from any provision of the CEA that might be transgressed

    by trading and clearing those transactions as described above.

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    \10\ HOUSE CONF. REPORT NO. 102-978, 1992 U.S.C.C.A.N. 3179,

    3213 (``4(c) Conf. Report'').

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    In proposing this exemption, the CFTC need not--and does not--find

    that the CDOs and CDBOs are (or are not) subject to the CEA. During the

    legislative process leading to the enactment of Section 4(c) of the

    CEA, the House-Senate Conference Committee noted that:

    The Conferees do not intend that the exercise of exemptive

    authority by the Commission would require any determination

    beforehand that the agreement, instrument, or transaction for which

    an exemption is sought is subject to the Act. Rather, this provision

    provides flexibility for the Commission to provide legal certainty

    to novel instruments where the determination as to jurisdiction is

    not straightforward. Rather than making a finding as to whether a

    product is or is not a futures contract, the Commission in

    appropriate cases may proceed directly to issuing an exemption.\11\

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    \11\ 4(c) Conf. Report at 3214-3215.

    CDOs and CDBOs are ``novel instruments'' and the ``determination as to

    [their] jurisdiction is not straightforward.'' Given their potential

    usefulness to the significant market for credit derivatives products,

    however, the Commission believes that this may be an appropriate case

    for issuing an exemption without making a finding as to the nature of

    these particular instruments.

    Section 4(c)(2) provides that the Commission may grant exemptions

    only when it determines that the requirements for which an exemption is

    being provided should not be applied to the agreements, contracts or

    transactions at issue, and the exemption is consistent with the public

    interest and the purposes of the CEA; that the agreements, contracts or

    transactions will be entered into solely between appropriate persons;

    and that the exemption will not have a material adverse effect on the

    ability of the Commission or any contract market or derivatives

    transaction execution facility to discharge its regulatory or self-

    regulatory responsibilities under the CEA.\12\

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    \12\ Section 4(c)(2) of the CEA, 7 U.S.C. Sec. 6(c)(2),

    provides that:

    The Commission shall not grant any exemption under paragraph (1)

    from any of the requirements of subsection (a) of this section

    unless the Commission determines that--

    (A) The requirement should not be applied to the agreement,

    contract, or transaction for which the exemption is sought and that

    the exemption would be consistent with the public interest and the

    purposes of this Act; and

    (B) The agreement, contract, or transaction--

    (i) Will be entered into solely between appropriate persons; and

    (ii) Will not have a material adverse effect on the ability of

    the Commission or any contract market or derivatives transaction

    execution facility to discharge its regulatory or self-regulatory

    duties under this Act.

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    The purposes of the CEA include ``promot[ing] responsible

    innovation and fair competition among boards of trade, other markets

    and market participants.'' \13\ It may be consistent with these and the

    other purposes of the CEA, and with the public interest, for the mode

    of trading of these transactions--whether it is to be through CFTC-

    regulated markets and clearing organizations or SEC-regulated markets

    and clearing organizations--to be determined by competitive market

    forces rather than by regulatory line-drawing. Accordingly, the CFTC is

    requesting comment as to whether an exemption from the requirements of

    the CEA should be granted in the context of these transactions.

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    \13\ CEA Sec. 3(b), 7 U.S.C. 5(b). See also CEA Sec. 4(c)(1),

    7 U.S.C. 6(c)(1) (purpose of exemptions is ``to promote responsible

    economic or financial innovation and fair competition.'')

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    Section 4(c)(3) includes within the term ``appropriate persons'' a

    number of specified categories of persons, and also in subparagraph (K)

    thereof ``such other persons that the Commission determines to be

    appropriate in light of * * * the applicability of appropriate

    regulatory protections.'' Both CBOE and OCC, as well as their members

    who will intermediate these transactions, are subject to extensive and

    detailed regulation by the SEC under the 1934 Act. The CFTC is

    requesting comment as to whether all persons trading CDOs and CDBOs

    traded on CBOE and cleared on OCC are appropriate persons.

    In light of the above, the Commission also is requesting comment as

    to whether this exemption will interfere with its ability to discharge

    its regulatory responsibilities under the CEA, including its ability to

    determine whether the listing of similar or

    [[Page 27093]]

    identical products on a designated contract market or derivatives

    transaction execution facility would or would not violate the CEA, or

    with the self-regulatory duties of any contract market or derivatives

    transaction execution facility.

    III. Request for Comment

    The Commission requests comment on all aspects of the issues

    presented by this proposed order.

    IV. Related Matters

    A. Paperwork Reduction Act

    The Paperwork Reduction Act of 1995 (``PRA'') \14\ imposes certain

    requirements on federal agencies (including the Commission) in

    connection with their conducting or sponsoring any collection of

    information as defined by the PRA. The proposed exemptive order would

    not, if approved, require a new collection of information from any

    entities that would be subject to the proposed order.

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    \14\ 44 U.S.C. 3507(d).

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    B. Cost-Benefit Analysis

    Section 15(a) of the CEA, as amended by Section 119 of the

    Commodity Futures Modernization Act of 2000 (``CFMA''),\15\ requires

    the Commission to consider the costs and benefits of its action before

    issuing an order under the CEA. By its terms, Section 15(a) as amended

    does not require the Commission to quantify the costs and benefits of

    an order or to determine whether the benefits of the order outweigh its

    costs. Rather, Section 15(a) simply requires the Commission to

    ``consider the costs and benefits'' of its action.

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    \15\ 7 U.S.C. 19(a).

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    Section 15(a) of the CEA further specifies that costs and benefits

    shall be evaluated in light of five broad areas of market and public

    concern: Protection of market participants and the public; efficiency,

    competitiveness, and financial integrity of futures markets; price

    discovery; sound risk management practices; and other public interest

    considerations. Accordingly, the Commission could in its discretion

    give greater weight to any one of the five enumerated areas and could

    in its discretion determine that, notwithstanding its costs, a

    particular order was necessary or appropriate to protect the public

    interest or to effectuate any of the provisions or to accomplish any of

    the purposes of the CEA.

    The proposed exemptive order may facilitate market competition. The

    Commission is considering the costs and benefits of this proposed order

    in light of the specific provisions of Section 15(a) of the CEA, as

    follows:

    1. Protection of market participants and the public. CBOE, OCC and

    their members who would intermediate CDOs and CDBOs are subject to

    extensive SEC oversight.

    2. Efficiency, competition, and financial integrity. The proposed

    exemption may enhance market efficiency and competition since it could

    encourage potential trading of CDOs and CDBOs on markets other than

    designated contract markets or derivative transaction execution

    facilities. Financial integrity will not be affected since the CDOs and

    CDBOs will be cleared by OCC, a DCO and SEC-registered clearing agency,

    and intermediated by SEC-registered broker-dealers.

    3. Price discovery. Price discovery may be enhanced through market

    competition.

    4. Sound risk management practices. OCC has described appropriate

    risk-management practices that it will follow to margin CDOs and CDBOs.

    5. Other public interest considerations. The proposed exemption may

    encourage development of credit derivative products through market

    competition without unnecessary regulatory burden.

    After considering these factors, the Commission has determined to

    seek comment on the proposed order as discussed above. The Commission

    invites public comment on its application of the cost-benefit

    provision.

    * * * * *

    Issued in Washington, DC, on May 9, 2007 by the Commission.

    Eileen A. Donovan,

    Acting Secretary of the Commission.

    [FR Doc. E7-9212 Filed 5-11-07; 8:45 am]

    BILLING CODE 6351-01-P

    Last Updated: May 8, 2012



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