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2010-14680

  • FR Doc 2010-14680[Federal Register: June 17, 2010 (Volume 75, Number 116)]

    [Notices]

    [Page 34429-34434]

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

    [DOCID:fr17jn10-53]

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    COMMODITY FUTURES TRADING COMMISSION

    Petition of Hard Eight Futures, LLC for Exemptive Relief,

    Pursuant to Section 4(c) of the Commodity Exchange Act, From Section

    2(a)(1)(C)(iv) of the Commodity Exchange Act and Appendix D to Part 30

    of the Rules of the Commodity Futures Trading Commission

    AGENCY: Commodity Futures Trading Commission.

    ACTION: Notice of petition and request for comment.

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    SUMMARY: Hard Eight Futures, LLC (``HEF'') has petitioned the Commodity

    Futures Trading Commission (``Commission'' or ``CFTC'') for exemptive

    relief, pursuant to Section 4(c) of the Commodity Exchange Act

    [[Page 34430]]

    (``Act'' or ``CEA''),\1\ to permit U.S. eligible contract participants

    (``ECPs''),\2\ subject to certain conditions, to trade foreign non-

    narrow-based security index futures contracts where the foreign

    exchange has not obtained a staff no-action letter with respect to the

    offer and sale of such futures contracts to U.S. persons. The

    conditions proposed in HEF's petition are: (i) Relief is only available

    for futures on broad-based security indexes; (ii) the securities

    comprising such an index are principally traded on, by, or through any

    exchange or market located outside the U.S.; (iii) the Commission must

    have a Memorandum of Understanding with the foreign exchange's

    regulator with respect to information sharing and cooperation; \3\ and

    (iv) an ECP seeking to claim the exemption would file notice with the

    Commission, which would be effective with respect to that person and

    index, unless the Commission notifies the person within ten (10)

    business days that the claimant does not meet the requirements of the

    exclusion, or that the index does not qualify as broad based.

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    \1\ 7 U.S.C. 6(c).

    \2\ The term ``eligible contract participant'' is defined in

    Section 1a(12) of the Act, 7 U.S.C. 1a(12).

    \3\ A foreign exchange seeking to offer foreign security index

    futures to the general public in the U.S. would still need staff no-

    action relief, and if it sought to do so through terminals located

    in the U.S., it would still need a second ``direct access no-action

    letter'' from the staff.

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    The Commission seeks comment on HEF's petition and related

    questions. Copies of the petition are available for inspection at the

    Office of the Secretariat by mail at the address listed below, by

    telephoning (202) 418-5100, or on the Commission's Web site (http://

    www.cftc.gov).

    DATES: Comments must be received on or before July 19, 2010. Comments

    must be in English or, if not, accompanied by an English translation.

    ADDRESSES: Comments should be sent to David A. Stawick, Secretary,

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

    Street, NW., Washington, DC 20581. Comments may be sent by facsimile

    transmission to (202) 418-5521, or by e-mail to

    hardeightfutures@cftc.gov. Reference should be made to ``Hard Eight

    Futures Petition for Exemption from Section 2(a)(1)(C)(iv) of the Act

    and Appendix D to Part 30 of the Rules of the Commission.'' Comments

    may also be submitted by connecting to the Federal eRulemaking Portal

    at http://www.regulations.gov and following the comment submission

    instructions. Comments will be published on the Commission's Web site.

    FOR FURTHER INFORMATION CONTACT: Julian E. Hammar, Assistant General

    Counsel, Office of General Counsel, Commodity Futures Trading

    Commission, Three Lafayette Centre, 1155 21st Street, NW., Washington,

    DC 20581. Telephone: (202) 418-5118. E-mail: jhammar@cftc.gov or Edwin

    J. Yoshimura, Counsel, Office of General Counsel, Commodity Futures

    Trading Commission, 525 W. Monroe Street, Suite 1100, Chicago, IL

    60661. Telephone: (312) 596-0562. E-mail: eyoshimura@cftc.gov.

    SUPPLEMENTARY INFORMATION:

    I. Background

    In general, foreign exchange-traded futures and commodity option

    products may be offered or sold by properly registered or exempt

    intermediaries to persons located in the U.S., without prior product

    approval.\4\ Special review procedures apply, however, to the offer or

    sale of futures contracts based on a group or index of securities

    (``security index'').\5\ Specifically, Section 2(a)(1)(C)(iv) of the

    CEA \6\ 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 Section 2(a)(1)(C)(ii) or Section

    2(a)(1)(D).\7\ By its terms, Section 2(a)(1)(C)(iv) applies to futures

    contracts on security indexes traded on both domestic and foreign

    boards of trade.

