e8-21865

FR Doc E8-21865[Federal Register: September 18, 2008 (Volume 73, Number 182)]

[Proposed Rules]

[Page 54097-54106]

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

[DOCID:fr18se08-25]

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COMMODITY FUTURES TRADING COMMISSION

17 CFR Parts 1 and 38

Execution of Transactions: Regulation 1.38 and Guidance on Core

Principle 9

AGENCY: Commodity Futures Trading Commission.

ACTION: Proposed rules.

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SUMMARY: The Commodity Futures Trading Commission (``Commission'' or

``CFTC'') is re-proposing a number of amendments to its rules, guidance

and acceptable practices, initially proposed on July 1, 2004,\1\

concerning trading off the centralized market, including the addition

of guidance on contract market block trading rules and exchanges of

futures for commodities or derivatives positions. The Commission is re-

proposing these amendments and requesting comment as part of its

continuing efforts to update its regulations in light of the Commodity

Futures Modernization Act of 2000 (``CFMA'').

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\1\ 69 FR 39880.

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DATES: Comments must be received by November 17, 2008.

ADDRESSES: Comments should be sent to the Commodity Futures Trading

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

DC 20581, attention: Office of the Secretariat. Comments may be sent by

facsimile transmission to 202-418-5521 or, by e-mail to

[email protected] Reference should be made to ``Proposed Rules for

Trading Off the Centralized Market.'' Comments may also be submitted by

connecting to the Federal eRulemaking Portal at http://

www.regulations.gov and following comment submission instructions.

FOR FURTHER INFORMATION CONTACT: Gabrielle A. Sudik, Special Counsel,

Division of Market Oversight; Telephone 202-418-5171; e-mail

[email protected]; Commodity Futures Trading Commission, Three Lafayette

Center, 1155 21st Street, NW., Washington, DC 20581.

SUPPLEMENTARY INFORMATION:

I. Background

Commission Regulation 1.38 (17 CFR 1.38) sets forth a requirement

that all purchases and sales of a commodity for future delivery or a

commodity option on or subject to the rules of a designated contract

market (``DCM'') should be executed by open and competitive methods.

This ``open and competitive'' requirement is modified by a proviso that

allows transactions to be executed in a ``non-competitive'' manner if

the transaction is in compliance with DCM rules specifically providing

for the non-competitive execution of such transactions, and such rules

have been submitted to, and approved by, the Commission.

The Commodity Futures Modernization Act of 2000 (``CFMA''),\2\

which was enacted after Regulation 1.38 was promulgated,\3\

significantly changed the Federal regulation of commodity futures and

option markets by replacing ``one-size-fits-all'' regulation with

broad, flexible core principles.\4\ At the same time, the CFMA modified

section 3 of the Commodity Exchange Act (``Act'') (7 U.S.C. 1 et seq.),

making a finding that transactions subject to the Act provide ``a means

for managing and assuming price risks, discovering prices, or

disseminating pricing information through trading in liquid, fair and

financially secure trading facilities,'' and providing that the purpose

of the Act is now, among other things, ``to deter and prevent price

manipulation or any other disruptions to market integrity; to ensure

the financial integrity of all transactions subject to this Act and the

avoidance of systemic risk; to protect all market participants from

fraudulent or other abusive sales practices and misuses of customer

assets. * * * '' \5\ The CFMA also expanded the types of transactions

that could lawfully be executed off the centralized market.

Specifically, the CFMA permits DCMs to establish trading rules that:

(1) Authorize the exchange of futures for swaps; or (2) allow a futures

commission merchant, acting as principal or agent, to enter into or

confirm the execution of a contract for the purchase or sale of a

commodity for future delivery if the contract is reported, recorded, or

cleared in accordance with the rules of a contract market or

derivatives clearing organization.\6\ At the same time, exchanges must

balance such rules with Core Principle 9 (7 U.S.C. 5(d)(9)) (Execution

of transactions), which states ``The board of trade shall provide a

competitive, open, and efficient market and mechanism for executing

transactions.''

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\2\ Public Law 106-554, 114 Stat. 2763 (2000). Under the CFMA,

such DCM rules may be effected by the certification procedures set

forth in section 5c(c) of the Commodity Exchange Act and 40.6 of the

Commission's regulations.

\3\ Regulation 1.38 was originally adopted in 1953 by the

Commodity Exchange Authority, the predecessor of the Commission. See

18 FR 176 (Jan. 19, 1953). For subsequent amendments, see 31 FR 5054

(Mar. 29, 1966), 41 FR 3191 (Jan. 21, 1976, eff. Feb. 20, 1976), and

46 FR 54500 (Nov. 3, 1981, eff. Dec. 3, 1981).

\4\ The CFMA was intended, in part, ``to promote innovation for

futures and derivatives.'' Sec. 2 of the CFMA. It was also intended

``to reduce systemic risk,'' and ``to transform the role of the

[Commission] to oversight of the futures markets.'' Id.

\5\ 7 U.S.C. Sec. 5 (2000).

\6\ See Section 7(b)(3) of the Act.

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In 2001, the Commission promulgated regulations implementing

provisions of the CFMA that established procedures relating to trading

facilities, interpreted certain of the CFMA's provisions, and provided

guidance on compliance with various of its requirements.\7\ Later, in

2002, the Commission promulgated amendments to those regulations in

response to issues that had arisen in administering the rules, noting

that the Commission would consider ``additional amendments to the rules

implementing the CFMA based upon further administrative experience.''

\8\ Consistent with that rationale, the Commission now proposes to

amend Commission Regulation 1.38 and Commission guidance and acceptable

practices concerning Core Principle 9 as it relates to Commission

Regulation 1.38 to include changes that the Commission has developed

based upon its experience administering those provisions.

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\7\ See 66 FR 14262 (Mar. 9, 2001) and 66 FR 42256 (Aug. 10,

2001).

\8\ See 67 FR 20702 (Apr. 26, 2002) and 67 FR 62873 (Oct. 9,

2002).

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[[Page 54098]]

II. Discussion of the Proposed Rule Amendments, Guidance and Acceptable

Practices

A. The Commission's July 1, 2004 Notice of Proposed Rulemaking

On July 1, 2004, the Commission published proposed amendments to

Regulation 1.38 and Commission guidance concerning Core Principle 9,

found in Appendix B to Part 38 of the Commission's Regulations (17 CFR

Part 38) (the ``July 1, 2004 NPRM'').\9\ The Commission proposed to

update the language of Regulation 1.38 to more accurately identify the

types of transactions that may lawfully be executed off a contract

market's centralized market and to simplify the language of the

Regulation. The Commission also wished to provide more detail regarding

acceptable practices for how contract markets can satisfy the

requirements of Core Principle 9, particularly on four general topics:

Electronic trading systems, general provisions for transactions off the

centralized market, block transactions, and the exchange of futures for

a commodity or a derivatives position.

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\9\ 69 FR 39880 (July 1, 2004).

