COMMODITY FUTURES TRADING COMMISSION
New York Mercantile Exchange Proposed Specialist Market Maker Program
AGENCY: Commodity Futures Trading Commission.
ACTION: Notice of proposed new rule and rule amendments of the New York Mercantile Exchange to establish a Specialist Market Maker program.
SUMMARY: The New York Mercantile Exchange ("NYMEX" or "Exchange") has submitted a proposed new rule and rule amendments that would establish a Specialist Market Maker ("SMM") program for certain new or low-volume futures contracts. The Exchange would appoint one SMM for each contract market that it determined would benefit from the SMM program. The SMM would be required to maintain a continuous physical presence on the floor of the Exchange throughout the regular trading session of the contract and to maintain a two-sided market in the contract for which he or she had been appointed. The SMM also would be required to maintain a limit order book of member and non-member (i.e., customer) limit orders. In return for these services, the SMM would be paid a contract development fee and receive various priorities with respect to certain transactions executed in the trading ring for the appointed contract.
Acting pursuant to the authority delegated by Commission Regulation 140.96, the Division of Trading and Markets ("Division") has determined to publish the NYMEX proposal for public comment. The Division believes that publication of the proposal is in the public interest and will assist the Commission in considering the views of interested persons.
DATE: Comments must be received on or before [insert 30 days from publication in the Federal Register].
FOR FURTHER INFORMATION CONTACT: Thomas Smith, Attorney, Division of Trading and Markets, Commodity Futures Trading Commission, Three Lafayette Centre, 1155 21st street, NW, Washington, DC 20581. Telephone: (202) 418-5495; or electronic mail: email@example.com.
I. Description of Proposed SMM Program
By letter dated April 16, 1998, NYMEX submitted proposed new Rule 6.45 ("Specialist Market Maker Program") and proposed amendments to Rule 6.43A ("Broker Registration Requirements") pursuant to Section 5a(a)(12)(A) of the Commodity Exchange Act ("Act") and Commission Regulation 1.41(c). The proposed new rule and rule amendments would establish an SMM program for certain new or low-volume futures contracts. The SMM program is intended to provide liquidity for new or illiquid markets and would be terminated once the contract obtained a predetermined trading volume. The SMM program is patterned after a market maker program at the Chicago Mercantile Exchange that was previously approved by the Commission on April 20, 1995.
NYMEX intends to implement the SMM program in the Cinergy Electricity and Entergy Electricity futures contracts, which were approved by the Commission for trading on March 23, 1998. NYMEX anticipates listing the two new electricity futures contracts for trading within the next few months. The SMM program may be extended to other new or low-volume futures contracts at a later date.
B. SMM Eligibility Criteria
Applications for SMM positions would be accepted from members and member firms. Applications also would be accepted from individuals and firms that were not members or member firms. Appointment as an SMM could not occur however, until the individual or firm had been approved by the NYMEX Board of Directors as a member or member firm.
NYMEX would establish a new Exchange Committee, the Specialist Review Committee ("SRC"). The SRC would assess each SMM applicantís financial resources, operational capabilities, trading experience, regulatory history, and ability and willingness to promote NYMEX as a marketplace and would report its findings to the Board of Directors. Prospective SMM applicants also would need to demonstrate that they have the ability to provide multiple qualified personnel with the capability to perform the defined SMM obligations and have working capital in excess of $500,000. The Board of Directors would make the final decision as to which applicants to appoint as SMMs.
Only one SMM would be appointed for each contract market eligible for the SMM program. The Board of Directors, however, may appoint a member or member firm as an SMM for more than one contract market.
For any market for which an SMM has been appointed, the Exchange would issue an SMM trading permit to the SMM. The permit would allow the member or member firm to perform the SMM functions without incurring the cost of dedicating a membership for use in that designated futures contract. Thus, for example, if a member firm with two full NYMEX memberships were appointed an SMM in a new contract, the member firm would be permitted to act as the SMM for the new market while also retaining the trading privileges associated with the two full memberships.