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    \4\ See Foreign Commodity Options, 61 FR 10891 (Mar. 18, 1996).

    \5\ The CEA, as amended by the Commodity Futures Modernization

    Act of 2000 (``CFMA''), Appendix E of Public Law No. 106-554, 114

    Stat. 2763 (2000), provides that the offer or sale in the U.S. of

    futures contracts based on a security index, including those

    contracts traded on or subject to the rules of a foreign board of

    trade, is subject to the Commission's exclusive jurisdiction, with

    the exception of security futures products, over which the

    Commission shares jurisdiction with the Securities and Exchange

    Commission (``SEC''). A security future, in turn, is defined in CEA

    Section 1a(31) as a futures contract on a single security or a

    ``narrow-based security index.'' 7 U.S.C. 1a(31). Thus, the

    Commission's jurisdiction remains exclusive with regard to futures

    contracts on a security index that is broad-based, i.e., that does

    not meet the definition of a ``narrow-based security index'' in CEA

    Section 1a(25), 7 U.S.C. 1a(25).

    \6\ 7 U.S.C. 2(a)(1)(C)(iv).

    \7\ CEA Section 2(a)(1)(D), 7 U.S.C. Sec. 2(a)(1)(D), governs

    the offer and sale of security futures products.

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    Section 2(a)(1)(C)(ii) of the CEA \8\ sets forth three criteria to

    govern the trading of futures contracts on a security index to be

    traded on contract markets and derivatives transaction execution

    facilities designated or registered by the Commission:

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    \8\ 7 U.S.C. 2(a)(1)(C)(ii).

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    (a) The contract must provide for cash settlement;

    (b) The contract must not be readily susceptible to manipulation or

    to being used to manipulate any underlying security; and

    (c) The security index must not constitute a narrow-based security

    index.\9\

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    \9\ With regard to the third criterion, the CFTC and SEC have

    jointly promulgated Commission Rule 41.13 under the CEA and Rule

    3a55-3 under the Securities Exchange Act of 1934, governing security

    index futures contracts traded on foreign boards of trade. These

    rules provide that ``[w]hen a contract of sale for future delivery

    on a security index is traded on or subject to the rules of a

    foreign board of trade, such index shall not be a narrow-based

    security index if it would not be a narrow-based security index if a

    futures contract on such index were traded on a designated contract

    market or registered derivatives transaction execution facility.''

    Commission Rule 41.13, 17 CFR 41.13; SEC Rule 3a55-3, 17 CFR

    240.3a55-3.

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    The CEA does not explicitly address the standards to be applied to

    a security index futures contract traded on a foreign board of trade.

    Historically, though, Commission staff has applied the aforementioned

    three criteria in evaluating requests by foreign boards of trade

    seeking to offer and sell their foreign security index futures

    contracts in the U.S. (without becoming designated as a contract

    market, or registered as a derivatives transaction execution facility).

    In reviewing such requests, Commission staff 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 making its

    determination, the staff 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 other relevant factors.\10\ With respect to

    whether a foreign futures contract based on a foreign security index is

    not readily susceptible to manipulation or being used to manipulate any

    underlying security, one preliminary consideration is the requesting

    board of trade's ability to access information regarding the securities

    underlying the index.\11\

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    \10\ See generally Appendix D to Part 30 of the Commission's

    regulations.

    \11\ In general, staff has requested that the foreign board of

    trade provide a copy of the surveillance agreements between the

    board of trade and the exchange(s) on which the underlying

    securities are traded; assurances that the board of trade will share

    information with the Commission, directly or indirectly; and 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 futures contracts on security

    indexes. The staff reviews this information to ensure that the

    requesting foreign board of trade (and/or its regulator) has the

    ability and willingness to access adequate surveillance data

    necessary to detect and deter manipulation in the futures contracts

    and underlying securities, as well as share such data with the

    Commission.

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    [[Page 34431]]

    Upon determination by staff that the subject futures contract and

    underlying index comport with the criteria set forth in Section

    2(a)(1)(C)(ii) of the CEA, Commission staff issues a no-action letter

    to the foreign board of trade with respect to the offer and sale of

    such futures contract in the U.S.\12\ A foreign board of trade that has

    received prior no-action relief with respect to a particular foreign

    security index futures contract must file a new submission for each

    foreign security index futures contract that it seeks to offer or sell

    in the U.S.

