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e9-28101

  • FR Doc E9-28101[Federal Register: November 23, 2009 (Volume 74, Number 224)]

    [Notices]

    [Page 61116-61117]

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

    [DOCID:fr23no09-40]

    [[Page 61116]]

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    COMMODITY FUTURES TRADING COMMISSION

    SECURITIES AND EXCHANGE COMMISSION

    [Release No. 34-61020]

    Joint Order To Exclude Indexes Composed of Certain Index Options

    From the Definition of Narrow-Based Security Index Pursuant to Section

    1a(25)(B)(vi) of the Commodity Exchange Act and Section 3(a)(55)(C)(vi)

    of the Securities Exchange Act of 1934

    AGENCY: Commodity Futures Trading Commission and Securities and

    Exchange Commission.

    ACTION: Joint order.

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    SUMMARY: The Commodity Futures Trading Commission (``CFTC'') and the

    Securities and Exchange Commission (``SEC'') (collectively,

    ``Commissions'') by joint order under the Commodity Exchange Act

    (``CEA'') and the Securities Exchange Act of 1934 (``Exchange Act'')

    are excluding certain security indexes from the definition of ``narrow-

    based security index.'' Specifically, the Commissions are excluding

    from the definition of the term ``narrow-based security index'' certain

    volatility indexes composed of series of index options on broad-based

    security indexes.

    DATES: Effective Date: November 17, 2009.

    FOR FURTHER INFORMATION CONTACT:

    CFTC: Thomas M. Leahy, Jr., Branch Chief, Market and Product Review

    Section, Division of Market Oversight, telephone: (202) 418-5278 or

    Julian E. Hammar, Assistant General Counsel, telephone: (202) 418-5118,

    Commodity Futures Trading Commission, 1155 21st Street, NW.,

    Washington, DC 20581.

    SEC: Richard R. Holley III, Senior Special Counsel, Division of

    Trading and Markets, Securities and Exchange Commission, 100 F Street,

    NE., Washington, DC 20549. Telephone (202) 551-5614.

    SUPPLEMENTARY INFORMATION:

    I. Background

    Futures contracts on single securities and on narrow-based security

    indexes (collectively, ``security futures'') are jointly regulated by

    the CFTC and the SEC.\1\ To distinguish between security futures on

    narrow-based security indexes, which are jointly regulated by the

    Commissions, and futures contracts on broad-based security indexes,

    which are under the exclusive jurisdiction of the CFTC, the CEA and the

    Exchange Act each includes an objective definition of the term

    ``narrow-based security index.'' A futures contract on an index that

    meets the definition of a narrow-based security index is a security

    future. A futures contract on an index that does not meet the

    definition of a narrow-based security index is a futures contract on a

    broad-based security index.\2\

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    \1\ See Section 1a(31) of the CEA and Section 3(a)(55)(A) of the

    Exchange Act, 7 U.S.C. 1a(31) and 15 U.S.C. 78c(a)(55)(A).

    \2\ See 17 CFR 41.1(c).

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    Section 1a(25)(A) of the CEA \3\ and Section 3(a)(55)(B) of the

    Exchange Act \4\ provide that an index is a ``narrow-based security

    index'' if, among other things, it meets one of the following four

    criteria:

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    \3\ 7 U.S.C. 1a(25)(A).

    \4\ 15 U.S.C. 78c(a)(55)(B).

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    (i) The index has nine or fewer component securities;

    (ii) any component security of the index comprises more than 30

    percent of the index's weighting;

    (iii) the five highest weighted component securities of the index

    in the aggregate comprise more than 60 percent of the index's

    weighting; or

    (iv) the lowest weighted component securities comprising, in the

    aggregate, 25 percent of the index's weighting have an aggregate dollar

    value of average daily trading volume of less than $50,000,000 (or in

    the case of an index with 15 or more component securities,

    $30,000,000), except that if there are two or more securities with

    equal weighting that could be included in the calculation of the lowest

    weighted component securities comprising, in the aggregate, 25 percent

    of the index's weighting, such securities shall be ranked from lowest

    to highest dollar value of average daily trading volume and shall be

    included in the calculation based on their ranking starting with the

    lowest ranked security.

    The first three criteria evaluate the composition and weighting of

    the securities in the index. The fourth criterion evaluates the

    liquidity of an index's component securities.