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The Commission received seven comment letters in response to the

July 1, 2004 NPRM: From the Chicago Mercantile Exchange (``CME''), the

Futures Industry Association (``FIA''), the Chicago Board of Trade

(``CBOT''), the U.S. Futures Exchange (``USFE'') (two letters), the DRW

Trading Group (``DRW''), and Man Financial. The comments addressed

eight general areas of concern: The proposed amendments to Regulation

1.38, the Commission's proposed guidance for compliance with Core

Principle 9 in general, block trading in general, the minimum size of

block transactions, block trade prices, the time within which parties

must report block trades to the exchange, block trades between

affiliated parties, and the exchange of futures for a commodity or a

derivatives position. Some comments offered specific recommendations

regarding the proposed amendments, while other comments were of a more

general nature.

Between the publication of the July 1, 2004 NPRM and this current

proposal, the Commission has continued to gain experience in

administering Regulation 1.38 and Core Principle 9. Staff has also

learned more about the common practices involved in transactions done

off of the centralized market from the comment letters received, from

informal interviews with various entities in the futures industry, from

DCM rule submissions, and from informal studies of trading data related

to off-centralized-market transactions. In light of this, as well as

the length of time that has passed since the July 1, 2004 NPRM, the

Commission has determined to re-propose amendments to Regulation 1.38

and the guidance to Core Principle 9. Commenters are invited to submit

feedback on all areas of this proposal, including those areas already

addressed in earlier comment letters.

B. Core Principle 9 Guidance and Acceptable Practices

This proposal contains regulations, guidance and acceptable

practices. Commission regulations, such as Regulation 1.38, are

requirements that all contract markets must follow. Such regulations go

beyond mere illustrations of how a contract market may comply with a

section of the Act; they are requirements that stand alone and that the

Commission believes are necessary in order to comply with the Act. In

issuing guidance, the Commission strives to offer advice about how

contract markets can ensure compliance with sections of the Act. The

Commission recognizes that in certain areas there is more than one

possible approach that would allow a contract market to comply with a

related Section of the Act. For example, as will be discussed below,

there can be more than one way to determine an appropriate minimum size

for block trades. The Commission offers guidance on such subjects in an

effort to inform the exchanges of what it believes are some reasonable

approaches to take when tackling such issues and concerns to be

addressed in complying with Core Principles. The acceptable practices

provide examples of how exchanges may satisfy particular requirements

of the Core Principles; they do not establish mandatory means of

compliance.\10\ Acceptable practices are more specific than guidance.

An exchange rule modeled after an acceptable practice will be presumed

to comply with the related Core Principle, since the Commission has

already found such practice complies with that Core Principle. The

Commission wishes to emphasize that acceptable practices are intended

to assist DCMs by establishing non-exclusive safe harbors.\11\ The

introduction to Appendix B to Part 38 makes it clear that the

acceptable practices in Appendix B are not the sole means of achieving

compliance with the Act:

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\10\ See Section 5c(a) of the Act 7 U.S.C. 7a-2(a).

\11\ The Commission notes that safe harbor treatment applies

only to compliance with the specific aspect of the Core Principle in

question. In this regard, an exchange rule that meets a safe harbor

will not necessarily protect the exchange or market participants

from charges of violations of other sections of the Act or other

aspects of the Core Principle.

Acceptable practices meeting the requirements of the core

principles are set forth in paragraph (b) following each core

principle. Boards of trade that follow the specific practices

outlined under paragraph (b) for any core principle in this appendix

will meet the applicable core principle. Paragraph (b) is for

illustrative purposes only, and does not state the exclusive means

for satisfying a core principle.\12\

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\12\ See also A New Regulatory Framework for Trading Facilities,

Intermediaries and Clearing Organizations Proposed Rules, 66 FR

14262, 14263 (March 9, 2001).

The Commission also notes that it drafted the acceptable practices

based on its experience in reviewing exchange rules and in considering

related matters currently facing the Commission. The acceptable

practices provided in the proposal are, in large measure, modeled on

exchange rules that have previously been found to satisfy the

requirements of Core Principle 9. The Commission does not mean to imply

that it will find other rules unacceptable. Indeed, some of the

acceptable practices explicitly note that a DCM could adopt rules that

differ from the acceptable practice, although any such deviation would

still require the DCM and parties to trades to comply with Core

Principle 9, as required by section 5(d)(1) of the Act.

The Commission believes that its proposed issuance of guidance and

acceptable practices will generally ease the burden on exchanges in

complying with Core Principle 9. Without the adoption of these

amendments, DCMs are without any meaningful guidance as to whether

their requirements for trading off the centralized market comply with

Core Principle 9. These amendments provide certainty for those rules

that fall under an acceptable practice, while the burden for those that

fall outside of the acceptable practices is no greater than before. The

Commission believes that it would not be appropriate to lessen the

specificity of the acceptable practices because doing so would render

the guidance meaningless.

C. General Changes to the Re-Proposed Amendments

The amendments proposed in this rulemaking are in large measure

substantively similar to what was proposed in the July 1, 2004 NPRM.

This proposal, like its predecessor, strives to update the language of

Regulation 1.38 to more accurately

[[Page 54099]]

identify the types of transactions that may lawfully be executed off of

a contract market's centralized market and to simplify the language of

the Regulation. The proposed language also updates Regulation 1.38 to

make it clear that DCMs may self-certify (not just seek approval for)

rules or rule amendments related to transactions off the centralized

marketplace. This proposed amendment is consistent with section 5c(c)

of the Act, which allows for the certification of any DCM rule or rule

amendment.

In addition, Regulation 1.38 requires, subject to certain

exceptions, that all purchases and sales of a commodity for future

delivery or a commodity option on or subject to the rules of a DCM

should be executed by open and competitive methods. The implicit

assumption in Regulation 1.38 is that trading should take place on the

centralized market unless there is a compelling reason to allow certain

transactions to take place off the centralized market. Similarly,

exchange rules and policies that allow such transactions should ensure

that the impact on the centralized market is kept to a minimum. For

example, certain types of off-centralized market transactions, such as

block trades and exchanges of futures for related positions, can create

new positions or reduce prior positions. If these transactions become

the exclusive or predominant method of establishing or offsetting

positions in a particular market, it might jeopardize the centralized

market's role in price discovery and would not comply with Core

Principle 9, which provides that trading be competitive, open and

efficient.\13\ Other types of off-centralized market transactions are

bookkeeping in nature, such as transfer trades or office trades, which

move existing positions between accounts. These transactions do not

affect the price discovery mechanism of the centralized market because

they do not establish or offset positions.

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\13\ See also, section 3(a) of the Act, which finds that

transactions subject to the Act provide ``a means for managing and

assuming price risks, discovering prices, or disseminating pricing

information through trading in liquid, fair and financially secure

trading facilities.'' Using the example above, markets on which

transactions are exclusively or predominantly carried out by blocks

are not liquid markets. Furthermore, it has been questioned whether

markets are fair if they do not offer viable centralized trading.

This also calls into question such a market's compliance with

designation criterion 3, 7 U.S.C. 7(b)(3), which requires the

exchange to establish and enforce trading rules to ensure fair and

equitable trading through the facilities of the contract market.

