77962 Federal Register / Vol. 65, No. 240 / Wednesday, December 13, 2000 / Rules and Regulations

1Recognizing the importance of the OTC

derivatives markets, the Chairmen of the Senate and

House Agriculture Committees asked the

President’s Working Group on Financial Markets

(PWG) to conduct a study of OTC derivatives

markets. After studying the existing regulatory

framework for OTC derivatives, recent innovations,

and the potential for future developments, the PWG

on November 9, 1999, reported to Congress its

recommendations. See, Over-the-Counter

Derivatives Markets and the Commodity Exchange

Act, Report of the President’s Working Group. The

PWG report focused on promoting innovation,

competition, efficiency, and transparency in OTC

derivatives markets and in reducing systemic risk.

Although specific recommendations about the

regulatory structure applicable to exchange-traded

futures were beyond the scope of its report, the

PWG suggested that the Commission review

existing regulatory structures (particularly those

applicable to markets for financial futures) to

determine whether they were appropriately tailored

to serve valid regulatory goals. 2Products subject to the special procedural

provisions of section 2(a)(1)(B)(ii) of the Act,

however, must continue to be designated and

regulated by the Commission as contract markets. 3The eligible commodities are those that are

listed as eligible for trading on an exempt MTEF.

COMMODITY FUTURES TRADING

COMMISSION

17 CFR Parts 1, 5, 15, 36, 37, 38, 100,

170 and 180

RIN 3038–AB55

A New Regulatory Framework for

Multilateral Transaction Execution

Facilities, Intermediaries and Clearing

Organizations

AGENCY: Commodity Futures Trading

Commission.

ACTION: Final rulemaking.

SUMMARY: The Commodity Futures

Trading Commission (Commission or

CFTC) is promulgating a new regulatory

framework to apply to multilateral

transaction execution facilities, to

market intermediaries and to clearing

organizations. This new framework

constitutes a broad exemption under the

authority of section 4(c) of the

Commodity Exchange Act (Act or CEA)

from many of the current rules

applicable to designated contract

markets. In addition, the new

framework relies more heavily on

disclosure rather than merit regulation.

It establishes three new market

categories, including the category of

exempt multilateral transaction

execution facility and two categories of

Commission-recognized and regulated

multilateral transaction execution

facilities. In companion releases

published in this edition of the Federal

Register, the Commission also is

adopting new rules for intermediaries

and entities that clear derivative

transactions. These final rules make

fundamental and far-reaching changes

to Federal regulation of commodity

futures and option markets. However,

nothing in these rules alters or

diminishes the Commission’s

responsibility for overseeing and

enforcing compliance by self-regulatory

organizations, Commission registrants

and market participants with the

provisions of the Act.

The Commission in a companion

release published in this edition of the

Federal Register also is expanding and

clarifying the operation of the current

swaps exemption. Nothing in these

releases, however, would affect the

continued vitality of the Commission’s

exemption for swaps transactions under

part 35 of its rules, or any of its other

existing exemptions, policy statements

or interpretations. Moreover, nothing in

the final rules would affect the

application of any statutory exclusion,

including in particular, the applicability

of the exclusion under section

2(a)(1)(A)(ii), known as ‘‘the Treasury

Amendment.’’

EFFECTIVE DATE: February 12, 2001.

FOR FURTHER INFORMATION CONTACT: Paul

M. Architzel, Chief Counsel, Division of

Economic Analysis, or Alan L. Seifert,

Deputy Director or Riva Spear Adriance,

Special Counsel, Division of Trading

and Markets, Commodity Futures

Trading Commission, Three Lafayette

Centre, 1155 21st Street, N.W.,

Washington, D.C. 20581. Telephone:

(202) 418–5260. E-mail:

(PArchitzel@cftc.gov),

(ASeifert@cftc.gov) or

(RAdriance@cftc.gov).

SUPPLEMENTARY INFORMATION:

I. Background

A. Overview

The Commission, on June 22, 2000,

proposed a new regulatory framework to

apply to multilateral transaction

execution facilities that trade contracts

of sale of a commodity for future

delivery or commodity options. 65 FR

38986. The Commission proposed this

new framework to ‘‘promote innovation,

maintain U.S. competitiveness, and at

the same time reduce systemic risk and

protect customers.’’ Id. The framework

provides U.S. futures exchanges greater

flexibility with which to respond to the

competitive challenges brought about by

new technologies.

Specifically, the framework proposed

to replace the current ‘‘one-size-fits-all’’

regulation for futures markets with

broad, flexible ‘‘core principles,’’ and to

establish three regulatory tiers for

markets: recognized futures exchanges

(RFEs), derivatives transaction facilities

(DTFs) and exempt multilateral

transaction execution facilities (exempt

MTEFs). The proposed core principles

were tailored to match the degree and

manner of regulation to the varying

nature of the products and the

participants permitted to trade on a

facility.

In general, the framework proposed a

lower level of regulatory oversight

where access to an exchange or facility

is restricted to eligible participants or

commercial participants or where the

nature of the underlying commodity

poses a relatively low susceptibility to

manipulation. This reflects the reduced

need to monitor closely such markets.

The Commission also proposed,

however, that markets serving a price

discovery function, irrespective of the

product traded or market participants,

provide a degree of price transparency.

