Division of Trading and Markets
The Division of Trading and Markets (Division or T&M) develops, implements, and interprets regulations that protect customers, prevent trading and sales practice abuses, and assure the financial integrity of the futures markets and firms holding customer funds. In addition, the Division oversees the compliance activities of the futures industry self-regulatory organizations (SROs), which include the U.S. commodity exchanges, their clearinghouses, and the National Futures Association (NFA).� The Division also conducts trade practice surveillance, performs financial and sales practice compliance audits of registrants, reviews exchange and futures association rule amendments and submissions, and oversees the registration of industry professionals.
Rulemakings, Orders and Advisories
During FY 2000, the Division recommended and the Commission published the following final rules, proposed rules, orders, and advisories as part of the Commission's effort to reduce regulatory burdens.
Block Trading Proposals.� The Commission approved a proposal by the Cantor Financial Futures Exchange, Inc. (CFFE) to establish block-trading procedures at CFFE.� Under CFFE’s block trading program, qualified market participants are allowed to negotiate and arrange futures transactions of a minimum size bilaterally, away from the centralized, competitive market. Once the specific terms of the block transaction are agreed to, the counter-parties report the relevant details of the transaction to the exchange for clearing and settlement.� CFFE’s proposal was the first block trading proposal that the Commission received from a contract market.� The Commission also approved a proposal from the Chicago Mercantile Exchange (CME) to establish block-trading procedures at CME. CME’s proposal was similar to CFFE’s block trading program.
NYMEX Pilot Program For Trading at Settlement.� The Division allowed into effect a New York Mercantile Exchange (NYMEX) rule proposal that permits NYMEX members to enter into transactions prior to the close that are priced according to the later-determined settlement price.� This “trading at settlement” procedure was put in place in the crude oil futures contract to accommodate market participants who wished to trade at the settlement price to liquidate futures positions that hedged over-the-counter (OTC) swaps that referenced NYMEX settlement prices.
Use of Electronic Signatures by Brokerage Customers, Advisory Clients and Pool Participants.� The Commission adopted new rules permitting FCMs, IBs, commodity trading advisors (CTAs) and commodity pool operators (CPOs) to accept from their customers, clients or pool participants electronic signatures in those instances where Commission rules require registrants to obtain a signature on a document (such as an acknowledgment of receipt of required disclosure).� The new rules include a definition of "electronic signature" patterned on the definition in the Uniform Electronic Transactions Act and a requirement to employ reasonable safeguards in accepting electronic signatures.
Advisory Permitting Average Price Calculations by FCMs.� The Commission issued an advisory permitting FCMs to calculate average prices for their customers when multiple prices are received on an order, or series of orders, when permitted to do so by exchange rules.� Previously, the Commission had only authorized U.S. trading clearinghouses to perform the calculations. FCMs now have greater flexibility and increased efficiency in providing average pricing.
Foreign Futures and Options. The Commission adopted Rule 30.12 permitting certain foreign firms, acting in the capacity of FCMs and IBs, to accept and execute foreign futures and option orders received directly from certain sophisticated U.S. customers without the firms being required to register with the Commission.
In addition, the Commission issued a revised interpretation of the foreign futures or foreign options secured amount requirement contained in Rule 30.7, clarifying that the requirement for FCMs to obtain an acknowledgement from a depository regarding the treatment of foreign futures and option customer funds applies only to the treatment of those funds by the initial depository.� In conjunction with this revised interpretation, the Commission also issued an order that amends prior orders issued to foreign self-regulatory organizations concerning how their members must treat funds of U.S. customers related to trading on boards of trade outside of the U.S.
Investment of Customer Funds.� The Commission adopted amendments to Rule 1.25 to expand the range of instruments in which FCMs and clearing organizations may invest customer funds to include such highly liquid and readily marketable instruments as agency debt, sovereign debt, certificates of deposit, commercial paper, corporate notes, and money market mutual funds.� Purchases and sales of these instruments pursuant to agreements for resale or repurchase will also be permitted.� The rule amendments also include requirements concerning ratings of instruments, time to maturity, concentration limits, and a prohibition of leverage that are intended to minimize credit, market, and liquidity risk.