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    \12\ A no-action letter generally is a written statement issued

    by the staff of a Division or Office of the Commission that it will

    not recommend enforcement action to the Commission for failure to

    comply with a specific provision of the Act or of a Commission rule,

    regulation or order if a proposed transaction is completed by the

    requestor. See Commission Rule 140.99(a)(2), 17 CFR 140.99(a)(2). A

    no-action letter to a foreign board of trade does not affect or

    alter the application of Part 30 of the Commission's Rules, which

    governs the offer and sale by financial intermediaries of foreign

    futures and foreign option contracts to persons located in the U.S.

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    II. HEF's Petition

    By letter dated April 21, 2008 (``Petition''), HEF, a registered

    commodity trading advisor (``CTA''), applied for exemptive relief,

    pursuant to Section 4(c) of the Act, from Section 2(a)(1)(C)(iv) of the

    Act and Appendix D to Part 30 of the Rules of the Commission.\13\

    According to the Petition, this exemption is necessary to promote

    responsible economic innovation and fair competition. Granting the

    exemption will enable U.S. ECPs \14\ to trade a foreign security index

    futures contract even if the foreign board of trade that lists the

    contract has not obtained no-action relief relating to the offer and

    sale of that contract to U.S. persons.

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    \13\ Appendix D to Part 30 sets forth the process by which

    Commission staff evaluates requests for no-action relief from

    foreign boards of trade seeking to offer and sell their futures

    contracts on non-narrow-based security indexes in the U.S., and sets

    forth the information that such a foreign board of trade should

    submit when seeking no-action relief. 17 CFR Part 30, Appendix D.

    \14\ The CEA provides that the Commission may only issue

    exemptive relief to ``appropriate persons'' as described in CEA

    Section 4(c)(3), 7 U.S.C. 6(c)(3). For purposes of its Petition, HEF

    requests that the Commission define ``appropriate persons'' as

    including all ECPs.

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    Under the exemptive relief requested by HEF's Petition, U.S. ECPs

    could trade, on a foreign board of trade, futures contracts on foreign

    security indexes that are not security futures products (i.e., the

    index is not a narrow-based security index) on the same basis as they

    may trade any other futures contract on a foreign board of trade.

    Currently, no prior qualifying action by the Commission or its staff is

    required in order for U.S. persons to enter into non-security-based

    futures contracts traded on a foreign board of trade. Rather, U.S.

    customers are permitted to access futures products offered by a foreign

    board of trade through a U.S. registered futures commission merchant or

    introducing broker, or through a foreign firm pursuant to an exemption

    under Commission Rule 30.10.\15\ HEF's Petition asks that for U.S.

    ECPs, the same rules apply to foreign security index futures contracts

    as well.

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    \15\ 17 CFR 30.10.

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    III. SEC Exemptive Order Regarding Foreign Security Futures

    Due to the applicability of the federal securities laws, though,

    security index futures are not the same as futures on non-security

    based commodities. In this regard, with respect to security futures

    products (i.e., futures on a single security or a narrow-based security

    index) traded on foreign boards of trade, Section 2(a)(1)(E) of the CEA

    and Section 6(k) of the Securities Exchange Act of 1934 (``Exchange

    Act'') provide that: (i) The CFTC and SEC ``shall jointly issue such

    rules, regulations, or orders as are necessary and appropriate to

    permit the offer and sale of a security futures product traded on or

    subject to the rules of a foreign board of trade to United States

    persons;'' and (ii) such rules, regulations or orders ``shall take into

    account, as appropriate, the nature and size of the markets that the

    securities underlying the security futures product reflects.'' \16\

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    \16\ 7 U.S.C. 2(a)(1)(E); 15 U.S.C. 78f(k).

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    After HEF's Petition was filed, the SEC on June 30, 2009, issued an

    Order (``SEC Order'') \17\ exempting certain persons from Section

    6(h)(1) of the Exchange Act, which makes it unlawful for U.S. persons

    to enter into security futures traded on foreign boards of trade

    (``foreign security futures'').\18\ The SEC Order, among other things,

    permits certain sophisticated investors to access foreign security

    futures and provides relief for certain intermediaries in order to

    effect these transactions under certain conditions, including that the

    ``primary trading market'' for the underlying securities of foreign

    private issuers is outside the U.S.\19\ Specifically, the sophisticated

    investors to which the SEC Order applies include qualified

    institutional buyers (``QIBs'') as defined in SEC Rule 144A under the

    Securities Act of 1933.\20\ A QIB is generally an entity that owns and

    invests on a discretionary basis at least $100 million in securities of

    unaffiliated issuers; it is, therefore, a narrower class of investors

    than the class of ECPs as defined in the CEA.\21\

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    \17\ See Order Under Section 36 of the Securities Exchange Act

    of 1934 Granting an Exemption From Exchange Act Section 6(h)(1) for

    Certain Persons Effecting Transactions in Foreign Security Futures

    and Under Exchange Act Section 15(a)(2) and Section 36 Granting

    Exemptions From Exchange Act Section 15(a)(1) and Certain Other

    Requirements, 74 FR 32200 (July 7, 2009).