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This proposed rulemaking also addresses the same four general

topics under Core Principle 9 that were addressed in the July 1, 2004

NPRM: Electronic trading systems, general provisions for transactions

off the centralized market, block transactions, and the exchange of

futures for a commodity or a derivatives position.

The majority of changes made since the July 1, 2004 NPRM strive to

do one of two things. First, the Commission has attempted to clarify

any language that was ambiguous, particularly in response to questions

raised in the comment letters. Second, the proposed acceptable

practices under Core Principle 9 have been redrafted to more closely

resemble the language of the acceptable practices for the other Core

Principles. The Commission believes that in addition to harmonizing the

language of the acceptable practices, these changes make the language

of the acceptable practices easier to read.

The Commission has made more significant changes to the proposed

amendments in three areas, based on the comment letters received, as

well as the Commission's own experience in administering Regulation

1.38 and Core Principle 9. These three areas, discussed in more detail

below, concern the appropriate minimum size of block trades; when block

trades may be permitted between affiliated parties; and exchanges of

futures for a commodity or derivatives position, including the

permissibility of transitory exchanges of futures for a commodity or

derivatives position (``transitory EFPs'').

D. The Minimum Size of Block Trades

In the July 1, 2004 NPRM the Commission proposed that an acceptable

minimum size for block trades would be at a level larger than 90% of

the transactions in a relevant market (``90% threshold'') or, for new

contracts with no relevant market, 100 contracts. CME, CBOT, DRW, FIA

and USFE all offered comments regarding those proposed acceptable

practices. CME and CBOT disagreed with the Commission's proposed

minimum sizes of the 90% threshold and 100 contracts: CME thought the

numbers were arbitrary, unresponsive to market needs and inconsistent

with the Commission's oversight role. Similarly, CBOT believed there

may be instances where 90% or 100 contracts could be too high or not

high enough. CBOT suggested that an acceptable minimum block trade size

be at the point where the block would move the market or where the

customer would not be able to obtain a fair price or fill the order on

the centralized market.

DRW suggested that the Commission clarify its intent that the

minimum block trade size should be derived from the size of trades in

the entire relevant market, which should include the central market,

related derivatives markets and the cash market. DRW also suggested

that using the 90% threshold would result in artificially low minimums

because many transactions in the central market are often broken down

into smaller trades at the same price. DRW suggested tying the minimum

block trade size to the size of orders instead of trades or by

developing a risk-based system that would consider both outright and

spread transactions.

USFE seemed to imply that the 90% threshold should be lower for

options than for futures. USFE noted that options transactions,

particularly combination trades, are more complex than futures trades

and require more human intervention than other trades. The options

market is therefore more conducive to trading off the centralized

market. While USFE did not suggest a different minimum threshold for

options, it indicated that more off-centralized-market trading of

options was necessary until technology could accommodate complex

options positions on the electronic trading screen.

In response to these comments, as well as the Commission's own

increased knowledge about block trades, the Commission is changing the

proposed guidance and acceptable practices on this topic. In this

regard, the Commission's guidance for determining appropriate minimum

sizes relies on the purpose for allowing block trades. Block trades are

allowed to be transacted off the centralized market for two reasons.

First, prices attendant to the execution of large transactions on the

centralized market may diverge from prevailing market prices that

reflect supply and demand of the commodity. This is because the

centralized market may not provide sufficient liquidity to execute

large transactions without a significant risk premium, so that the

prices of such trades tend to reflect, to a significant degree, the

cost of executing the trade. Accordingly, reporting these prices as

conventional market trades would be misleading to the public. Second,

block trading facilitates hedging by providing a means for commercial

firms to transact large orders without the need for significant price

concessions and resulting price uncertainty for parties to the

transaction that would occur if transacted on the centralized market.

Using these reasons as guidance, block trades should be limited to

large orders, where ``large'' is the number at which there is a

reasonable expectation that

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the order could not be filled in its entirety at a single price, but

would need to be broken up and executed at different prices if

transacted in the centralized marketplace. As such, the proposed

guidance notes that minimum block trade sizes should be larger than the

size at which a single buy or sell order is customarily able to be

filled in its entirety at a single price (though not necessarily with a

single counterparty) in that contract's centralized market, and

exchanges should determine a fixed minimum number of contracts needed

to meet this threshold.

The Commission now believes that its previous means of determining

an appropriate minimum size--the 90% threshold--may not be appropriate

for all markets because this figure does not necessarily correspond

with the size of the order that would move the market price. Because

the determination of what constitutes a large trade will vary between

DCMs, contracts and even over time, the acceptable practices will not

set forth an explicit threshold, but will instead leave it to the DCMs

to determine appropriate minimum sizes, based on the above purpose.\14\

This new approach should also address DRW's concern that using trade

size alone to determine a threshold might result in lower-than-

appropriate minimum sizes, because breaking an order into several small

trades ideally should not affect the overall volume or liquidity of the

centralized market. Similarly, the presence of many small trades

submitted by multiple traders will also not artificially lower the

appropriate minimum block trade size. The Commission also understands

that, as exchange volume migrates from floor trading to electronic

trading, the average size of transactions tends to decrease, resulting

in artificially low 90% thresholds and minimum block trade sizes that

are too low given the criteria discussed above.

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\14\ In this regard, the guidance could result in different DCMs

arriving at different minimum size requirements for the same or

similar futures contracts, if the liquidity and volume on each DCM

is different.

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One method by which DCMs could determine what number of contracts

is an appropriate minimum size would be to assess the market liquidity

(the number of contracts the centralized market is able to absorb at

the best execution price) and market depth (which measures the

potential price slippage if a large order were to be executed in the

centralized market). For example, a DCM could examine a contract's

market liquidity over time and determine that a certain size order in

that contract could rarely, if ever, be filled in its entirety at the

best price, and set a minimum block trade size based on this data. Such

calculations should be re-examined periodically, as volume, liquidity

and market depth change over time to ensure that a contract's minimum

block trade size remains appropriate. Such an analysis would most

easily be done for an electronically-traded contract, since trade data

about the contract is easy to gather and analyze.

Calculating a minimum size based on market liquidity and depth is

not the only possible way to determine what size order should be

considered ``large.'' DCMs could employ other methods to reasonably

determine what size order would move the price in the centralized

market. For instance, along with a review of trade sizes and/or order

sizes, DCMs could interview experienced floor brokers and floor traders

to determine what size order is generally too large to fill at a single

price. This method might be most appropriate for open-outcry markets

because DCMs will not have the same type of trade data generated by

electronic trading platforms, and will not as easily be able to

determine, based on electronic data, what size order is ``large.''

For new contracts that have no trading history, a DCM should strive

to set its initial minimum block trade size based on what the DCM

reasonably believes will be a ``large'' order (i.e., the order size

that would likely move the market price). So, for example, the DCM

might base its initial minimum block trade size on sources of data

other than transaction data in that particular contract such as

transaction patterns in related futures or cash markets, the DCM's

experience regarding other newly-launched contracts, and/or a survey of

potential market users to determine how many contracts might be

executed in a typical transaction. Where a DCM is unable to determine

an appropriate minimum size (due, for instance, to the lack of data in

other markets or other methods for estimating an appropriate minimum

size), the Commission believes it would be an acceptable practice for a

DCM to set the minimum block trade size at 100 contracts. In the past,

the Commission has considered 100 contracts to be a reasonable figure

to use as the minimum size until enough market data exist to allow that

figure to be adjusted, if need be. Once there is adequate trade data to

re-evaluate the minimum size, the DCM should ensure that it be adjusted

to a level where a trade would move the centralized market, if traded

there.