CPO and CTA Exemptive Provisions.� The Commission adopted amendments to Rule 4.7 to combine the former definitions of "qualified eligible participant" (QEP) and "qualified eligible client" (QEC) into a single "qualified eligible person" definition.� The amendments also added several categories of persons to the “qualified eligible person” category.� Under Rule 4.7, CPOs who solicit only QEPs and CTAs who advise only QEPs may claim exemption from certain otherwise applicable disclosure, reporting, and recordkeeping requirements.
The Commission adopted amendments to Rule 4.5 to add those plans the Employee Retirement Income Security Act of 1974 defines as “church plans” to the types of employee benefit plans that are not construed to be commodity pools (and whose operators are not required to register as CPOs).
Notional Funds.� The Commission proposed amendments to rules under Part 5 concerning the documentation, computation, and disclosure of CTA past performance information.� The proposed amendments would simplify the recordkeeping and computational requirements for CTAs who accept partially funded client accounts.� The amendments would also provide meaningful and focused disclosure to clients regarding the past performance of the CTA and the risks associated with trading on a partially funded basis.
Profile Disclosure.� The Commission adopted an amendment to Rule 4.21(a) to allow CPOs to provide prospective pool participants with a profile document prior to providing them with a full disclosure document as required by Part 4 of the Commission's regulations.� NFA Compliance Rule 2-35(d) permits CPOs to use a profile document containing key information about the pool.� The Commission's rule permits usage of a profile document under NFA's rule.� The Commission also published amendments to Commission Rule 4.26 to establish procedures for the issuance, amendment and filing of profile documents with the Commission.
Exemptive Relief and Guidance
In FY 2000, the Division responded to a high volume of requests for guidance concerning the applicability of regulations to specific transactions, products, persons, and market circumstances. Division staff issued over 250 exemptive letters, no-action positions, and interpretative guidance in response to written requests from members of the public and the regulated industry.� Staff also issued more that 125 responses to requests for guidance received through the Commission's website and responded to more than 2,000 telephone inquiries concerning the application of Commission requirements.
Access to Foreign Automated Boards of Trade.� The Commission continued the policy that was resumed in FY 1999 of issuing no-action letters in response to requests by foreign boards of trade to place electronic terminals in the U.S. without requiring those boards of trade to be designated as contract markets (the first such letter was issued in FY 1996 and four letters were issued in FY 1999). Specifically, no-action letters were issued to the International Petroleum Exchange of London Limited; the Singapore Exchange Limited (formerly known as the Singapore International Monetary Exchange); the London International Financial Futures and Options Exchange Limited (supplemental no-action letter to original letter issued in FY 1999); the Hong Kong Futures Exchange Ltd.; and the OM London Exchange Limited.� A request from Eurex (Switzerland) for a no-action letter was pending as of the end of FY 2000.� The Commission also issued a statement of policy that foreign exchanges that had already received no-action relief could trade additional contracts upon notice to the Commission, obviating the need for subsequent no-action letters.
Automated System for Buying and Selling Electric Power.� The Division issued a no-action letter permitting the operation and use of an automated system for buying and selling electricity for delivery in the future, without the system operator obtaining contract market designation pursuant to Section 5 of the CEA.� The system enables commercial entities that meet specified eligibility requirements to buy/sell electricity for on-peak hours in one-month blocks, up to 12 months in advance of delivery.� The transactions are the result of the anonymous matching of bids to buy and offers to sell electricity.� They establish binding, specific physical delivery obligations; do not allow parties to make cash settlement in lieu of delivery; and do not provide a contractual right to extinguish delivery obligations absent commercial necessity.� The relief was granted on condition that the system operator monitor market activity; notify the Commission if less than 75% of the total volume of electricity contracted on the system, measured on an annual basis and calculated at the end of each calendar month, is delivered; and maintain transaction and financial records, and make those records and other information available to Commission staff upon request.
Electronic Trading Platform for Petroleum Products.� The Division issued a letter granting no-action relief in connection with the operation of a proposed electronic trading platform for the trading of physical commodities and derivative products involving crude oil, heating oil, unleaded gasoline and jet kerosene (other commodities may be added later).� The platform will utilize an electronic trading and matching system that can be accessed through the Internet or dedicated communications lines, and it will be available only to approved participants and authorized brokers entering orders on their behalf.� Participants will be limited to commercial entities that qualify as “eligible swap participants” under Part 35 of the Commission’s rules.� Prior to the Division granting relief, Commission staff toured the facility that houses the hardware for the platform, and evaluated whether the platform meets the IOSCO principles for the oversight of screen-based trading systems for derivative products.