The proposed framework therefore

balanced the public interests of market

and price integrity, protection against

manipulation and customer protection

with the need to permit exchanges and

other trading facilities to operate more

flexibly in today’s competitive

environment. As noted in the Notice of

Proposed Rulemaking, the President’s

Working Group on Financial Markets

and the chairmen of the Commission’s

Congressional oversight committees

encouraged the Commission to consider

proposing such major revisions to the

regulatory framework.1 65 FR at 38987.

B. The Proposed Rules

Under the proposed framework,

current U.S. futures exchanges would be

included automatically in the RFE

category.2 These exchanges would be

permitted greater business flexibility

through compliance with core

principles rather than the prescriptive

regulations now in place. In addition to

achieving greater flexibility in their

current operations, the exchanges, as a

business choice, also could operate as a

DTF or as an exempt MTEF, as

appropriate.

The proposed DTF market would be

subject to an intermediate level of

regulation. DTFs, like RFEs, would be

Commission-recognized markets. As

proposed, DTFs would be geared either

to mainly institutional traders or to only

commercial traders. Specific

requirements proposed for DTFs differ

somewhat depending upon whether a

DTF is an institutional or a commercial

market.

The Commission proposed that

institutional-participant DTFs may

provide a trading platform for

transactions involving those

commodities listed in the rules that are

eligible for such an intermediate level of

regulation.3 Additional commodities,

Federal Register / Vol. 65, No. 240 / Wednesday, December 13, 2000 / Rules and Regulations 77963

The rules relating to exempt MTEFs are discussed

below. A market that otherwise might be eligible to

be exempt from regulation as an exempt MTEF may

voluntarily become a DTF in order to be become a

‘‘recognized’’ market.

4The proposed list of commodities included: a

debt obligation, a foreign currency, an interest rate,

an exempt security, a measure of credit risk or

quality, or cash-settled based upon an economic or

commercial index or based upon an occurrence or

contingency.

5A significant number of letters commenting on

aspects of the regulatory framework raised in

companion notices were also submitted to the

Commission. In this and three companion Notices

of Final Rulemaking which are being published in

this edition of the Federal Register, comment letters

(CL) are referenced by file number, letter number

and page. Comments filed in response to the notice

of proposed rulemaking on MTEFs, parts 36–38, are

contained in file No. 21, on the notice of proposed

rulemaking on intermediaries in file No. 22, on the

notice of proposed rulemaking on clearing in file

No. 23 and on the notice of proposed rulemaking

on the part 35 exemption in file No. 24. These

letters are available through the Commission

internet web site, www.cftc.gov.

6A transcript of the proceedings was included in

the Commission’s comment file and is available

through the Commission’s internet web site.

7A transcript of the AAC meeting is also included

in the Commission’s comment file and is available

on the Commission’s website.

including agricultural commodities,

would be eligible to trade on an

institutional-participant DTF on a caseby-case determination. The Commission

would make that determination based

upon the depth and liquidity of the cash

market and on the surveillance history

of the commodity based on its actual

trading history.

Although institutional-participant

DTFs would be intended primarily for

institutional traders, the proposed rules

provide individual DTFs with the

flexibility to decide whether or not to

permit access by non-institutional

traders. The Commission proposed,

therefore, to permit access to a DTF by

non-institutional traders only through a

registered futures commission merchant

(FCM) that is a member of a recognized

clearing organization and that has $20

million of adjusted net capital. Those

FCMs would be required to provide

their non-institutional customers

trading on a DTF with additional

disclosures and other protections.

In addition, the rules proposed an

intermediate level of oversight for

commercial-participant DTFs. Only

commercial participants trading for

their own accounts would have access

to these facilities. Commercialparticipant DTFs may trade any

commodity other than the agricultural

commodities enumerated in section

1a(3) of the Act, government securities

and commodities subject to the

provisions of section 2(a)(1)(B)(ii) of the

Act. Such commercial traders generally

would have both the financial ability

and the physical means to deliver

tangible commodities or otherwise be

involved in trading that commodity in

connection with their line of commerce.

Accordingly, certain requirements that

were proposed to apply to institutionalparticipant DTFs would not be

applicable to commercial-participant

DTFs.

The Commission also proposed a

market tier exempt from all Commission

regulation, subject only to the Act’s antifraud and anti-manipulation provisions

and a requirement that, if performing a

price discovery function, the market

provide pricing information to the

public. This exemption was proposed

for facilities on which transactions

would be entered into among

institutional traders in contracts based

upon a specified list of commodities.4

The Commission proposed to exempt

counterparties to such transactions from

a claim in a private right of action that

a violation of the terms of the exemption

renders the transactions void. These

exempt markets could not hold

themselves out as being regulated by the

Commission. As noted above, existing

futures markets, where appropriate,

would have the opportunity to operate

under the terms of this exemption, if

they so choose.

C. Overview of Comments

The Commission received a total of 71

comments from a wide range of

commenters on the proposed new

regulatory framework for multilateral

transaction execution facilities.5 The

commenters included 24 trade

associations, six commodity exchanges,

two government agencies, four financial

institutions, three attorneys, two

institutional study organizations, one

agri-business firm, a self-regulatory

organization, and several energy and

communication firms or markets.