In this regard, the Commission proposes as an acceptable practice

that DCMs review the minimum size thresholds for block trades no less

frequently than on a quarterly basis to ensure that the minimum sizes

remain appropriate for each contract. As noted in the proposed

guidance, such review should take into account the sizes of trades in

the centralized market and the market's volume and liquidity. This

review and any necessary adjustments should be made to both new and

existing contracts. In addition, quarterly reviews of minimum block

trade sizes should take into account whether the minimum sizes ensure

that block trades remain the exception, rather than the rule. As noted

above, transactions off the centralized market should remain an

exception as the expectation is that most trading will occur on the

centralized market. Exchanges that established their minimum sizes for

block trades long ago may find they need to adjust their minimum sizes

as a result of changes in volume, liquidity, or the typical sizes of

transactions in the respective market.

Finally, the Commission notes that DCMs are free to require a

minimum size that is larger than what the guidance suggests a ``large''

trade would be. They are not obligated to set the minimum size at the

smallest acceptable minimum size.

E. Block Trades Between Affiliated Parties

Based on comment letters and the Commission's growing experience

with implementing Core Principle 9, the Commission has determined to

revise Regulation 1.38 and the related acceptable practices regarding

block trades between affiliated parties. An affiliated party is a party

that directly or indirectly through one or more persons, controls, is

controlled by, or is under common control with another party. These

proposed changes differ from the July 1, 2004 NPRM's treatment of block

trades between affiliated parties.

Block trades between affiliated parties may be permitted by DCMs,

so long as appropriate safeguards are in place to guard against the

heightened possibility that transactions between two closely related

parties are more susceptible to abuse, such as setting unreasonable

prices, artificially boosting volume, money passing, or wash trading.

It is not always clear that two related parties are motivated solely by

their own separable best interests, since they often both report to or

are accountable to a single person or entity, and as such they may be

encouraged by those in control of both sides of the transaction to

engage in trading strategies that benefit from abusive trading

practices. It is for this reason that the Commission believes it

[[Page 54101]]

is appropriate that DCMs that allow block trades between affiliates

also include additional safeguards to guard against the heightened

possibility of abuse, and that DCMs must have rules to ensure that

these safeguards are satisfied.

The Commission proposes to amend Regulation 1.38 by requiring that

when block trades take place between affiliated parties: (i) The block

trade price must be based on a competitive market price, either by

falling within the contemporaneous bid/ask spread on the centralized

market or calculated based on a contemporaneous market price in a

related cash market; (ii) each party must have a separate and

independent legal bona fide business purpose for engaging in the

trades; and (iii) each party's decision to enter into the block trade

must be made by a separate and independent decision-maker. Under the

acceptable practices for Core Principle 9, a DCM could permit block

trades between affiliated parties that meet these requirements and are

otherwise appropriate parties to engage in block trading.\15\

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\15\ Similarly, the proposed acceptable practices regarding the

prices of block trades also include reference to Regulation 1.38 as

it relates to block trades between affiliated parties.

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The Commission believes these proposed requirements for block

trades between affiliated parties strike an appropriate balance between

making clear that such trades are allowable and ensuring that each

party is acting independently when it agrees to enter into such a

transaction. The requirement that affiliated parties who engage in a

block trade meet objective criteria regarding that block trade will

help guard against the possibility that such closely related parties

might collude in some type of abuse.

F. Exchange of Futures for a Commodity or for a Derivatives Position

In the July 1, 2004 NPRM, the Commission proposed to include

acceptable practices regarding the exchange of futures for a commodity

or derivatives position (often referred to as an exchange-for-physical

or EFP, although it also includes, but is not limited to, similar

transactions such as exchanges-for-swaps or exchanges-for-risk).

Specifically, the Commission proposed a definition of what constituted

a bona fide EFP in the Core Principle 9 acceptable practices. The

Commission received comments from FIA, CBOT and CME regarding these

acceptable practices. Among other things, the commenters requested the

Commission clarify that trades commonly known as ``transitory EFPs''

are still permitted and that third parties may effect the cash portion

of an EFP transaction.

In response to these comments and other concerns that have arisen

since the July 1, 2004 NPRM, the Commission is proposing to make two

substantive amendments to its acceptable practices regarding exchanges

of futures for a commodity or derivatives position. First, the

Commission is proposing to expand the acceptable practices regarding

EFPs' bona fides, pricing, reporting, and DCMs' publication of EFP

transactions. Second, the Commission is proposing to make clear that

transitory EFPs are permissible when each part of the transaction--the

EFP itself and the related cash transaction--is a stand-alone, bona

fide transaction.

The Commission is proposing to offer general acceptable practices

for exchange of futures for a commodity or derivatives position,

including a definition of what constitutes a bona fide EFP, the pricing

of the legs, the reporting of the transaction to the exchange, and the

exchange's obligation, consistent with Regulation 16.01, to publicize

daily the total quantity of exchanges of futures for a commodity or

derivatives position. In response to the comment letters, the

Commission is proposing to clarify in the text of the acceptable

practices that a DCM may permit a third party to facilitate the

transfer of the cash leg of an EFP, so long as the commodity or

derivatives position is passed through to the party receiving the

futures position. These provisions are meant to be consistent with

previous publications by the Commission, including the 1987 EFP Report

prepared by the Commission's then Division of Trading and Markets and

the 1998 EFP Concept Release.\16\

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\16\ DIVISION OF TRADING AND MARKETS, REPORT ON EXCHANGES OF

FUTURES FOR PHYSICALS (1987) (the 1987 EFP Report); 63 FR 3708 (Jan.

26, 1998) (the 1998 EFP Concept Release).

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The essential elements of bona fide EFPs have been provided in the

guidance to Core Principle 9 below. The proposed elements are found in

current contract market ``exchange of futures'' rules and are based on

the essential elements for bona fide EFPs detailed in the 1987 EFP

Report.\17\ The elements include separate but integrally related

transactions, an actual transfer of ownership of the commodity or

derivatives position, and both legs transacted between the same two

parties. The Commission notes that the determination whether an actual

transfer of ownership has occurred will depend upon the facts and

circumstances of each transaction. In each instance where an exchange

of futures for a commodity or for a derivatives position is linked to

another offsetting transaction, the particular facts and circumstances

may warrant a determination that there was not an actual ownership

transfer of each leg of the commodity or derivatives position.

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\17\ See generally, the 1987 EFP Report. See also, CBOT Rules

331.08; CFE Rule 414; CME Rule 538; KCBT Rules 1128.00, 1128.02,

1129.00, and 1129.02; MGE Rule 719; NYBOT Rules 4.12 and 4.13; NYMEX

Rules 6.21, 6.21A and 6.21E; and OCX Rule 416.