    Section 1a(25)(B)(vi) of the CEA \5\ and Section 3(a)(55)(C)(vi) of

    the Exchange Act \6\ provide that, notwithstanding the above criteria,

    an index is not a narrow-based security index if a contract of sale for

    future delivery on the index is traded on or subject to the rules of a

    board of trade and meets such requirements as are jointly established

    by rule, regulation, or order by the Commissions. Pursuant to that

    authority, the Commissions may jointly exclude an index from the

    definition of the term ``narrow-based security index.''

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    \5\ 7 U.S.C. 1a(25)(B)(vi).

    \6\ 15 U.S.C. 78c(a)(55)(C)(vi).

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    Using this authority, on March 25, 2004, the Commissions issued a

    joint order excluding volatility indexes that satisfy certain

    conditions from the definition of ``narrow-based security index''.\7\

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    \7\ See Securities Exchange Act Release No. 49469 (March 25,

    2004), 69 FR 16900 (March 31, 2004) (``2004 Joint Order'').

    Following the issuance of the 2004 Joint Order, the CBOE Futures

    Exchange, LLC listed for trading futures contacts on the CBOE

    Volatility Index (``VIX'').

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    II. Discussion

    The statutory definition of the term ``narrow-based security

    index'' is designed to distinguish among indexes composed of individual

    stocks. As a result, certain aspects of that definition are designed to

    take into account the trading patterns of individual stocks rather than

    those of other types of exchange-traded securities, such as security

    index options. However, the Commissions believe that the definition is

    not limited to indexes on individual stocks. In fact, Section

    1a(25)(B)(vi) of the CEA \8\ and Section 3(a)(55)(C)(vi) of the

    Exchange Act \9\ give the Commissions joint authority to make

    determinations with respect to security indexes that do not meet the

    specific statutory criteria.

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    \8\ 7 U.S.C. 1a(25)(B)(vi).

    \9\ 15 U.S.C. 78c(a)(55)(C)(vi).

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    The Commissions believed, when issuing the 2004 Joint Order

    excluding certain volatility indexes from the definition of ``narrow-

    based security index,'' that certain volatility indexes were

    appropriately classified as broad-based because they measure the

    magnitude of changes in the level of an underlying index that is a

    broad-based security index. Further, the Commissions noted that they

    believed that futures contracts on volatility indexes that satisfied

    the conditions set forth in the 2004 Joint Order should not be readily

    susceptible to manipulation. The Commisions believed that those

    conditions reduce the ability to manipulate the price of the futures

    contracts through manipulation of the options comprising the volatility

    index.

    Eurex \10\ has requested that the Commissions exclude the VDAX-

    NEW[supreg] volatility index from the definition of ``narrow-based

    security index.'' \11\ According to Eurex, this volatility index

    [[Page 61117]]

    meets all the conditions set forth in the 2004 Joint Order, except the

    sixth condition, which requires that ``[o]ptions on the Underlying

    Broad-Based Security Index * * * [be] listed and traded on a national

    securities exchange registered under section 6(a) of the Exchange

    Act.'' \12\ The Commissions note that a volatility index based on index

    options traded on a foreign exchange, such as the VDAX-NEW[supreg],

    would be unable to satisfy this condition.

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    \10\ Eurex Deutschland is operated by Eurex Frankfurt AG

    (hereinafter ``Eurex Deutschland'' and ``Eurex Frankfurt AG''

    together are referred to as ``Eurex'').

    \11\ See Letter from Paul M. Architzel, Alston & Bird, LLP, to

    Nancy Morris, Secretary, SEC, and Eileen Donovan, Acting Secretary,

    CFTC, dated December 18, 2006.

    \12\ See 2004 Joint Order, supra note 7, 69 FR at 16901.

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    In the 2004 Joint Order the Commissions stated, with respect to the

    sixth condition, that:

    Given the novelty of volatility indexes, the Commissions believe

    at this time that it is appropriate to limit the component

    securities to those index options that are listed for trading on a

    national securities exchange where the Commissions know pricing

    information is current, accurate and publicly available.\13\

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    \13\ See id.