Review and Approval of Exchange Rules
The Division promotes and enhances self-regulation by reviewing proposed exchange rules, rule amendments, and other proposals for consistency with the CEA and Commission regulations. During FY 2000, the Division reviewed and the Commission approved 637 new exchange rules or rule amendments.� The Division also reviewed and permitted 766 new exchange rules or rule amendments to go into effect without prior Commission approval. These submissions often present complex new trading procedures and market structures, as well as financial arrangements that raise novel issues. The Commission acted on a number of issues related to the developments in electronic trading, including designation applications for new electronic futures exchanges, and developments in exchange operations.
FutureCom.� The Commission issued orders that designated FutureCom, Ltd. (FutureCom), a Texas limited partnership owned by the Texas Beef Group, as a new contract market for the automated Internet-based trading of cash-settled live cattle futures and options contracts.� FutureCom is unique in that it is the first Internet-based futures exchange and every member is its own clearing member.� Full margin for a position must be deposited with FutureCom before the order can be accepted by the system, and margin levels and position limits are tied directly to the creditworthiness of the member.� FutureCom was approved to be its own clearinghouse while outsourcing certain clearing and settlement functions to a bank pursuant to a cash settlement agreement.
Merchants’ Exchange of St. Louis.� The Commission issued orders that designated the Merchants’ Exchange of St. Louis, L.L.C. (MESL) as a contract market for the automated trading of deliverable Illinois Waterway and St. Louis Harbor barge freight futures contracts.� MESL has contracted with the Board of Trade Clearing Corporation (BOTCC) to provide all clearance and settlement functions and with NFA to perform several of MESL’s self-regulatory organization functions, including trade practice and market surveillance.� All MESL trade will be cleared through existing BOTCC members.
BrokerTec Financial Futures Exchange.� The Division received an application for review from BrokerTec Futures Exchange, L.L.C. (BrokerTec) for designation as a fully automated contract market in short, medium, and long term U.S. Treasury bond futures contracts.� The application provides that membership would be open internationally, based on such criteria as assets, capital, and creditworthiness.� BrokerTec will have its own clearinghouse with clearing services to be provided by BOTCC.� BrokerTec is wholly owned by BrokerTec Global, L.L.C., which was formed by a number of major international banks to provide electronic inter-dealer brokerage for fixed-income markets.
onExchange Board of Trade, Inc. and onExchange Clearing Corporation.� The Division received an application for review from onExchange Board of Trade, Inc. and onExchange Clearing Corporation (onExchange) for designation as a fully automated contract market in Five Year U.S. Treasury Note futures contracts.� The application provides that membership is open to any Eligible Swap Participant as defined in Commission rules who meets certain operational capabilities. Participation would not be intermediated, but may be facilitated by third party credit enhancement.� In addition, onExchange would operate its own clearinghouse.
CBOT-Eurex Alliance Rules.� The Division notified the Chicago Board of Trade (CBOT) that it could make effective immediately, without Commission approval, CBOT’s new rules for “e-cbot,” a new trading platform using technology adapted from the electronic trading system employed by Eurex Deutschland.� CBOT products began trading on this platform in August and it replaces the CBOT’s existing electronic trading system, Project A, as part of a strategic alliance between CBOT, Eurex, and other affiliates.� Users can access e-cbot or Eurex through the same front-end application and terminal.
CME Foreign Cross-Exchange Trading.� The Division allowed into effect a CME rule proposal that permits link arrangements with various foreign exchanges (in addition to March� � Terme International de France, with which CME already had such an arrangement).� Under the new rules, members of CME and a linked foreign exchange will be able to trade all products accessible on either exchange’s automated trading system in addition to cross-exchange contracts listed on Globex.� The rules of the exchange listing a particular contract will apply to all members of either exchange trading in that contract.� The proposal was submitted in anticipation of a CME link arrangement with the London International Futures Exchange (LIFFE), which was also allowed into effect.