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Further, the Commission is proposing that the acceptable practices

relating to the bona fides of an EFP should apply to transitory EFPs as

well. A transitory EFP involves both an EFP and an offsetting cash

commodity transfer. For example, party A purchases the cash commodity

from party B and then engages in an EFP whereby A sells the cash

commodity back to B and receives a long futures position. As a result

of these two transactions, the parties acquire futures positions but

end up with the same cash market positions they had before the

transaction.

To be a legitimate transitory EFP, the cash transaction must be

bona fide and the EFP itself must be bona fide. As with an EFP, a

primary indicator of a bona fide cash transaction is the actual

transfer of ownership of the cash commodity or position. In this

regard, the cash leg of the transaction must be able to stand on its

own as a commercially appropriate transaction, and may not be

intrinsically linked to the EFP transaction. A cash commodity transfer

that cannot stand on its own may indicate that there was no actual

economic risk in the cash leg of the related EFP and may raise concerns

about whether the EFP involved an ``exchange'' of futures contracts for

cash commodity as required by Section 4c(a) of the Act. There must be

no obligation on either party that the cash transaction will require

the execution of a related EFP, or vice versa.

G. Other Proposed Acceptable Practices

The rest of the proposed acceptable practices are for the most part

similar to what was proposed in the July 1, 2004 NPRM. As with the

acceptable practices discussed more fully above, the Commission

considered the comment letters when re-drafting these acceptable

practices, and strove to clarify any ambiguities and make them easier

to read. And, as in the July 1, 2004 NPRM, the Commission notes that

these proposed acceptable practices are based in large measure on

existing DCM rules.

[[Page 54102]]

1. Block Trade Prices

In the July 1, 2004 NPRM, the Commission proposed acceptable

practices regarding the prices of block trades. The most basic element

of this acceptable practice is that prices be ``fair and reasonable.''

In its comment letter, CBOT noted an inconsistency between the text of

the July 1, 2004 NPRM proposed guidance and the preamble and also

questioned whether ``circumstances'' of the party or market could or

should be relevant in determining whether a block trade price is fair

and reasonable. In this proposal, the Commission intends to eliminate

the ambiguity and to make clear its belief that a DCM could permit

``circumstances'' to be a factor in determining whether a block trade

price was fair and reasonable. Such an approach could include, for

example, the participants' legitimate trading objectives or the

condition of the market. The Commission does not believe that

permitting such flexibility will harm the centralized market because,

regardless of how a block trade price is determined, it must still be

fair and reasonable. The ability to price the trade away from the

centralized market is not a carte blanche to set unfair or unreasonable

prices.

2. Block Trade Reporting Times

In the July 1, 2004 NPRM, the Commission proposed in its acceptable

practices that block trades should be reported to the contract market

within a reasonable period of time. In response, DRW made two

suggestions: First, that reasonable reporting times for block trades

should be as close to immediately after the completion of the trade as

possible, with a maximum of no more than 5 minutes; and second, that

parties to a block trade should not be allowed to trade in the

centralized market until information about the block trade has been

made public.

The Commission will re-propose that block trades should be reported

to the contract market within a reasonable period of time. The

Commission declines to establish a specific length of time in order to

allow exchanges to determine what an appropriate length of time should

be on a contract-by-contract basis. But the Commission notes that most

current DCM rules require reporting of block trades within 5

minutes.\18\ A small number of DCM rules allow as many as 15 minutes,

but the Commission understands these are limited to contracts that have

very high block trade minimum size thresholds or where the contracts

are typically traded as part of large and complex spreads, requiring

more time to double check details and convey the information to the

exchange.\19\ When determining length of time for parties to report

block trades, DCMs should consider the importance of providing

information about block trades to the market as well as the potential

for abuses, such as front running, and whether longer reporting periods

may heighten the potential for abuse. Additionally, staff has

previously noted that allowing a few minutes' delay between the time a

block trade is executed and reported will allow the market price to

continue to respond to prevailing supply and demand factors, and not be

unduly influenced by the block itself. In other words, a reporting

delay will help the centralized market avoid the momentary price and

volume distortion that would occur if large trades were made on the

centralized market in the first place. In regards to whether parties to

a block trade may trade in the centralized market before the block

trade information is published, the Commission believes that the

reporting window offers parties to the block trade an opportunity to

hedge or offset the trade, which in turn supplies information to the

centralized market. As such, the Commission believes that compliance

with the Core Principles does not require that DCMs restrict the

ability of parties to a block trade from making transactions on the

central marketplace before the block trade is reported. DCMs, however,

are permitted to forbid such trading.

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\18\ See, e.g., CBOT Rule 331.05(d); CME Rule 526(F); NYMEX Rule

6.21C.

\19\ See, e.g., CME Rule 526(F).

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3. Publication of Transaction Details

The Commission is re-proposing that DCMs would publicize details

about transactions off the centralized market immediately upon the

receipt of the transaction report. The Commission wishes to clarify

that it does not intend to impose new publication requirements on DCMs

in regards to trades made off the centralized market beyond what is

required by the Commission's regulations. So, for example, DCMs would

need to publish the total number of exchanges of futures for a

commodity or for a derivatives position, as required by Commission

Regulation 16.01. But there would be no similar requirement to publish

office trades or transfer trades.

Similarly, the proposed guidance also identifies publication of

block trade details by DCMs immediately upon receipt of block trade

reports as an acceptable practice.\20\ The proposed acceptable

practices also would require the DCM to identify block trades on its

trade register.

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\20\ This also is an element of compliance with Designation

Criterion 3 (Fair and Equitable Trading) and Core Principle 8 (Daily

Publication of Trading Information).

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4. Recordkeeping

Current Commission Regulation 1.38(b) provides that every person

handling, executing, clearing, or carrying trades, transactions or

positions that are not competitively executed, must identify and mark

by appropriate symbol or designation all such transactions or contracts

and all associated orders, records, and memoranda. In addition to

updating the language of Regulation 1.38(b), the proposed amendments

add this requirement to the guidance under Core Principle 9, in order

to provide consolidated guidance regarding recordkeeping practices

pertaining to transactions off the centralized market.

Similarly, acceptable block trade rules would require parties to,

and members facilitating, a block trade to keep appropriate records.

Appropriate block trade records would comply with the requirements of

Core Principle 10 and Core Principle 17. Records kept in accordance

with the requirements of Statement No. 133 (``Accounting for Derivative

Instruments and Hedging Activities''), issued by the Financial

Accounting Standards Board (``FASB''), would be satisfactory.\21\

Acceptable block trade rules would require that block orders be

recorded by the member and time-stamped with both the time the order

was received by the member and the time the order was executed. When

requested by the exchange, the Commission or the Department of Justice,

parties to, and members facilitating, a block trade shall provide

records to document that the block trade is executed in accordance with

contract market rules.

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\21\ FASB Statement No. 133 provides guidance on the use of

accounting for corporate hedge activity involving derivative

transactions. The statement includes guidance on documenting the

hedging relationship.