    In response to Eurex's request, the Commissions believe that

    certain volatility indexes should be excluded from the definition of

    ``narrow-based security index'' if the index options used to calculate

    the magnitude of change in the level of the underlying broad-based

    security index are listed for trading on an exchange and pricing

    information for the underlying broad-based security index, and options

    on such index, is computed and disseminated in real-time though major

    market data vendors. For purposes of this Order, the Commissions would

    consider such pricing information to be current, accurate, and publicly

    available.

    The Commissions believe that, when pricing information for the

    index underlying a volatility index and for the index options that

    compose the volatility index is current, accurate, and publicly

    available, it would minimize the ability to manipulate the index

    options used to calculate the volatility index. As a result, futures

    contracts on such a volatility index would not be readily susceptible

    to manipulation.

    Therefore, the Commissions believe that an alternative to the sixth

    condition in the 2004 Joint Order, which requires that the component

    securities of a volatility index (i.e., options on the underlying

    broad-based index) be listed for trading on a national securities

    exchange registered pursuant to Exchange Act Section 6(a), would be

    appropriate in certain circumstances. The Commissions believe that it

    is appropriate to permit the component securities of a volatility index

    to be listed for trading on any exchange, provided that pricing

    information for the underlying broad-based security index, and the

    options on such index that compose the volatility index, is current,

    accurate, and publicly available. Specifically, the new sixth condition

    would require such pricing information to be computed and disseminated

    in real-time through major market data vendors.

    In addition to the alternative sixth condition discussed above, a

    volatility index would have to satisfy the other conditions in the 2004

    Joint Order, which are set forth below.\14\ The Commissions also

    reaffirm the rationale for those conditions stated in the 2004 Joint

    Order.

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    \14\ The Commissions note that nothing in this joint order

    should be construed as repealing or otherwise revoking the 2004

    Joint Order.

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    Accordingly,

    It is ordered, pursuant to Section 1a(25)(B)(vi) of the CEA and

    Section 3(a)(55)(C)(vi) of the Exchange Act, that an index is not a

    narrow-based security index and is therefore a broad-based security

    index, if:

    (1) The index measures the magnitude of changes in the level of an

    underlying broad-based security index that is not a narrow-based

    security index as that term is defined in Section 1a(25) of the CEA and

    Section 3(a)(55) of the Exchange Act over a defined period of time,

    which magnitude is calculated using the prices of options on the

    underlying broad-based security index and represents (a) an annualized

    standard deviation of percent changes in the level of the underlying

    broad-based security index, (b) an annualized variance of percent

    changes in the level of the underlying broad-based security index, or

    (c) on a non-annualized basis, either the standard deviation or the

    variance of percent changes in the level of the underlying broad-based

    security index;

    (2) The volatility index has more than nine component securities,

    all of which are options on the underlying broad-based security index;

    (3) No component security of the volatility index comprises more

    than 30% of the volatility index's weighting;

    (4) The five highest weighted component securities of the

    volatility index in the aggregate do not comprise more than 60% of the

    volatility index's weighting;

    (5) The average daily trading volume of the lowest weighted

    component securities in the underlying broad-based security index upon

    which the volatility index is calculated (those comprising, in the

    aggregate, 25% of the underlying broad-based security index's

    weighting) has a dollar value of more than $50,000,000 (or $30,000,000

    in the case of an underlying broad-based security index with 15 or more

    component securities), except if there are two or more securities with

    equal weighting that could be included in the calculation of the lowest

    weighted component securities comprising, in the aggregate, 25% of the

    underlying broad-based security index's weighting, such securities

    shall be ranked from lowest to highest dollar value of average daily

    trading volume and shall be included in the calculation based on their

    ranking starting with the lowest ranked security;

    (6) The index options used to calculate the magnitude of change in

    the level of the underlying broad-based security index are listed for

    trading on an exchange and pricing information for the underlying

    broad-based security index, and options on such index, is computed and

    disseminated in real-time through major market data vendors; and

    (7) The aggregate average daily trading volume in options on the

    underlying broad-based security index is at least 10,000 contracts

    calculated as of the preceding 6 full calendar months.

    By the Commodity Futures Trading Commission.

    Dated: November 17, 2009.

    David A. Stawick,

    Secretary.

    By the Securities and Exchange Commission.

    Dated: November 17, 2009.

    Elizabeth M. Murphy,

    Secretary.

    [FR Doc. E9-28101 Filed 11-20-09; 8:45 am]

    BILLING CODE 6351-01-P

    Last Updated: November 23, 2009



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