    \18\ 15 U.S.C. 78f(h).

    \19\ In light of questions received following the issuance of

    the SEC Order, the Commission's Division of Clearing & Intermediary

    Oversight has recently issued an ``Advisory Concerning the Offer and

    Sale of Foreign Security Futures Products to Customers Located in

    the United States.''

    \20\ 15 U.S.C. 77a et seq.

    \21\ 17 CFR 230.144A (a QIB is one of the enumerated entities,

    ``acting for its own account or the accounts of other qualified

    institutional buyers, that in the aggregate owns and invests on a

    discretionary basis at least $100 million in securities of issuers

    that are not affiliated with the entity'').

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    The relief granted by the SEC Order, although not coterminous with

    the relief requested by HEF, is relevant to HEF's Petition. Prior to

    the SEC Order, if a foreign broad-based security index underlying a

    foreign exchange-traded futures contract became a narrow-based security

    index for a certain period of time, a U.S. person had to exit its

    position in that futures contract during a specified grace period, or

    be in violation of the Exchange Act's prohibition on trading foreign

    security futures.\22\ Since June 30, 2009, though, if an ECP is

    eligible for and the contract satisfies the requirements for the

    exemption issued in the SEC Order, the ECP could continue to trade such

    a contract as a foreign security future pursuant to the terms and

    conditions of the SEC Order. But if an ECP is not eligible--that is, if

    the ECP does not meet the high threshold to qualify as a QIB--or the

    contract is not eligible under the SEC Order, then the ECP would not

    have relief in trading such a contract.

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    \22\ If an index becomes narrow-based for more than 45 business

    days over three consecutive calendar months, the CEA and the

    Exchange Act provide a grace period of three months during which the

    index is excluded from the definition of a ``narrow-based security

    index.'' See Section 1a(25)(D) of the CEA, 7 U.S.C. 1a(25)(D) and

    Section 3(a)(55)(E) of the Exchange Act, 15 U.S.C. 78c(a)(55)(E).

    Although these provisions apply to security index futures contracts

    traded on certain U.S. exchanges, by joint regulation, the

    Commission and the SEC have made these provisions applicable to

    security index futures contracts traded on foreign boards of trade.

    See Commission Rule 41.13, 17 CFR 41.13 and SEC Rule 3a55-3, 17 CFR

    240.3a55-3.

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    [[Page 34432]]

    IV. Relief Sought by HEF

    Section 4(c)(1) of the Act empowers the Commission to ``promote

    responsible economic or financial innovation and fair competition'' by

    exempting any transaction or class of transactions, including any

    person offering or entering into such transaction, 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.\23\ The Petition requests relief from the

    requirement that U.S. persons may only enter into a futures contract on

    a foreign security index listed on a foreign board of trade if the

    foreign board of trade has first received a letter providing no-action

    relief to offer and sell that futures contract to U.S. persons.

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    \23\ Section 4(c)(1) of the Act, 7 U.S.C. 6(c)(1), provides

    that:

    In order to promote responsible economic or financial innovation

    and fair competition, the Commission by * * * order, after notice

    and opportunity for hearing, may (* * * on application of any

    person, including any board of trade designated or registered as a

    contract market * * *) 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

    services with respect to, the agreement, contract, or transaction),

    either unconditionally or on stated terms or conditions or for

    stated periods * * * from any * * * provision of this Act (except

    subparagraphs (C)(ii) and (D) of section 2(a)(1), except that the

    Commission and Securities and Exchange Commission may by rule,

    regulation, or order jointly exclude any agreement, contract, or

    transaction from section 2(a)(1)(D)), if the Commission determines

    that the exemption would be consistent with the public interest.

    While Section 4(c)(2) of the Act, 7 U.S.C. 6(c)(2), imposes

    additional requirements with respect to any exemption from the

    requirements of Section 4(a) of the Act, 7 U.S.C. 6(a), HEF is not

    seeking such relief.

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    The proposed exemptive relief would require that a person wishing

    to trade a particular security index futures contract listed on a

    foreign board of trade that has not received no-action relief notify

    the Commission of the person's intent to do so. The notice would

    require the claimant to demonstrate his or her qualification for the

    exemption (i.e., that he or she is an ECP), and that the index is not a

    narrow-based security index. The exemption would be effective with

    respect to that person and index unless the Commission notifies the

    person within ten (10) business days that the claimant does not meet

    the requirements of the exclusion, or the index does not qualify under

    the Act as a non-narrow based index (including an explanation of why it

    considers the person not to be qualified or the index to be narrow-

    based, respectively).