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5. Testing of Automated Trading Systems

The guidance for Core Principle 9 also addresses the testing and

review of automated trading systems. Currently, the guidance states

that acceptable testing of automated systems should be ``objective,''

and calls for the provision of ``objective'' test results to the

Commission. The proposed guidance would also call for the provision to

the

[[Page 54103]]

Commission of test results of any ``non-objective'' testing carried out

by or for a DCM (such as informal in-house reviews) regarding the

system functioning capacity or security of any automated trading

systems. Although the results of ``non-objective'' testing would be of

more limited use, the Commission believes that test results of any

``non-objective'' testing carried out by or for the DCM should also be

provided to the Commission.

6. Parties to a Block Trade

The Commission is proposing that block trade parties are required

to be eligible contract participants (``ECPs'') as that term is defined

in Section 1a(12) of the Act, although commodity trading advisors

(``CTAs'') and investment advisors having over $25 million in assets

under management, including foreign persons performing equivalent

roles, are allowed to carry out block trades for non-ECP customers.

A majority of exchanges that permit block trading prohibit persons

from effecting block trades on behalf of customers unless the person

receives a customer's explicit instruction or prior consent to do

so.\22\ The proposed rulemaking incorporates this prohibition as an

acceptable practice.

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\22\ See CME Rule 526(C), CFE Rule 415(a)(i), CBOT Rule

331.05(a), NYBOT Rule 4.31(a)(ii)(A), OCX Rule 417(a)(i), and USFE

Rule 415(c).

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III. Request for Comment

The Commission requests comment on all aspects of this proposal.

IV. Related Matters

A. Regulatory Flexibility Act

The Regulatory Flexibility Act \23\ requires federal agencies, in

proposing rules, to consider the impact of those rules on small

businesses. The rule amendments proposed herein will affect DCMs, FCMs,

CTAs and large traders. The Commission has previously established

certain definitions of ``small entities'' to be used by the Commission

in evaluating the impact of its rules on small entities in accordance

with the RFA.\24\ The Commission has previously determined that

DCMs,\25\ registered FCMs,\26\ and large traders \27\ are not small

entities for purposes of the RFA. With respect to CTAs, the Commission

has determined to evaluate within the context of a particular rule

proposal whether CTAs would be considered ``small entities'' for

purposes of the Regulatory Flexibility Act and, if so, to analyze the

economic impact on the affected entities of any such rule at that

time.\28\ The Commission believes that the instant proposed rules will

not place any new burdens on entities that would be affected hereunder,

and the Commission does not expect the proposed amendments in most

cases to cause persons to change their current methods of doing

business. This is because requirements under this proposal, if adopted,

would be similar to most existing DCM requirements.

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\23\ 5 U.S.C. 601 et seq.

\24\ 47 FR 18618-21 (Apr. 30, 1982).

\25\ Id. at 18618-19.

\26\ Id. at 18619-20.

\27\ Id. at 18620.

\28\ Id. at 18620.

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Accordingly, the Commission does not expect the rules, as proposed

herein, to have a significant economic impact on a substantial number

of small entities. Therefore, the Chairman, on behalf of the

Commission, hereby certifies, pursuant to 5 U.S.C. 605(b), that the

proposed amendments will not have a significant economic impact on a

substantial number of small entities. The Commission invites the public

to comment on this finding and on its proposed determination that the

entities covered by these rules would not be small entities for

purposes of the Regulatory Flexibility Act.

B. Paperwork Reduction Act

The Paperwork Reduction Act of 1995 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 rule amendments do not require a new collection

of information on the part of any entities subject to these rules.

Accordingly, for purposes of the Paperwork Reduction Act of 1995, the

Commission certifies that these rule amendments do not impose any new

reporting or recordkeeping requirements.

C. Cost-Benefit Analysis

Section 15 of the Act, as amended by section 119 of the CFMA,

requires the Commission to consider the costs and benefits of its

action before issuing a new regulation. The Commission understands

that, by its terms, Section 15 does not require the Commission to

quantify the costs and benefits of a new regulation or to determine

whether the benefits of the proposed regulation outweigh its costs. Nor

does it require that each proposed regulation be analyzed in isolation

when that regulation is a component of a larger package of regulations

or of rule revisions. Rather, Section 15 simply requires the Commission

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

Section 15(a) 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 of concern

and could, in its discretion, determine that, notwithstanding its

costs, a particular regulation was necessary or appropriate to protect

the public interest, to effectuate any of the provisions, or to

accomplish any of the purposes of the Act.

The proposed amendments constitute a package of amendments to

Regulation 1.38 and to guidance that the Commission originally

promulgated to implement the CFMA. The amendments are proposed in light

of past experience with the implementation of the CFMA and are intended

to facilitate increased flexibility and consistency. Some sections of

the proposed amendments merely clarify or make explicit past Commission

decisions concerning transactions off the centralized market.

As most provisions incorporate DCM rules previously approved by the

Commission or submitted to the Commission under its self-certification

procedures, the proposed amendments would not, in most cases, impose

new costs on DCMs or market participants. The great majority of current

DCM rules already meet the acceptable practices proposed. Furthermore,

these amendments incorporate standards that the Commission has

previously determined protect market participants and the public, the

financial integrity or price discovery function of the markets, and

sound risk management practices. Moreover, the additional clarification

of acceptable practices provides a benefit to markets and market

participants. In addition, the amendments are expected to benefit

efficiency and competition by providing more detailed guidance as to

acceptable means of meeting the applicable designation criteria and

core principles, thus allowing a greater degree of legal certainty to

the markets and market participants.

After considering the five factors enumerated in the Act, the

Commission has determined to propose the rules and rule amendments set

forth below. The Commission invites public comment on its application

of the cost-benefit provision. Commenters also are invited to submit

any data that they may have quantifying the costs and benefits of the

[[Page 54104]]

proposed rules with their comment letters.

List of Subjects

17 CFR Part 1

Block transactions, Commodity futures, Contract markets,

Transactions off the centralized market, Reporting and recordkeeping

requirements.

17 CFR Part 38

Block transactions, Commodity futures, Contract markets,

Transactions off the centralized market, Reporting and recordkeeping

requirements.

In consideration of the foregoing, the Commission hereby proposes

to amend Chapter I of Title 17 of the Code of Federal Regulations as

follows:

PART 1--GENERAL REGULATIONS UNDER THE COMMODITY EXCHANGE ACT

1. The authority citation for part 1 continues to read as follows:

Authority: 7 U.S.C. 1a, 2, 5, 6, 6a, 6b, 6c, 6d, 6e, 6f, 6g, 6h,

6i, 6j, 6k, 6l, 6m, 6n, 6o, 6p, 7, 7a, 7b, 8, 9, 12, 12a, 12c, 13a,

13a-1, 16, 16a, 19, 21, 24, and 24, as amended by the Commodity

Futures Modernization Act of 2000, Appendix E of Pub L. 106-554, 114

Stat. 2763 (2000).

2. Section 1.38 is revised to read as follows:

Sec. 1.38 Execution of transactions.