In addition to comment letters, the

Commission received oral and written

statements during a public meeting held

at the Commission’s headquarters on

June 27 and 28, 2000. At that meeting,

members of the public had an

opportunity to address the Commission

and to respond to questions.6 During the

meeting, several panels of industry

experts, representing the U.S. futures

exchanges, the over-the-counter

derivatives markets, emerging

information and technology providers,

market intermediaries and clearing

organizations discussed the proposals in

the context of current market structures

and future trends. The proposed rules

were also discussed and public

comments received at a July 19, 2000,

meeting of the Commission’s

Agricultural Advisory Committee

(AAC).7

The overwhelming majority of the

comments expressed general support for

the Commission’s proposed framework,

and provided specific suggestions for its

improvement. Many commenters

described the Commission’s initiative as

a bold or important departure from the

status quo which recognizes the

beginnings of a new financial market

landscape. In general, the commenters

supported the framework’s innovative

concepts of providing greater regulatory

flexibility by substituting core

principles for prescriptive, one-size-fitsall regulations, and of tiered regulations

tailored to the particular nature of the

market. They also generally supported

the Commission’s initiative as providing

greater legal certainty to various types of

instruments.

Four commenters, however, strongly

disagreed with the Commission’s

approach, albeit for opposing reasons.

One institutional study organization

argued that the proposal would take

regulatory reform too far. In contrast, a

second institutional study organization,

an investment banking firm and an

attorney expressed serious reservations,

contending that the framework provided

neither significant regulatory relief nor

greater legal certainty. The substance of

individual comments is discussed in

greater detail below.

II. Final Rules

A. Exempt Multilateral Transaction

Execution Facilities (Exempt MTEFs)

As discussed above, the Commission,

in revised part 36, proposed a new, selfeffectuating exemption for those

multilateral transaction facilities

(MTEFs) to which only eligible

participants have access, either trading

for their own account or through

another eligible participant, and only for

contracts based upon: (1) A debt

obligation; (2) a foreign currency; (3) an

interest rate; (4) an exempt security or

index thereof, as provided in section

2(a)(1)(B)(v) of the Act; (5) a measure of

credit risk or quality, including

instruments known as ‘‘total return

swaps,’’ ‘‘credit swaps’’ or ‘‘spread

swaps’’; (6) an occurrence or

contingency beyond the control of the

counterparties to the transaction; or (7)

cash-settled, based upon an economic or

commercial index or measure beyond

the control of the counterparties to the

transaction and not based upon prices

derived from trading in a directly

77964 Federal Register / Vol. 65, No. 240 / Wednesday, December 13, 2000 / Rules and Regulations

8 It should be noted that the instruments eligible

for exemption are limited by operation of section

2(a)(1)(B) of the Act, which is reserved in proposed

§ 36.3(a). As the Commission observed, ‘‘[t]he

reservation, and application, of this provision is

consistent with the language of section 4(c) of the

act which limits the Commission’s authority to

exempt transactions from the application of section

2(a)(1)(B) of the Act.’’ 65 FR at 38988.

9They are: Chase Manhattan Bank; Citigroup,

Inc.; Credit Suisse First Boston, Inc.; Goldman

Sachs & Co.; Merrill Lynch & Co., Inc.; and Morgan

Stanley Dean Witter & Co.

10H.R. Rep. No. 978, 102d Cong., 2d Sess. 82–83

(1992). 11See also, CL 21–57 at 4, which makes the same

fundamental error. 12 In this regard, it must be noted that sections

6(c) and 9(a)(2) of the Act prohibit manipulation of

‘‘the market price of any commodity, in interstate

commerce,’’ and is not limited in application to

‘‘contracts of sale of a commodity for future

delivery.’’ 13For example, were the Chicago Mercantile

Exchange (CME) to offer trading of its Eurodollar

contract through an exempt MTEF, the rule

provides for public notice and an opportunity for

public comment in determining that the market

‘‘serves as a significant source for the discovery of

prices for an underlying commodity’’ and to require

that, as a consequence, it disseminate certain

information to the public. See, PWG Report at 19.

corresponding underlying cash market.8

The Commission proposal was based

upon the ‘‘view that these commodities,

when traded between or among eligible

participants need not be subject to the

regulatory scheme of the Act. Accord

PWG Report at 17.’’ 65 FR at 38988.

Many commenters strongly supported

this new exemption. For example, the

International Swaps and Derivatives

Association, Inc. (ISDA) observed that

the ‘‘clarifications contained in the

Exempt MTEF proposal are of critical

importance to ISDA and its members.’’