Placement of NYMEX ACCESS Terminals in Singapore.� The Division notified the NYMEX that its proposed linkage with Singapore Exchange Derivatives Trading Limited (SGX-DT) for the purpose of trading on NYMEX ACCESS, its automated electronic trading system, was approved and could be made effective immediately. ACCESS terminals are now located in England and are linked with SGX-DT, Sydney Futures Exchange, and Hong Kong Futures Exchange. All linkages were approved under substantially similar qualifying factors.
Updated Version of NYMEX ACCESS Automated Trading System.� The Division allowed into effect the most recent version of NYMEX ACCESS, the NYMEX electronic trading system, developed to update the old ACCESS electronic trading system, originally approved by the Commission in 1992. The new version of ACCESS includes a “credit checking” function, allowing clearing members to take a more proactive approach to handling the financial risks associated with the trading activity of the accounts they clear.
CFFE Proprietary Trading Program.� The Commission notified CFFE that it would allow into effect a proposal to permit proprietary trading by a CFFE affiliate, CF Entity.� The action was based on CFFE representations concerning the erection of a “firewall” between CFFE and any CF Entity before proprietary trading could be carried out.
CME Demutualization.� The Commission approved a CME proposal to convert CME from an Illinois not-for-profit membership organization to a Delaware for-profit stock corporation and the issuance of an order transferring all of CME’s current contract market designations to the new entity, the Chicago Mercantile Exchange, Inc.� Although there are other for-profit futures exchanges, CME’s proposal was the first demutualization plan of an existing exchange approved by the Commission.�� In preparing its recommendation, staff analyzed the potential impact of the plan on the ability of the new for-profit exchange to perform its self-regulatory responsibilities effectively, as well as the plan’s impact on other current CME activities.� The Commission’s action included specified conditions relating to the self-regulatory functions of the exchange.
NYMEX Demutualization.� The Commission approved a NYMEX proposal to convert the exchange from a New York not-for-profit membership organization into a Delaware membership company that is a subsidiary of a Delaware for-profit stock corporation, NYMEX Holdings, Inc. and the issuance of an order transferring all of NYMEX’s current contract market designations to the new entity.� NYMEX’s proposal was approved subject to conditions similar to those imposed with respect to CME.
CME/LCH Cross-Margining Proposal.� The Division allowed the CME to put into effect without prior approval proposed CME rule amendments to facilitate a proprietary CME/London Clearinghouse (LCH) cross-margining program that uses the so-called “two-pot” approach. The rule amendments provide reduced margin requirements and net settlement obligations for program participants who trade eligible offsetting contracts based on the reduced risk associated with cross-margined positions.� Because it involves clearing organizations in different nations, the CME/LCH program raised novel issues concerning insolvency in a transnational context.
Financial Oversight
The Division conducts a financial surveillance and audit program. The Division also oversees the self-regulatory programs of NFA and the exchanges, which include audits, daily financial surveillance, and other self-regulatory programs.� The Division’s programs include oversight of financial compliance programs of these SROs and direct quality control audits to assess the efficiency of SRO programs.� Through this combination of direct examination and SRO oversight the Division ensures that FCM and IB registrants maintain required capital and that appropriate custodians hold customer funds in segregation.� This oversight includes audits of clearing organizations and review of financial reports filed by registrants.
During FY 2000 the Division staff worked on a number of projects to enhance the financial oversight of the industry, including the following.
FCM Financial Emergency.� Klein & Company Futures, Inc., an FCM, failed as a result of a major customer's inability to meet an account deficit.� Commission staff worked with representatives of Klein, NYBOT, NYCC, and NYMEX to have customer securities and cash returned to customers.� The Division is preparing a report to the Commission analyzing the events surrounding the failure and making recommendations for prevention of such events in the future.
Electronic Filing.� The Commission continued its efforts to implement procedures to enable registrants to file required financial reports electronically.� Approximately 80 CME and CBOT member firms now solely employ electronic filing for required reports. The Division expects to implement electronic filing procedures for firms that are required to file with NYMEX in FY2001. Approximately one-half of registered FCMs are not exchange members.� Most of these firms continue to file required reports with the Commission and NFA in hard copy.� The staff is continuing to work with NFA to convert hard copy reports to electronic reports either by converting hard copy to electronic format or by encouraging conversion to electronic filing instead of hard copy.