C. Duties of the SMM
The SMMís rights and obligations would be set forth in a written agreement (the "SMM Agreement"). The SMM Agreement would require the SMM to provide a continuous physical presence on the floor of the Exchange throughout the regular trading session in order to maintain an orderly market in the appointed futures contract. During the trading session of the appointed market, the SMM would continuously provide bid and offer quotes for outright futures trades and price differentials for spread transactions for the contract delivery months set forth in the SMM Agreement.
The SMM Agreement would establish a maximum bid/offer quote spread and maximum price differential for certain contract delivery months. At a given bid or offer, the SMM would be obligated to satisfy all bids and offers in the ring at the same price up to a predefined maximum number of contracts for any one trade. In complying with this obligation for a particular price, the SMM could fill a bid or offer, as applicable, with one or more limit orders maintained in a limit order book at that price (the limit order book is discussed further below), with a trade for the SMMís proprietary account, or with a combination of limit orders and trading for his or her proprietary account.
NYMEX anticipates that a maximum bid/offer quote spread and maximum price differential would be set only for the "near" months (e.g., for one to three months out from the front-month contract) and the most active spread transactions. In addition, the SMM Agreement
may provide for a maximum bid/offer quote spread and price differential during usual market conditions and a larger maximum bid/offer quote spread and price differential during periods of extreme volatility, extreme trading volume, or market emergencies. The SMM Agreement would define these "unusual" market conditions for the purposes of the SMM program.
The SMM also would be required to maintain an order book of limit orders ("OB") in the markets for which he or she has been appointed an SMM. The limit orders could be for outright futures trades or spread transactions. The term "Order Book Official" ("OBO") would be used to refer to the SMM whenever the SMM was acting in the capacity of managing the OB.
A customer may elect to have a limit order given to the SMM for inclusion in the OB. NYMEX members also may place limit orders for their proprietary accounts with the SMM for inclusion in the OB. The OBO would be obligated to accept all limit orders presented for inclusion in the OB. Customers also may request that non-limit orders be given to the OBO for execution. The OBO would not be obligated to accept non-limit orders.
Upon a request from a member or clerk on the trading floor, the OBO would be required to disclose the prices, quantities and contract delivery months for the limit orders held in the OB. The promptness of the OBOís response would depend upon market conditions.
All orders presented to the OBO would have to be in writing. Orders entered into the OB would be executed on a price-priority and time-priority basis. The Exchange would provide the OBO with a time-stamp clock in the trading ring, and the OBO would be required to time-stamp each limit order that he or she received.
The proposal also would provide that the SMM may, at his or her discretion, respond to a request for a bid or offer as part of a large-order execution procedure. The SMM would be permitted to survey the ring to determine if other floor members were interested in participating in responding to the request.
D. Transaction Priorities
The SMM program would provide certain trading priorities to the OBO and to the SMM. With respect to the execution of limit orders in the OB, the OBO would have a 100% priority right over other proprietary traders and floor brokers in the ring for trades that take place at the OBOís bid or offer. For example, if the OB contained limit orders to buy a total of 10 contracts at a price of 40, the OBO would have a right to participate in any transactions executed at a price of 40 in the trading ring until all 10 of the limit orders in the OB were executed. With respect to this priority, no distinction would be made between member and customer limit orders in the OB.
In connection with the SMMís proprietary account, the SMM would have priority rights with respect to trades executed (1) against the OB; (2) in the ring and within the SMMís bid/offer spread; and (3) as a cross-trade against the OB. The SMM, however, would not be obligated to exercise his or her priority rights. The extent of each of these priorities is specified below.
The SMM would have a 10% priority right with respect to any transaction executed opposite the OB. For example, if a floor broker executed a trade opposite the OB for 20 contracts at a price of 39, the SMM may exercise his or her priority right and "take" 2 of the contracts at a price of 39 from the floor broker.