CL 21–37 at 4. Reuters Group PLC

(Reuters), a provider and developer of

‘‘electronic business-to-business

transaction communities,’’ stated that in

its view, ‘‘[t]his new category of Exempt

MTEF provides significant legal

certainty to new electronic marketplaces

in the enumerated derivatives.’’ CL 21–

62 at 3. A group of commercial and

investment banks (Coalition) 9

commented that it ‘‘strongly supports

the Commission’s proposal, and

believes that the proposal represents a

very important initiative both to

promote legal certainty and to facilitate

the development by U.S. market

participants of electronic trading

systems and technologies and the

expanded use of clearing facilities. In

addition, proposed part 36 would * * *

limit[] the ability of an eligible

participant to repudiate unprofitable

contracts based on the CEA. The

Coalition strongly supports these

provisions. * * *’’ CL 21–65 at 9. An

attorney with the firm of Covington &

Burling commented that:

Derivative transactions satisfying these

three conditions would be exempt from

virtually all CEA regulation * * * and either

(1) were traded on a multilateral transaction

execution facility (MTEF), under newlyproposed part 36 of the Commission’s

regulations; or (2) were not traded on an

MTEF, under newly-revised part 35 of the

Commission’s regulations. Thus, participants

* * * would obtain legal certainty about the

limited scope of CEA regulation regardless of

whether the means for executing transactions

did or did not satisfy the technical definition

of an MTEF.

It is our understanding that several

comments have been filed with the

Commission that seek changes to the

proposed regulations in ways that

conceivably could affect the legal certainty

described above, including the Commission’s

statement supporting such legal certainty. We

urge the Commission not to make any

changes that would affect the

interrelationship between the MTEF

exemption and the bilateral transactions

exemption in a manner that would diminish

the legal certainty provided to eligible

participants trading exempt commodities.

CL 21–63 at 2–3.

A number of the comments that

generally supported proposed part 36

also suggested specific modifications,

relating mainly to the commodities

which were proposed to be eligible for

the part 36 exemption and the proposed

definition of MTEF. These issues, along

with three comments opposing the

proposed part 36 exemption on mainly

jurisdictional grounds, are discussed

below.

1. Jurisdictional Issues

Three commenters objected to the part

36 exemption on jurisdictional grounds.

See, CLs 21–28, 55 and 57. One of the

three, JP Morgan Securities, Inc. (JP

Morgan), objected generally to proposed

part 36, and particularly to the inclusion

of instruments eligible for the

exemption that are ‘‘a measure of credit

risk or quality, including instruments

known as ‘total return swaps,’ ‘credit

swaps,’ or ‘credit spread swaps,’’’

reasoning that:

An Exempt MTEF is to be subject to the

anti-fraud and anti-manipulation provisions

of the Act, as well as to whatever future rule

the Commission may enact governing

information dissemination. Therefore, a

proposed ‘‘exemption’’ from the CEA has the

effect of extending the Commission’s

authority to facilities that may trade

products, such as swaps, which are not the

Commission’s to regulate under the terms of

the Act itself. A self-effectuating

‘‘exemption’’ in this instance unintentionally

becomes the reverse, an assertion of CFTC

jurisdiction over non-futures products.

CL 21–55 at 4.

However, JP Morgan’s conclusion is

erroneous. As explained in its Notice of

Proposed Rulemaking (65 FR at 38989),

and reiterated herein, the Commission,

by providing an exemption under part

36, is not thereby making an initial

determination that any particular

instrument which may be trading in

reliance on the exemption is or is not

within the Commission’s jurisdiction.

The use of the Commission’s section

4(c) exemptive authority in this context

to provide legal certainty to novel

instruments without a preliminary

determination by the Commission of

complex jurisdictional issues is

precisely as intended by the Congress.

When Congress adopted section 4(c) in

1992, the Conferees stated:

The conferees do not intend that the

exercise of exemptive authority by the

Commission [under Section 4(c)] would

require any determination beforehand that

the agreement, instrument, or transaction for

which an exemption is sought is subject to

the Act. Rather, this provision provides

flexibility for the Commission to provide

legal certainty to novel instruments where

the determination as to jurisdiction is not

straightforward.10

Moreover, the assertion that the

Commission through this exemption

would extend provisions of the Act to

instruments or persons not subject to

the Act misconstrues the nature and the

scope of the exemption. As proposed,

rule 36.3(a) provides that the anti-fraud

and anti-manipulation sections of the

Act ‘‘continue to apply to transactions

and persons otherwise subject to those

provisions.’’ 11 65 FR at 38999. Thus, it

is clear that the proposed rules do not

attempt to extend application of the Act

to any transactions not already subject

to the Act.12

Proposed rule 36.2(g) requires that an

exempt MTEF disseminate trading

volume, price ranges and other trading

data, but only pursuant to a Commission

determination, after notice and an

opportunity for a hearing, that the

facility serves as a significant source for

the discovery of prices. That procedure

provides the facility with an

opportunity to challenge the validity of

the Commission’s authority to issue and

enforce such an order on the grounds

that the instruments being traded are

not subject to the Act.13 Nevertheless,

the Regulatory Studies Program of the

Mercatus Center (Mercatus) opined that,

even though ‘‘a party could contest the

CFTC’s assertion of jurisdiction * * * it

is the mere assertion of regulatory

jurisdiction by the CFTC that in the past

has created the legal uncertainties that

these Proposals attempt to address.’’ CL

21–57 at 4.