    Further, this exemption would be available only for contracts

    traded on foreign boards of trade for which the applicable foreign

    regulator has entered into a Memorandum of Understanding (``MOU'') with

    respect to information sharing and cooperation with the CFTC.\24\ Also,

    the securities comprising the index underlying the futures contract

    would have to be principally traded on, by, or through an exchange or

    market located outside the U.S.

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    \24\ This could be either a bilateral MOU between the Commission

    and the applicable foreign regulator, or a multilateral MOU such as

    the ``Multilateral Memorandum of Understanding Concerning

    Consultation and Cooperation and the Exchange of Information''

    created by the International Organization of Securities Commissions

    (``IOSCO Multilateral MOU'').

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    The Petition does not seek an exemption from the requirement that a

    foreign board of trade be granted no-action relief before offering and

    selling such foreign security index futures contracts to the general

    public. Nor does it seek an exemption from the requirement that such

    contracts may be traded through direct access from the U.S. to a

    foreign board of trade's electronic trading system only pursuant to a

    Commission staff direct access no-action letter.\25\

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    \25\ See Policy Statement Regarding Boards of Trade Located

    Outside of the United States and No-Action Relief From the

    Requirement To Become a Designated Contract Market or Derivatives

    Transaction Execution Facility, 71 FR 64443 (Nov. 2, 2006).

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    More specifically, HEF is seeking an exemption, pursuant to Section

    4(c) of the Act, from Section 2(a)(1)(C)(iv) of the Act and 17 CFR Part

    30 Appendix D in the following form, with conditions:

    (X) Exemption for Eligible Contract Participants Trading Non-narrow

    Based Stock Indexes on a Foreign Board of Trade. The Commodity Futures

    Trading Commission, pursuant to its authority under Section 4(c)(1) of

    the Commodity Exchange Act, hereby determines that notwithstanding the

    provisions of Section 2(a)(1)(C)(iv) of the Act and Appendix D to Part

    30 of its Rules, nothing in the Act is intended to prohibit any

    ``eligible contract participant,'' as defined in Section 1a(12) of the

    Act, located in the U.S. from purchasing or carrying futures contracts

    on a securities index that is not a ``narrow-based index'' as defined

    in Section 1a(25) of the Act, traded on or subject to the rules of a

    foreign board of trade to the same extent such person may be authorized

    to purchase or carry a futures contract on any other commodity so long

    as the underlying securities comprising such index are principally

    traded on, by or through any exchange or market located outside the

    United States, and the regulator of such foreign board of trade has

    entered into a Memorandum of Understanding with respect to information

    sharing and cooperation with the Commission.

    (a) Notification: Persons wishing to avail themselves of this

    exemption shall so notify the Commission. This notification shall be

    filed with the Secretary of the Commission at its Washington, D.C.

    headquarters, in electronic form, shall be labeled as ``Notification of

    Trading in a Non-narrow Based Index Traded on a Foreign Board of

    Trade,'' and shall include:

    (1) The name and address of the person and representation that the

    person qualifies as an Eligible Contract Participant, and the basis

    upon which the person so qualifies;

    (2) The name of the non-narrow based index and of the foreign board

    of trade on which the index is traded;

    (3) A demonstration that the index is not a ``narrow-based index''

    under the definition of Section 1a(25) of the Act; and

    (4) A representation that the regulator of the foreign board of

    trade has entered into an information-sharing agreement with the

    Commission or to which the Commission is also a signatory.

    (b) Effective Date: The exemption shall be effective ten (10)

    business days after filing of the notice with the Commission, unless

    the Commission within that period notifies the person claiming the

    exemption that the exemption may not be made effective with respect to

    that person and/or that index and its reason for so finding.

    According to HEF, the purpose behind the no-action process is in

    furtherance of Congress' expressed intent ``to protect the interests of

    U.S. residents against fraudulent or other harmful practices.'' \26\

    HEF maintains that ECPs, due to their size and sophistication, are not

    dependent upon the terms and conditions imposed on the trading of

    foreign security index futures in the staff's no-action relief for

    protection from fraud. Further, HEF notes that in the U.S., ECPs

    currently are able to trade contracts, agreements, or transactions that

    replicate futures contracts on foreign security indexes in the over-

    the-counter (``OTC'') markets. HEF states that granting this exemptive

    relief will enable ECPs to trade futures contracts on a foreign board

    of trade that are equivalent to contracts that ECPs are able to trade

    in the OTC markets. Because contracts on foreign security

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    indexes are already traded in the OTC markets by U.S. ECPs, HEF

    believes that it is in the public interest to provide U.S. ECPs the

    choice to trade foreign security indexes in a more regulated,

    transparent exchange environment on foreign boards of trade.