Withdrawal of Net Capital. � The Commission adopted an amendment to Rule 1.17 that deleted the existing restriction on the withdrawal of equity capital from an FCM or IB based on a percentage of the amount of funds an FCM is required to segregate.� This rule was adopted in light of other early warning capital standards and the degree of surveillance performed by SROs.
Capital Charge on Unsecured Foreign Broker Receivables.� The Commission proposed an amendment to Rule 1.17 concerning the five- percent capital charge that an FCM or IB must take for certain unsecured receivables due from foreign brokers. The proposal would amend the current rule by increasing the amount of the unsecured receivable that is exempt from the capital charge under certain conditions.
Subordinated Loan Agreements.� The Commission approved amendments to Rule 1.17 concerning the capital treatment of subordination agreements.� The amendments ease the regulatory burdens imposed on SROs, FCMs and IBs by allowing SROs to rely on a securities designated examining authority's approval of any proposed subordination agreement, proposed prepayment of a subordinated loan, or a reduction in such a loan.
Offsetting Customer Deficits.� The Division prepared proposed an amendment to Rule 1.32 to permit an FCM to offset a customer deficit in the segregation account with readily marketable securities deposited by a customer. The proposed amendment would codify and expand prior Division no-action letters that limit the securities that an FCM may use to offset customer deficits to U.S. Treasuries and certain other Canadian government debt instruments.
Other Oversight Activities.� In FY 2000, other activities of the Division's program in fostering the furtherance of sound financial practices included:
Review of 5,506 financial reports filed by registrants.
Direct audits of 50 FCMs, CPOs, CTAs and other registrants.
Processing of 190 risk-assessment filings.
Issuance of 301 warning and non-compliance letters.
Follow-up of 190 required special notices that report events such reductions of capital of registered firms.
Issuance of 1,547 year-end guidance letters to assist such registrants in the preparation of required annual financial reports.
Conduct of 30 major market move reviews.
SRO Rule Enforcement Oversight
The CEA requires each exchange, through a program of continuing rule enforcement, to ensure that its members adhere to exchange rules. The Division oversees, reviews and reports to the Commission on the self-regulatory compliance programs of the exchanges.� When appropriate, the reports of these reviews include recommendations for improvements and schedules for implementing those recommendations.� During FY 2000, in connection with reviews of trade practice, market surveillance, audit and financial surveillance, and related SRO compliance programs, the Division conducted reviews of the following exchange rule enforcement programs.
COMEX Gold Options Report.� The Division conducted a review and issued a report on trading in COMEX gold options on September 28, 1999.� On that date, the gold options market was severely strained by an extraordinary spike in volume, volatility, and price, accompanied by a more than 12-fold increase over the normal number of trades processed.� This resulted in significant problems in the execution, clearing, and settlement of customer orders.� The Division reviewed these events in detail to determine whether orders were received, executed, and cleared in accordance with exchange trading rules, whether systemic problems were revealed, and what corrective steps should be taken to ameliorate the impact of such market conditions should they recur.� The report recommended, among other things, that COMEX adopt or upgrade various computer technologies for processing and recording gold options trades; hold special sessions to resolve trade processing problems in such situations; and develop a mechanism to determine the extent and location of improperly cleared trades in high volume situations.
CBOT Trade Practice Surveillance and Disciplinary Programs.� The Division conducted a rule enforcement review and issued a report on the trade practice surveillance and disciplinary programs of the CBOT.� The Division found that the CBOT maintained adequate trade practice surveillance and disciplinary programs, conducting thorough, well-analyzed, and adequately supported trade practice investigations and, in most cases, imposing adequate sanctions.� The report noted that use of the CBOT’s Sophisticated Market Analysis Research Technology system had significantly enhanced the CBOT’s trade practice surveillance capabilities.� Based on its findings, the Division recommended that the CBOT take steps to achieve significant improvements in the timeliness with which it completes investigations, and recommended improvements in particular aspects of the CBOT’s trade practice surveillance and disciplinary programs.