However, proposed rule 36.3(b), the

contract non-repudiation provision,

Federal Register / Vol. 65, No. 240 / Wednesday, December 13, 2000 / Rules and Regulations 77965

14See, CFTC Staff Letter No. 99–67, [Current

Transfer Binder] Comm. Fut. L. Rep. (CCH) ¶ 27,970

(Dec. 16, 1999), relating to a market established by

the legislature of California for the trading of

electricity.

further removes any such potential

negative, collateral effects on other

markets. To the extent that part 36

applies to transactions traded on a

facility, the contract non-repudiation

provision also applies, reinforcing the

legal certainty and validity of the

transactions. On the other hand, to the

extent that transactions and a market are

outside of the Commission’s

jurisdiction, the Act and Commission

rules (including the part 36 exemption)

are inapplicable, and hence there can be

no legal uncertainty about the validity

of the contracts arising from the Act or

Commission rules thereunder. As the

Commission explained in the Notice of

Proposed Rulemaking,

the Commission is not making a

determination that any market that is eligible

to be an exempt MTEF under the proposed

exemption is or is not subject to the

Commission’s jurisdiction under the CEA.

Moreover, the fact that one market may

operate as an exempt MTEF in reliance upon

the proposed exemption * * * does not

imply that the Commission has made a

determination that any firm or entity that

operates in a similar manner is subject to the

Commission’s jurisdiction under the CEA.

65 FR at 38989 (footnote omitted). Thus,

the existence and application to any

particular market of the part 36

exemption carries no negative legal

inference or uncertainty for any other

market.

Nevertheless, Mercatus further argues

that the proposed exemption ‘‘raises a

whole new area for legal uncertainty in

that the broad definition of MTEF in

Proposed Rule 36.1(b) would appear to

cover auction markets such as eBay and

all other forms of B2B trading facilities,

whether electronic or not.’’ CL 21–57 at

5. Similarly, an attorney with the firm

of Vinson & Elkins argues that,

‘‘multilateral transaction execution

facilities—regardless of the nature of

their participants or the nature of the

economic activity being undertaken on

those facilities—must agree to become

regulated by the CFTC.’’ CL 21–28 at 1.

This misconstrues the operation and

structure of the part 36 exemption. As

noted above, the exemption in part 36

is from application of the Act. To the

extent that the Act does not apply to a

facility’s transactions, the regulatory

framework is simply inapplicable. Thus,

so long as a facility auctions

instruments outside of the

Commission’s regulatory jurisdiction

under the Act, these exemptions

therefrom and this framework would

have no application to its business.

2. Eligible Commodities

Some commenters have suggested that

the commodities eligible for this

exemption should differ somewhat from

those proposed by the Commission.

Specifically, the United States

Department of the Treasury (Treasury)

recommended that government

securities should be ineligible for

trading on exempt MTEFs. Treasury

noted that contracts eligible to trade on

an exempt MTEF would have included

both single government securities and

baskets of government securities. It

further noted that ‘‘[s]ince the

introduction of futures contracts on

government securities in the late 1970s,

the trading of these instruments on

futures exchanges has always been

subject to Commission regulation, and

all dealers and brokers in the cash

market for government securities have

been subject to regulation since the

enactment of the Government Securities

Act.’’ CL 21–50 at 2.

As the Commission explained in its

Notice of Proposed Rulemaking, 65 FR

at 38988, its determination of which

commodities to include as eligible for

exempt MTEF status was informed by

the recommendations of the PWG,

including its recommendation to

exclude from the Act transactions by

eligible participants on electronic

trading systems in commodities other

than non-financial commodities with

finite supplies. Treasury, however, has

concluded that, for futures and options

on government securities, a higher level

of regulation than trading as an exempt

MTEF is necessary and appropriate in

order not to ‘‘undermine the integrity of

the government securities markets.’’ Id.

As Treasury noted in its comment letter,

[p]rior to 1986, * * * problems with these

entities [government securities brokers and

dealers] led to the passage of the Government

Securities Act of 1986, which was amended

in 1993 to address issues related to auction

irregularities, short squeezes, and unfair sales

practices * * *. Allowing government

securities futures to trade on exempt MTEFs,

where they would not be subject to the

Government Securities Act or any other

regulatory framework designed to address

potential problems, could undermine the

integrity of the government securities

markets.

[T]here have been a number of attempts to

manipulate individual securities within the

broader market. Additionally, fraud and

mistreatment of customers has in the past

also been a concern in the government

securities market.

Id.

In deference to Treasury’s expressed

concern that a higher level of regulation

is necessary than provided at the

exempt MTEF level, the final rules

adopted by the Commission do not

include government securities as

eligible for trading on exempt MTEFs.

Specifically, the Commission has

removed the reference to exempt

securities and indexes thereof

previously included in proposed rule

36.2(b)(4) and has amended final rule

36.2(b)(1) to make clear that eligible

debt instruments do not include such

exempt securities.

In contrast to Treasury’s

recommendation to delete government

securities from the list of eligible

commodities, several commenters with

energy-related businesses suggested that

energy-related products be added to the

list of commodities eligible to trade on

exempt MTEFs. See CLs 21–34, 37, 38,

43. Merrill Lynch Co., Inc. (Merrill

Lynch), for example, opined that ‘‘overthe-counter bilateral trading in energy

products between commercial entities

has been exempted * * * since 1993

* * * and that no pattern of abuses or

irregularities has been identified.’’ CL

21–38 at 9. It further reasoned that,

‘‘electricity trading remains subject to

oversight by the FERC and the states,

including licensing standards for market

participants, reporting requirements,

and enforcement authority to remedy

any problems that may arise.’’ Id. at 12.