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    \26\ H.R. Rep. No. 97-565, Part I, at p. 85 (May 17, 1982).

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    V. Request for Comments

    The Commission requests public comment on any aspect of the

    Petition that commenters believe may raise issues under the CEA or

    Commission regulations. In particular, the Commission invites comment

    regarding the following:

    (1) Conditions Proposed by HEF: Should an order granting the

    request for relief include any one or more of the conditions proposed

    by HEF in its Petition?

    (2) Surveillance: In granting no-action relief to a foreign board

    of trade seeking to offer and sell a futures contract on a foreign

    security index to U.S. persons, Commission staff generally rely on

    surveillance sharing agreements between the securities exchanges on

    which the securities comprising the index are traded, and the foreign

    board of trade. See infra n.11. Also, before issuing such no-action

    relief, Commission staff often requests a representation or commitment

    from the foreign board of trade of its willingness and ability to share

    information with the Commission. Id. Similarly, in granting no-action

    relief to a foreign board of trade seeking to offer and sell any

    futures contract to U.S. persons through direct access to its

    electronic trading system from the U.S., Commission staff typically

    confirm that the market and its regulator have the ability to obtain

    the specific types of information that may be needed by the Commission,

    as well as the authority to share that information with the Commission

    on an ``as needed'' basis. Moreover, Commission staff generally obtains

    evidence of the foreign market's and regulator's willingness to share

    information (e.g., through explicit undertakings) with the Commission.

    To ensure that there are similar protections in place in the

    circumstances posed by HEF's Petition, should an order granting the

    request for relief require that the foreign board of trade that lists

    the foreign security index futures contract to be traded by the ECP

    have: (i) Submitted a pending request for no-action relief with respect

    to that futures contract; (ii) received a prior no-action letter for

    another foreign security index futures contract; and/or (iii) received

    a foreign direct access no action letter?

    (3) MOUs: The Commission is concerned that the condition for an MOU

    included in HEF's Petition may not be workable in practice, given the

    wide spectrum of information sharing agreements to which the Commission

    is a party. An MOU may only mean that the foreign regulator will share

    information, not that it has access to surveillance information to

    share. Should an order granting the relief requested in HEF's Petition

    be conditioned on the existence of an MOU that is specifically tailored

    to obtain the information that the Commission needs to assess the

    efficacy of the foreign board of trade and its regulator, and to obtain

    surveillance information as it deems necessary? Should any such relief

    be limited to foreign security index futures contracts listed in

    jurisdictions that are signatories to the IOSCO Multilateral MOU?

    (4) Broad vs. Narrow-Based Security Indexes: As discussed above, a

    futures contract on a security index that moves from broad to narrow-

    based thereby becomes a security future that may no longer be traded by

    U.S. persons subject to the exclusive jurisdiction of the CFTC. To

    ensure full compliance with the requirements of the CEA and the federal

    securities laws, should an order granting the relief requested in HEF's

    Petition require an undertaking by the ECP to: (i) Continually monitor

    the underlying index to ensure that it remains broad-based; (ii) notify

    the Commission if the index becomes a narrow-based security index; and

    (iii) if the index continues to be narrow-based for more than 45

    business days during 3 consecutive calendar months, to cease trading

    the futures contract and liquidate existing positions in an orderly

    manner over the next 3 calendar months (provided, however, that if the

    ECP and the futures contract are eligible for the exemptive relief

    granted by the SEC Order, the ECP may continue to trade that contract

    as a foreign security future)?

    (5) Additional Conditions: Should an order granting the relief

    requested in HEF's Petition require that there be no solicitation of

    ECP orders, and/or that ECPs be required to trade only for their own

    account? \27\

    ---------------------------------------------------------------------------

    \27\ Granting the relief requested in HEF's Petition would in no

    way alter the requirements of Part 30 of the Commission's

    regulations concerning foreign futures and options transactions.