(a) Transactions on the centralized market. All purchases and sales

of any commodity for future delivery, and of any commodity option, on

or subject to the rules of a designated contract market, shall be

executed openly and competitively by open outcry, or posting of bids

and offers, or by other equally open and competitive methods, in a

place or through an electronic system provided by the contract market,

during the hours prescribed by the contract market for trading in such

commodity or commodity option.

(b) Transactions off the centralized market; requirements.

(1) Notwithstanding paragraph (a) of this section, transactions may

be executed off the centralized market, including by transfer trades,

office trades, block trades, inter-exchange spread transactions, or

trades involving the exchange of futures for commodities or for

derivatives positions, if transacted in accordance with written rules

of a contract market that provide for execution away from the

centralized market and that have been certified to or approved by the

Commission. Every person handling, executing, clearing, or carrying the

trades, transactions or positions described in this paragraph shall

comply with the rules of the appropriate contract market and

derivatives clearing organization, including to identify and mark by

appropriate symbol or designation all such transactions or contracts

and all orders, records, and memoranda pertaining thereto.

(2) Block trades between affiliated parties; requirements. An

affiliated party is a party that directly or indirectly through one or

more persons, controls, is controlled by, or is under common control

with another party. In addition to the other requirements of this

section, block trades between affiliated parties are permitted only in

accordance with written rules of a contract market that provide that:

(i) The block trade price must be based on a competitive market

price, either by falling within the contemporaneous bid/ask spread on

the centralized market or calculated based on a contemporaneous market

price in a related cash market,

(ii) Each party must have a separate and independent legal bona

fide business purpose for engaging in the trades, and

(iii) Each party's decision to enter into the block trade must be

made by a separate and independent decision-maker.

PART 38--DESIGNATED CONTRACT MARKETS

3. The authority citation for part 38 is revised to read as

follows:

Authority: 7 U.S.C. 2, 5, 6, 6c, 7 and 12a, as amended by the

Commodity Futures Modernization Act of 2000, Appendix E of Pub. L.

106-554, 114 Stat. 2763 (2000).

4. Appendix B to Part 38 is revised to read as follows:

Appendix B to Part 38--Guidance on, and Acceptable Practices in,

Compliance With Core Principles

Core Principle 9 of section 5(d) of the Act: EXECUTION OF

TRANSACTIONS--The board of trade shall provide a competitive, open,

and efficient market and mechanism for executing transactions.

(a) Guidance.

(1) Transactions on the centralized market.

(i) Purchases and sales of any commodity for future delivery,

and of any commodity option, on or subject to the rules of a

contract market shall be executed openly and competitively by open

outcry, by posting of bids and offers, or by other equally open and

competitive methods, in a place or through an electronic system

provided by the contract market, during the hours prescribed by the

contract market for trading in such commodity or commodity option.

(ii) A competitive and open market's mechanism for executing

transactions includes a contract market's methodology for entering

orders and executing transactions.

(iii) Appropriate objective testing and review of a contract

market's automated systems should occur initially and periodically

to ensure proper system functioning, adequate capacity and security.

A designated contract market's analysis of its automated system

shall address compliance with appropriate principles for the

oversight of automated systems, ensuring proper system

functionality, adequate capacity and security.

(2) Transactions off the centralized market.

(i) In order to facilitate the execution of transactions,

transactions may be executed off the centralized market, including

by transfer trades, office trades, block trades, inter-exchange

spread transactions, or trades involving the exchange of futures for

a commodity or for a derivatives position, if transacted in

accordance with written rules of a contract market that specifically

provide for execution of such transactions away from the centralized

market and that have been certified to or approved by the

Commission.

(ii) Every person handling, executing, clearing, or carrying

trades off the centralized market shall comply with the rules of the

applicable designated contract market and derivatives clearing

organization, including to identify and mark by appropriate symbol

or designation all such transactions or contracts and all orders,

records, and memoranda pertaining thereto.

(iii) A designated contract market that determines to allow

trades off the centralized market shall ensure that such trading

does not operate in a manner that compromises the integrity of price

discovery on the centralized market or facilitate illegal or non-

bona fide transactions.

(3) Block trades-minimum size.

(i) When determining the number of contracts that constitutes

the appropriate minimum size for block trades, a contract market

should ensure that block trades are limited to large transactions

and that the minimum size is appropriate for that specific contract,

by applying the principles set forth in this section. For any

contract that has been trading for one calendar quarter or longer,

the acceptable minimum block trade size should be a number larger

than the size at which a single buy or sell order is customarily

able to be filled in its entirety at a single price in that

contract's centralized market. Factors to consider in determining

what constitutes a large transaction could include an analysis of

the market's volume, liquidity and depth; a review of typical trade

sizes and/or order sizes; and input from floor brokers, floor

traders and/or market users. For any contract that has been listed

for trading for less than one calendar quarter, an acceptable

minimum block trade size in such contract should be the size of

trade the exchange reasonably anticipates will not be able to be

filled in its entirety at a single price in that contract's

centralized market. An appropriate minimum size could be estimated

based on centralized market data in a related futures contract, the

same contract traded on another exchange, or trading activity in the

underlying cash market. The exchange could also consider the

anticipated volume,

[[Page 54105]]

liquidity and depth of the contract; input from potential market

users; or consider that exchange's experience with offering similar

new contracts. The minimum size thresholds for block trades should

be reviewed periodically to ensure that the minimum size remains

appropriate for each contract. Such review should take into account

the sizes of trades in the centralized market and the market's

volume and liquidity.

(b) Acceptable practices.

(1) General matters relating to trade execution facilities.

(i) General provisions. [Reserved]

(ii) Electronic trading systems.

(A) The guidelines issued by the International Organization of

Securities Commissions (IOSCO) in 1990 (which have been referred to

as the ``Principles for Screen-Based Trading Systems''), and adopted

by the Commission on November 21, 1990 (55 FR 48670), as

supplemented in October 2000, are appropriate guidelines for a

designated contract market to apply to electronic trading systems.

(B) Any objective testing and review of the system should be

performed by a qualified independent professional. A professional

that is a certified member of the Information Systems Audit and

Control Association experienced in the industry is an example of an

acceptable party to carry out testing and review of an electronic

trading system.

(C) Information gathered by analysis, oversight, or any program

of testing and review of any automated systems regarding system

functioning, capacity and security must be made available to the

Commission upon request.

(iii) Pit trading. [Reserved]

(2) Transactions off the centralized market.

(i) General provisions.

(A) Allowable trades. Acceptable transactions off the

centralized market include: transfer trades, office trades, block

trades, inter-exchange spread transactions or trades involving the

exchange of futures for commodities or for derivatives positions, if

transacted in accordance with written rules of a contract market

that specifically provide for execution away from the centralized

market and that have been certified to or approved by the

Commission.

(B) Reporting. Transactions executed off the centralized market

should be reported to the contract market within a reasonable period

of time.

(C) Publication. The contract market should publicize details

about block trade transactions immediately upon the receipt of the

transaction report and publicize daily the total quantity of the

exchange of futures for commodities or for derivatives positions and

the total quantity of the block trades that are included in the

total volume of trading, as required by Sec. 16.01 of this chapter.