Merrill Lynch also noted that action has

been taken by the FERC,

to promote open access to transmission grids

for natural gas. * * * Similarly, many state

legislatures and public utility commissions

* * * have adopt[ed] rules to facilitate or

require the unbundling of gas distribution

from production and supply. [A]

standardized form of contract is in

widespread use in the natural gas market.

Given this statutory background, it would be

inconsistent with the intent of Congress and

actions taken by the FERC for the

Commission to impose additional regulation

on natural gas trading.

Id. at 13.

However, the Commission does not

require that cash markets, such as those

described above, come within the

regulatory framework.14 Centralized

markets to trade spot and forward

agricultural commodities have long

existed outside of the regulatory scheme

that applies to futures and option

markets. The Act, and the regulatory

framework thereunder, apply to markets

that trade futures or option contracts on

such underlying commodities.

Accordingly, there is no inconsistency

between the Commission’s regulation of

futures markets and regulation of the

underlying cash markets by other

regulators, such as the FERC or the

states. To the contrary, the Commission

in its oversight of the futures and option

77966 Federal Register / Vol. 65, No. 240 / Wednesday, December 13, 2000 / Rules and Regulations

15See, comment letter from the California Power

Exchange, an exchange offering physical delivery

cash forward markets for the purchase and sale of

electricity between commercial parties. CL 21–34 at

3.

16Of course, the framework does not preclude the

trading of such contracts altogether. Under the

framework, contracts for these commodities may

trade on an institutional-participant DTF based on

a case-by-case determination by the Commission,

on a commercial-participant DTF or on an RFE.

17 ISDA suggests including a ‘‘category of eligible

commodities * * * that over time become traded in

sufficient volume so as to be highly unlikely to be

susceptible to manipulation.’’ CL 21–37 at 4. The

Commission is of the view that the petition

procedure provided in part 36 would in fact

provide it with the type of flexibility to respond to

market developments that ISDA advocates. The

Coalition recommended that this authority be

delegated by the Commission to the Director of the

Division of Economic Analysis. CL 21–65 at 10. The

Commission is of the view that these

determinations should not be delegated at this time.

18Moreover, the specific named types of

instruments such as ‘‘total return swaps’’ in the

clause beginning with the word ‘‘including’’ modify

the more general description ‘‘a measure of credit

risk or quality.’’ Thus ‘‘total return swaps,’’ a term

which may include many different types of

instruments, are included under this prong of the

exemption only insofar as they are also ‘‘a measure

of credit risk or quality.’’ Of course, as noted in the

Notice of proposed Rulemaking and reiterated

above, nothing in these rules would affect the

markets coordinates and cooperates

with the regulators of related underlying

cash markets.

Moreover, although some commenters

expressed the view that energy products

under the regulatory framework should

be eligible to trade on exempt MTEFs

based on the sophistication of traders in

the market,15 eligibility for exempt

MTEF treatment must also be premised

upon a finding that the likelihood of

manipulation is sufficiently low that

regulation is not required. That case has

not yet been made. Existing derivative

contracts involving energy commodities

typically are based on physical delivery

within a relatively narrow geographic

area. Delivery under these contracts can

be subject to physical constraints, e.g.,

pipeline congestion, transmission

congestion in the case of electricity,

weather or natural disaster related

events, concentration of ownership of

transmission, pipeline or storage and

production capacity. Although the total

supplies of a broadly defined energy

commodity may be large if viewed on a

global basis, only a small subset of that

total supply typically would be

available for delivery on a derivatives

contract. As the New York Mercantile

Exchange (NYMEX) pointed out in its

comment,

[t]he President’s Working Group drew a

distinction in its report that limited

exclusion from CFTC regulatory authority to

financial derivatives. The Working Group’s

reasoning, in part, was that financial

derivatives had ‘‘virtually inexhaustible

supplies’’ and that dealers in the swaps

markets, * * * were subject to other forms of

regulatory oversight. That is not the case with

many participants in the OTC energy

derivative marketplace. Because the

President’s Working Group focused primarily

upon financial derivatives in its report, one

may reasonably conclude at this time that the

case has yet to be made that such wholesale

exemption from CFTC regulation for energy

derivatives would serve the public interest.

CL 21–47 at 3. In agreement, Williams

Energy Marketing and Trading

Company, a company engaged in energy

marketing and trading and risk

management activities, noted that it

‘‘supports the Commission’s proposal to

exempt from regulation those * * *

MTEFs meeting the conditions specified

in the proposed rule,’’ and it urged the

‘‘Commission to stay the course of

establishing the basic parameters for its

new regulatory framework.’’ CL 21–25 at

3, 4.