    ---------------------------------------------------------------------------

    (6) OTC Derivatives Reform Legislation: As discussed above, HEF's

    Petition justifies its request for relief, in part, on the proposition

    that: (i) U.S. ECPs currently are able to trade contracts that

    replicate futures on foreign security indexes in the unregulated OTC

    markets; and (ii) it is in the public interest to enable them to do so

    in a more regulated and transparent exchange environment on a foreign

    board of trade. Yet, legislation currently pending before the Congress,

    if eventually enacted, could change this premise to some degree, as it

    would significantly enhance the transparency of OTC derivatives and

    require that certain swaps (subject to an ``end-user exception'') be

    traded on a contract market or a ``swap execution facility'' as

    provided for in that legislation. What are the implications of the OTC

    derivatives reform legislation pending in Congress, if any, on HEF's

    Petition?

    (7) Foreign Securities: As discussed above, HEF's Petition proposes

    that an order granting its request for relief be conditioned upon all

    the securities in the index underlying the foreign futures contract

    being principally traded on, by, or through an exchange or market

    located outside the U.S. This ``principally traded'' formulation may be

    based on the language of CEA Section 2(a)(1)(F)(ii), which addresses

    trading of foreign security futures by ECPs in the U.S.\28\ What are

    the implications, if any, of the use of this standard in an order

    granting the relief requested in HEF's Petition in comparison to the

    ``primary trading market'' test that the SEC created for securities of

    foreign private issuers in a narrow-based security index as set forth

    in paragraph (1)(a)(ii) of the SEC Order? \29\ Should an order granting

    the relief requested in HEF's Petition treat securities in an index as

    being principally traded on, by, or through an exchange outside the

    United States if they meet the criteria for securities in a narrow-

    based security index contained in paragraph (1)(a)(ii) of the SEC

    Order? \30\

    ---------------------------------------------------------------------------

    \28\ 7 U.S.C. 2(a)(1)(F)(ii). See text accompanying n.31 infra

    for full text.

    \29\ The SEC Order provides that for U.S. QIBs to be able to

    trade foreign security futures, the securities issued by foreign

    private issuers that underlie a foreign security future must have

    their ``primary trading market'' outside the U.S. For purposes of

    this condition, under the SEC Order a security's ``primary trading

    market'' is deemed to be outside the U.S. if at least 55% of the

    worldwide trading volume in the security took place in, on, or

    through a securities market or markets located in either: (i) A

    single foreign jurisdiction; or (ii) no more than two foreign

    jurisdictions during the most recently completed fiscal year. If the

    trading in the foreign private issuer's security is in two foreign

    jurisdictions, the trading for the issuer's security in at least one

    of the two foreign jurisdictions must be greater than the trading in

    the U.S. for the same class of the issuer's securities in order for

    such security's ``primary trading market'' to be considered outside

    the U.S.

    \30\ In addition to securities of foreign private issuers whose

    primary trading market is outside the U.S. underlying narrow-based

    security indexes, paragraph (1)(a)(ii) of the SEC Order permits debt

    securities issued or guaranteed by a foreign government as defined

    in Rule 405 of the Securities Act, 17 CFR 230.405, that are eligible

    to be registered with the SEC under Schedule B of the Securities

    Act, 15 U.S.C. 77aa. Further, paragraph (1)(a)(ii) requires that at

    the time of the transaction, at least 90% of the index, both in

    terms of the number of underlying securities and their weight, must

    meet these eligibility requirements. No more than 10% of the

    securities in the index, both in terms of their number and their

    weight, at the time of the transaction, that do not meet the

    requirements, must be from issuers that are required to file reports

    with the SEC pursuant to Section 13 or Section 15(d) of the Exchange

    Act, 15 U.S.C. 78m and 78o.

    ---------------------------------------------------------------------------

    [[Page 34434]]

    (8) ECPs vs. QIBs: CEA Section 2(a)(1)(F)(ii), cited in the

    ---------------------------------------------------------------------------

    preceding paragraph, provides in full as follows:

    Nothing in this Act is intended to prohibit any eligible

    contract participant located in the United States from purchasing or

    carrying securities futures products traded on or subject to the

    rules of a foreign board of trade, exchange, or market to the same

    extent such person may be authorized to purchase or carry other

    securities traded on a foreign board of trade, exchange, or market

    so long as any underlying security for such security futures

    products is traded principally on, by, or through any exchange or

    market located outside the United States.\31\

    ---------------------------------------------------------------------------

    \31\ 7 U.S.C. 2(a)(1)(F)(ii).

    As discussed above, the SEC Order generally limits the category of U.S.

    persons that may trade foreign security futures to QIBs (who own and

    invest $100 million or more). This is a narrower class of investors

    than ECPs. The group of persons that satisfy the ECP definition but may

    not be QIBs includes registered investment companies, commodity pools,

    pension plans, corporations and high net worth individuals. These

    persons may have a real need for risk management based upon exposures

    in foreign financial markets or to economic conditions in other

    countries, or they may want to gain exposure to those markets as part

    of the asset allocation in their investment portfolio.