KCBOT Market Surveillance, Audit Trail, Trade Practice Surveillance, and Disciplinary Programs.� The Division conducted a rule enforcement review and issued a report on the market surveillance, audit trail, trade practice surveillance, and disciplinary programs of the KCBOT.� While the report noted that KCBOT maintains an adequate market surveillance program and audit trail system, the Division recommended that KCBOT treat No Quote errors as trade timing errors subject to the exchange’s summary disciplinary program.� The Division also noted that KCBOT’s trade practice surveillance and disciplinary program were adequate but recommended that the exchange impose penalties for substantive trading violations of an amount significant enough to address the seriousness of the violation and to serve as an effective deterrent.
NYMEX Trade Practice Surveillance, Audit Trail, and Disciplinary Programs.� The Division conducted a rule enforcement review and issued a report on the trade practice surveillance, audit trail, and disciplinary programs of NYMEX.� The report noted that NYMEX maintains an adequate trade practice surveillance program and audit trail and recordkeeping program.� Although NYMEX also maintains an adequate disciplinary program, staff recommended that the exchange order members to pay restitution to injured customers in all disciplinary dispositions where the amount of customer harm can be determined.� The Division also recommended that the exchange disclose a subject member’s prior relevant disciplinary history when the case is presented to any disciplinary committee for consideration of sanctions.
Oversight of the National Futures Association
The Commission promotes self-regulation through delegation of authority to NFA and oversight of NFA activities, including the review of all proposed NFA rules and rule amendments.� In addition, the Division coordinates regulatory efforts with NFA.� For example, Division staff participate in and chair the Registration Working Group, which was established in 1995 and brings together NFA and Commission staff members to discuss registration issues of mutual concern. During FY 2000, the Registration Working Group participated in suggesting enhancements to the redesign of NFA’s databases, lent guidance to NFA concerning factors to consider in statutory disqualification cases and how to treat respondents’ claims of rehabilitation or mitigating circumstances, and reviewed methods for placing and removing “holds” on registration.� The Commission also issued a revised “Guidance Letter” advising NFA to cease using Commission Rule 1.63 as the basis for determining whether the disciplinary history of an FB or floor trader (FT) should disqualify them from registration.� The Commission directed NFA to use instead the standard articulated in a recent court cast (In re Clark), that statutory disqualification may arise if the disciplinary history consists of a pattern of exchange disciplinary actions alleging serious rule violation that resulted in significant sanctions.
Cooperative Efforts
Year 2000 Outreach Program.� The Commission was an active participant in the President’s Council on Year 2000 Conversion, through which it interacted with agencies and departments throughout the Federal government on Year 2000 preparation and action.� The Commission served as a member of that council’s Financial Institutions Sector Group, working regularly and closely on Year 2000 issues with agencies in that group. Domestically, the Commission established standards and provided guidance to those it regulates and assured their ability to address the Year 2000 change.� The Commission also engaged in cooperative efforts with the futures industry relating to Year 2000 issues as a participant in the Futures Industry Association’s Year 2000 Task Force.� Internationally, the Commission addressed Year 2000 issues through IOSCO and the Joint Year 2000 Council.� Through these working relationships, Commission staff engaged in substantial, routine outreach activities regarding Year 2000 with all sectors of the Federal government, its regulatees, and the international regulatory community.
Financial Oversight Coordination. � The Division maintained strong working relationships with other financial oversight organizations and groups such as the President’s Working Group on Financial Markets.� In particular, Division staff participated in and wrote several sections of the President’s Working Group on Financial Market’s study, Hedge Funds, Leverage, and the Lessons of Long Term Capital Management.� In this connection, the Commission proposed a rule that would require commodity pools with net assets over $1 billion or total assets over $3 billion to file quarterly financial reports that include quantitative risk information.� This proposal is in response to a recommendation of the President’s Working Group on Financial Markets to give greater transparency to the risks posed by large hedge funds.� The Commission also participated in the Working Group’s study of the over-the-counter derivatives market.
Civil Monetary Penalty Collection Program.� The Division, in cooperation with the Division of Enforcement, operates a civil monetary penalty collection program to reinforce Commission sanctions by assuring vigorous pursuit of penalties assessed.� During FY 2000, the Commission collected approximately $3,300,000 in penalties, including restitution and disgorgement.