As proposed, the final rules do not

make energy-related commodities

eligible for trading on exempt MTEF

markets at this time.16 The Commission

is making this determination based

upon its surveillance experience of

designated contract markets on energyrelated products and upon careful

consideration of the comments. In

making this determination, the

Commission is not foreclosing generally

any subsequent reconsideration of the

issue. Moreover, the Commission

proposed to permit individual markets,

including those offering energy-related

products, to petition the Commission for

exemption under the provisions of part

36. As proposed, rule 36.2(h)

specifically provides that ‘‘any person

or entity may apply to the Commission

for exemption for other arrangements or

facilities, on such terms and conditions

as the Commission deems appropriate,

including but not limited to, the

applicability of other regulatory

regimes.’’ 65 FR at 38999. The New

York Independent System Operator

(NYISO) in its comment supported

inclusion of this provision, stating that,

[i]rrespective of whether the automatic

exemption criteria are modified, NYISO

supports the inclusion of a provision

permitting the Commission authority to grant

individual petitions for Exempt MTEF status

* * *. This type of flexibility is, we believe,

necessary to accommodate markets with

which the Commission may not as yet be

familiar as well as changing markets.

CL 21–61 at 7.

The Commission agrees that

flexibility to address new and changing

markets is both necessary and

appropriate and is adopting proposed

rule 36.2(h) as final.17 As with other

such general exemptive provisions, the

rule does not limit the grounds on

which such an exemption may be

granted. Compare, 17 CFR 32.4(b) and

35.2(d). However, those petitioning for

exemption should be guided by the

overall principles underlying the

framework, that

the level of oversight applied to exchanges or

trading facilities * * * be based on the

nature of participants allowed to trade on the

facility and certain characteristics of the

commodities being traded. In general, where

access to an exchange or facility is restricted

to more sophisticated traders or commercial

participants, or where the nature of the

commodity being traded poses a relatively

low susceptibility to manipulation,

regulatory oversight would be set at a lower

level, reflecting the reduced need to monitor

closely such markets.

65 FR at 38988. The commodities that

are eligible for exempt MTEF status

enjoy nearly inexhaustible deliverable

supplies or are otherwise not subject to

limitation. Petitions for inclusion of

additional commodities should be for

commodities of a similar nature. In

addition, petitioners should consider

addressing the sufficiency and

applicability of other regulatory

schemes.

Proposed rule 36.2(b)(5) would make

eligible for exemption contracts,

agreements or transactions which are ‘‘a

measure of credit risk or quality,

including instruments known as ‘total

return swaps,’ ‘credit swaps,’ or ‘spread

swaps.’ ’’ JP Morgan objected to their

proposed eligibility on the grounds that:

[t]he named swaps are commonly based

upon the price of corporate equities or, in the

case of credit swaps, corporate debt, which

is represented by a non-exempt security. The

Commission is given authority under 4(c) to

exempt futures contracts. But if these

particular swaps are futures, they cannot be

exempted because they would run afoul of

the Shad-Johnson Accord, which bans

futures on non-exempt securities prices

(except for indexes which have cleared a

lengthy regulatory approval process). The

part 36 exemption will be of no use because

it specifically does not exempt such

transactions from the Shad-Johnson Accord.

So if the Commission has authority to exempt

these transactions (which would only be the

case if they are futures), it cannot do so

(because the Shad-Johnson Accord prohibits

such futures).

CL 21–55 at 4.

However, ‘‘total return swaps,’’

include a greater variety of instruments

than just swaps on corporate equities or

debt, which as JP Morgan correctly

recognizes, are not exempt under part

36. Proposed rule 36.2(b) also includes

instruments that are not the subject of

the prohibitions of the Shad-Johnson

Accord.18 Specifically, for example,

Federal Register / Vol. 65, No. 240 / Wednesday, December 13, 2000 / Rules and Regulations 77967

continued applicability of any existing Commission

exemptions, policy statements or interpretations to

such ‘‘total return swaps,’’ or to any other

instrument. Moreover, the non-repudiation

provision of rule 35.3(c) that the Commission is

adopting in a companion release would also apply

to such instruments.

19The rule, as proposed, referenced ‘‘spread

swaps’’ rather than ‘‘credit spread swaps,’’ which

were referenced correctly in the preamble at page

38988. The final rule corrects this typographic

error.

20This is in contrast to proposed 36.2(b)(6) which

applies to ‘‘an occurrence, extent of an occurrence

or contingency beyond the control of the

counterparties to the transaction.’’ As the

Commission explained, this category is intended to

include contracts:

based upon the outcome of a contingency, such

as a recurring or nonrecurring event, a specific

incident, a natural phenomenon or the

unambiguous results of some other condition that

gives rise to a hedgeable risk.

65 FR at 38989. The Commission does not

anticipate that the settlement price of such

contracts could be derived from trading in a directly

related cash market and has therefore not included

that as a criterion.

21The Commission provided specific examples

for each category of commodities eligible to trade

on an exempt MTEF under proposed rule 36.2(b).

65 FR at 38988–89. Except for exempt securities,

which are being deleted from eligibility in the final

rules, each of those examples is incorporated herein

by reference.