(D) Recordkeeping. Parties to, and members facilitating,

transactions off the centralized market should keep appropriate

records. Appropriate recordkeeping for transactions off the

centralized market would comply with Core Principle 10 and Core

Principle 17.

(E) Identification of trades. Section 1.38(b) of this chapter

establishes the requirements regarding the identification of trades

off the centralized market. It requires contract market rules to

require every person handling, executing, clearing, or carrying

trades, transactions or positions that are executed off the

centralized market, including transfer trades, office trades, block

trades or trades involving the exchange of futures for a commodity

or for a derivatives position, to identify and mark by appropriate

symbol or designation all such transactions or contracts and all

orders, records, and memoranda pertaining thereto.

(F) Identification in the trade register. The contract market

should identify transactions executed off the centralized market in

its trade register, using separate indicators for each such type of

transaction.

(ii) Block trades.

(A) Acceptable minimum block trade size.

(a) New contracts or contracts that have been listed for trading

for less than one calendar quarter. If an exchange has no reasonable

basis upon which to estimate an initial minimum size, a minimum

block trade size of 100 contracts would be appropriate.

(b) Periodic review. The minimum size thresholds for block

trades should be reviewed no less frequently than on a quarterly

basis to ensure that the minimum size remains appropriate for each

contract.

(B) Appropriate parties.

(a) Acceptable block trade parties should be limited to eligible

contract participants. However, contract market rules could also

allow a commodity trading advisor registered pursuant to Section 4m

of the Act, or a principal thereof, including any investment advisor

who satisfies the criteria of Sec. 4.7(a)(2)(v) of this chapter, or

a foreign person performing a similar role or function and subject

as such to foreign regulation, to transact block trades for

customers who are not eligible contract participants, if such

commodity trading advisor, investment advisor or foreign person has

more than $25,000,000 in total assets under management.

(b) Affiliated parties. An affiliated party is a party that

directly or indirectly through one or more persons, controls, is

controlled by, or is under common control with another party.

Section 1.38(b) of this chapter establishes the requirements

regarding block trades between affiliated parties. Contract market

rules could permit block trades between affiliated parties that meet

the requirements of Regulation 1.38 and are otherwise appropriate

parties.

(C) Aggregation of orders. The aggregation of orders for

different accounts in order to satisfy the minimum size requirement

should be prohibited except in appropriate circumstances.

Aggregation would be acceptable if done by a commodity trading

advisor registered pursuant to Section 4m of the Act, or a principal

thereof, including any investment advisor who satisfies the criteria

of Sec. 4.7(a)(2)(v) of this chapter, or a foreign person

performing a similar role or function and subject as such to foreign

regulation, if such commodity trading advisor, investment advisor or

foreign person has more than $25,000,000 in total assets under

management.

(D) Acting for a customer. A person should transact a block

trade on behalf of a customer only when the person has received an

instruction or prior consent to do so from the customer.

(E) Recordkeeping. Parties to, and members facilitating, a block

trade should keep appropriate records. Appropriate block trade

records would comply with Core Principle 10 and Core Principle 17.

Records kept in accordance with the requirements of FASB Statement

No. 133 (``Accounting for Derivative Instruments and Hedging

Activities'') would be acceptable records. Block trade orders must

be recorded by the member and time-stamped with both the time the

order was received and the time the order was reported, and must

indicate when block trades are between affiliated parties. When

requested by the exchange, the Commission or the Department of

Justice, parties to, and members facilitating, a block trade shall

provide records to document that the block trade is executed in

conformance with contract market rules.

(F) Reporting. Block trades should be reported to the contract

market within a reasonable period of time.

(G) Publication. The contract market should publicize details

about the block trade immediately upon the receipt of the

transaction report and publicize daily the total quantity of the

block trades that are included in the total volume of trading, as

required by Sec. 16.01 of this chapter.

(H) Identification in the trade register. The contract market

should identify block trades as such on its trade register, and

should identify when block trades are between affiliated parties.

(I) Pricing. (a) Block trades between non-affiliated parties

should be at a price that is fair and reasonable. Consideration of

whether a block trade price is fair and reasonable could take into

account the size of the block plus the price and size of other

trades in any relevant markets at the applicable time, or the

circumstances of the market or the parties to the block trade.

Relevant markets could include the contract market itself, the

underlying cash markets and/or other related futures or options

markets. If a contract market rule requiring a fair and reasonable

price includes the circumstances of the parties or of the market, a

block trade participant could execute a block transaction at a price

that was away from the market provided that the participant retains

documentation to demonstrate that the price was indeed fair and

reasonable under the participant's or market's particular

circumstances.

(b) Block trades between affiliated parties are subject to the

pricing requirements of Sec. 1.38(b) of this chapter.

(iii) Exchange of futures for commodities or for derivatives

positions.

(A) Bona fide exchange of futures for commodities or for

derivatives positions. The exchange of futures for commodities or

for derivatives positions would include separate but integrally

related transactions involving the same or a related commodity, with

price correlation and quantitative equivalence of the futures and

cash legs. An exchange of futures for commodities or for derivatives

positions would be between a buyer of futures who is the seller of

the corresponding commodity or derivatives position and a

[[Page 54106]]

seller of futures who is the buyer of the corresponding commodity or

derivatives position. A third party could be permitted to facilitate

the purchase and sale of the commodity or derivatives position as

long as the commodity or derivatives position is passed through to

the party that receives the futures position. The transaction would

have to result in an actual transfer of ownership of the commodity

or derivatives position. It also would have to be between parties

with different beneficial owners or under separate control, who had

possession, right of possession, or right to future possession of

the commodity or derivatives position prior to the trade, the

ability to perform the transaction, and resulting in a transfer of

title.

(B) Pricing. The price differential between the futures leg and

the commodities leg or derivatives position should reflect

commercial realities, and at least one leg of the transaction should

be priced at the prevailing market price.

(C) Transitory exchange of futures for commodities or for

derivatives positions. Parties to an exchange of futures for

commodities or for derivatives positions could be permitted to

engage in a separate but related cash transaction that offsets the

cash leg of the exchange of futures for commodities or for

derivatives positions. The related cash transaction would have to

result in an actual transfer of ownership of the commodity or

derivatives position and demonstrate other indicia of being a bona

fide transaction as described in paragraph (a). The cash transaction

must be able to stand on its own as a commercially appropriate

transaction, with no obligation on either party that the cash

transaction be dependent upon the execution of the related exchange

of futures for commodities or for derivatives positions, or vice

versa.

(D) Reporting. Exchanges of futures for commodities or for

derivatives positions should be reported to the contract market

within a reasonable period of time.

(E) Publication. The contract market would publicize daily the

total quantity of exchanges of futures for commodities or for

derivatives positions that are included in the total volume of

trading, as required by Sec. 16.01 of this chapter.

(iv) Office trades. [Reserved]

(v) Transfer trades. [Reserved]

Issued in Washington, DC on September 12, 2008 by the

Commission.

David Stawick,

Secretary of the Commission.

[FR Doc. E8-21865 Filed 9-17-08; 8:45 am]

BILLING CODE 6351-01-P

Last Updated: September 18, 2008