The SMM would have a 40% priority right with respect to trades executed in the trading ring that do not involve the OB and are within the SMMís bid/offer spread. For example if the SMMís spread is bid 40 and offer 50, and two floor brokers execute a trade for 20 contracts at a price of 40, the SMM may exercise his or her right to buy 8 of the contracts from the selling floor broker.
The SMM may trade for his or her proprietary account against the OB, provided that the SMM follows the cross-trade procedures set forth in NYMEX Rule 6.40, including announcing the price and quantity of the contracts to be purchased and sold to the trading ring three times and executing the transaction in the presence of an Exchange employee designated to observe such transactions. If one or more floor members respond to the SMMís bid and offer, the SMM may exercise a right of priority to a maximum of 40% of the transaction. For example, if the OB contained limit orders to buy a total of 10 contracts at a price of 30, the SMM may elect to trade opposite the OB by announcing three times the bid and offer for 10 contracts at a price of 30 to the other floor members in the trading ring. If other floor members respond to the announcement by offering to sell 10 contracts at 30, the SMM may elect to exercise his or her priority and trade against four of the contracts in the OB. The remaining six contracts would go to the other floor members in the trading ring who wished to participate in the transaction.
The SMMís priorities would extend to floor members executing trades for proprietary accounts and floor brokers executing customer orders. Therefore, the SMMís priority may preempt the execution of customer orders.
E. Contract Development Fee
The SMM would receive a contract development fee ("CDF") as an incentive to perform the SMM function. The terms and duration of the CDF would be set forth in the SMM Agreement, and would be based upon the level of customer trading volume in the designated contract. Unless otherwise provided in the SMM Agreement, the SMM would receive $8,000 per month if monthly customer trading volume was less than 3,500 contracts. Once monthly customer trading volume exceeded 3,500 contracts, the SMM would receive $8,000 plus a per contract fee for each transaction in excess of 3,500 that involved a customer order.
F. Specialist Floor Brokers
The proposal would permit the SMM to contract with one or more floor brokers ("Specialist Floor Brokers" or "SFB") to perform all or part of the SMM function. For example, the SMM may contract with the SFB to manage the OB and to perform all of the OBO obligations, including the OBís priority with respect to trading against the OB.
The proposal would give significant latitude to the SMM to contract with an SFB. However, any contract between an SMM and an SFB would be subject to the review and approval of the SRC. The proposal also would provide that the SMM would be principally liable to the Exchange for the execution of all SMM obligations and duties.
II. Request for Comments
The Commission requests comments from interested persons concerning any aspect of NYMEXís proposed SMM program that the commenters believe raise issues under the Act or Commission Regulations. In particular, the Commission requests comments regarding the appropriateness of: (1) permitting members to place limit orders for their own accounts in the OB; (2) permitting member limit orders to be executed ahead of customer limit orders that are at the same price, but received by the OBO at a later time; (3) granting the SMMs trading priorities, including the priority to trade against the OB; and (4) permitting the SMMís trading priority to preempt the execution of customer orders in the trading ring.
Copies of the proposed new Rule 6.45 and the proposed amendments to Rule 6.43A and related materials are available for inspection at the Office of the Secretariat, Commodity Futures Trading Commission, Three Lafayette Centre, 1155 21st Street, NW, Washington, DC 20581. Copies also may be obtained through the Office of the Secretariat at the above address or by telephoning (202) 418-5100.
Any person interested in submitting written data, views, or arguments on the proposed SMM program should send such comments, by the specified date, to Jean A. Webb, Secretary, Commodity Futures Trading Commission, Three Lafayette Centre, 1155 21st Street, NW, Washington, DC 20581; transmitted by facsimile to (202) 418-5521; or transmitted electronically to firstname.lastname@example.org.
Issued in Washington, DC, on May 11, 1998.
Alan L. Seifert,