    If the relief requested in HEF's Petition is granted, an ECP that

    is a QIB and trades a foreign futures contract on a foreign security

    index that moves from broad to narrow-based can continue to trade that

    contract as a foreign security future, provided the contract otherwise

    meets the requirements of the SEC Order. An ECP that is not a QIB,

    however, would have to exit its position in the foreign futures

    contract within the applicable grace period or be in violation of the

    Exchange Act. Given this difference in legal status, should an order

    issued by the Commission granting the relief requested in HEF's

    Petition be limited to QIBs?

    With respect to access to foreign security futures by U.S. persons,

    are the conditions contained in the SEC Order consistent with Section

    2(a)(1)(F)(ii) of the CEA? Should ECPs that are not QIBs be permitted

    to trade foreign security futures? What conditions, if any, should be

    imposed on such trading by ECPs that are QIBs, and ECPs that are not

    QIBs? How should an order permitting ECPs to trade foreign security

    futures take into account, as mandated by Section 2(a)(1)(E) of the

    CEA, ``the nature and size of the markets that the securities

    underlying the security futures product reflects?''

    (9) Nature of Foreign Security Indexes: Lying at the core of the

    complex interplay between HEF's Petition on the one hand, and the CEA

    and the federal securities laws on the other hand, is the application

    of the statutory definition of a ``narrow-based security index'' to

    foreign security indexes. To the extent that a foreign security index

    falls squarely on the broad-based side of the line, distinctions

    between ECPs that are QIBs and those that are not, and the prospect of

    an ECP that is relying on the relief requested by HEF violating the

    securities laws, may be of less concern.

    Congress has recognized that ``[t]he detailed statutory test of a

    narrow-based security index was tailored to fit the U.S. equity

    markets, which are by far the largest, deepest and most liquid

    securities markets in the world.'' \32\ In the CFMA in 2000, Congress

    directed that the CFTC and the SEC, within one year, jointly adopt

    rules or regulations that set forth requirements for broad-based

    foreign security indexes traded on a foreign board of trade.\33\ And

    shortly thereafter, the CFTC and SEC promised to consider amending the

    rules regarding security index futures trading on or subject to the

    rules of a foreign board of trade.\34\

    ---------------------------------------------------------------------------

    \32\ H.R. Rep. No. 110-627 at 983 (2009) (Conference Report on

    the CFTC Reauthorization Act of 2008, Title XIII of the 2008 ``Farm

    Bill,'' Public Law No. 110-246, 122 Stat. 1651 (June 18, 2008)).

    \33\ See 7 U.S.C. 1a(25)(B)(iv) and 1a(25)(C); 15 U.S.C.

    3(a)(55)(C)(iv) and 3(a)(55)(D).

    \34\ See Method for Determining Market Capitalization and Dollar

    Value of Average Daily Trading Volume; Application of the Definition

    of Narrow-Based Security Index, 66 FR 44490, 44501-44502 (August 23,

    2001).

    ---------------------------------------------------------------------------

    Should the CFTC and the SEC establish criteria to exclude

    appropriate foreign security indexes from the definition of a ``narrow-

    based security index?'' If so, on what basis? How should it be

    determined whether a foreign security index is appropriately treated as

    a broad-based security index so that foreign futures on such an index

    would trade subject to the exclusive jurisdiction of the CFTC, or as a

    narrow-based security index so that foreign futures on such an index

    would trade as foreign security futures? The Commission encourages

    commenters to submit any quantitative data and analysis to support any

    proposed distinctions between broad and narrow-based foreign security

    indexes.

    (10) CEA Section 4(c) Requirements:

    Is the exemption requested in HEF's Petition consistent

    with the requirements for relief set forth in Section 4(c) of the CEA?

    Would granting the exemption requested in HEF's Petition

    be consistent with the public interest and purposes of the CEA?

    Would granting the relief requested in HEF's Petition have

    any material adverse effects upon derivatives clearing organizations,

    exchanges, or other Commission registrants from a competitive or other

    perspective?

    (11) Other Issues: The Commission welcomes comment on any other

    issues relevant to HEF's Petition for an exemption.

    * * * * *

    Issued in Washington, DC, on June 11, 2010 by the Commission.

    Sauntia S. Warfield,

    Assistant Secretary of the Commission.

    [FR Doc. 2010-14680 Filed 6-16-10; 8:45 am]

    BILLING CODE P

    Last Updated: June 17, 2010



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