‘‘total return swap’’ also describes an

agreement whereby one party agrees to

pay the total return on a loan portfolio

to its counterparty in exchange for semiannual payments based on a floating

interest rate. It is this type of contract,

transaction or agreement, traded among

eligible participants, that is exempt

under rule 36.2(b)(5), which the

Commission is adopting as proposed.19

Proposed rule 36.2(b)(7) provides that

cash-settled contracts on any economic

or commercial index or measure beyond

the control of the counterparties and not

based upon prices derived from trading

in a directly corresponding underlying

cash market are eligible to trade on an

exempt MTEF. The Board of Trade of

the City of Chicago (CBT) suggested that

proposed rule 36.2(b)(7) be modified so

that it is not limited to economic or

commercial indexes not based upon

prices derived from trading in a directly

corresponding cash market. It argued

that the requirement that the index or

measure be beyond the control of the

counterparties is alone sufficient to

protect against manipulation. CL 21–36

at 3. However, the Commission believes

that both requirements must be met to

qualify for the exemption. Basing the

cash settlement price of a futures

contract on prices derived from trading

on an underlying cash market

necessarily raises issues regarding the

potential ability and incentives of

traders in one market to affect pricing in

the other market.20 The Commission, by

adopting the rule as proposed, intends

to make eligible for this broad

exemption only those MTEFs on which

the contract’s settlement price is

objectively determined based upon

prices that are ‘‘an objective

measurement of an economic or

commercial index.’’ 65 FR at 38989. As

the Commission made clear, the

exemption,

is not intended to include contracts based

upon a cash-settlement price determined

through cash-market trading of any physical

commodity or financial instrument. * * *

Finally, included in this category are

contracts based on an objectively determined

index value or measure of an economic or

commercial index reflecting broad

characteristics of the economy as a whole, or

portions thereof, or material segments of

commercial activity.

Id. The Notice of Proposed Rulemaking

noted that the consumer price index or

the gross domestic product, insurance

data, bankruptcy rates, real estate rental

indexes, measures of physical

production or sales amounts such as

housing starts or auto sales or crop

yields are examples of contracts falling

within this category.21

3. Definition of MTEF

Several comments raised issues

relating to the proposed definition of

MTEF. The Commission proposed in

rule 36.1(b) to define ‘‘MTEF’’ as ‘‘an

electronic or non-electronic market or

similar facility through which persons,

for their own accounts or for the

accounts of others, enter into, agree to

enter into or execute binding

transactions by accepting bids or offers

made by one person that are open to

multiple persons conducting business

through such market or similar facility.’’

65 FR at 38999. As explained in the

Notice of Proposed Rulemaking,

[t]he definition as proposed does not, and is

not intended to, ‘‘preclude participants from

engaging in privately negotiated bilateral

transactions, even where these participants

use computer or other electronic facilities,

such as ‘‘broker screens,’’ to communicate

simultaneously with other participants so

long as they do not use such systems to enter

orders to execute transactions.’’ Accordingly,

the definition makes clear that it does not

include facilities merely used as a means of

communicating bids or offers nor does it

include markets in which a single market

maker offers to enter into bilateral

transactions with multiple counterparties

who may not transact with each other.

Id. at 38989 (citation omitted).

Several commenters recommended

that the definition of MTEF exclude

trading systems that include a credit

screen. CL 21–21 at 6; CL 21–37 at 4.

One commenter, DNI Holdings,

reasoned that ‘‘this credit emphasis has

always been a characteristic of swaps

transactions, but has never been a

characteristic of the futures exchanges.’’

CL 21–21 at 5–6. However, in a

companion notice of final rulemaking

published in this edition of the Federal

Register, the Commission, consistent

with the amendment of part 35 to

permit bilateral contracts, transactions

or agreements to be cleared, is deleting

individualized creditworthiness

determinations as a condition for

meeting its part 35 exemption for

bilateral transactions.

Moreover, as technology increases the

availability of electronic credit screens

or filters, their use has become common

in both multilateral and bilateral

environments. As NYMEX notes in

commenting on a different provision,

which applies to multilateral trading

facilities,

this provision would appear to be premised

upon the notion that the credit checking and

position limit functionality would reside

only within the FCM’s internal systems

* * *. However, * * * certain trading

systems, such as NYMEX’s NYMEX

ACCESS’’ electronic trading system

maintains the credit checking functionality

as a component of the host computer.

Clearing Members may enter inputs into the

system to set specific limits per customer.

CL 21–47 at 8.

Finally, the exemptions in part 35 and

part 36, when taken together, exempt

derivative instruments from regulation

under the Act whether or not they are

traded on an MTEF if: (1) They are

traded among or between eligible

counterparties; (2) they are based on the

underlying commodities, instruments or

measures listed in part 36; and (3) they

are, if cleared, cleared by an authorized

clearing organization. As correctly

observed in a comment referenced

above, ‘‘participants in transactions that

satisfy these three conditions would

obtain legal certainty about the limited

scope of CEA regulation regardless of

whether the means for executing

transactions did or did not satisfy the

technical definition of an MTEF.’’ CL

21–63 at 2. In light of the availability of

the same degree of exemptive relief

under either part 35 or part 36 for the

specified commodities, the deletion of

creditworthiness as a condition for

exemption under part 35, and the use of

credit screens and filters in both

bilateral and multilateral environments,

the final rule does not include such an

exclusion.

The CBT suggested that the exclusion

from the proposed MTEF definition in

rule 36.1(b)(3) for ‘‘any facility on which

only a single firm may participate as

market maker and participants other

than the market maker may not accept

77968 Federal Register / Vol. 65, No. 240 / Wednesday, December 13, 2000 / Rules and Regulations

22The CBT raises the concern whether the Act’s

Treasury Amendment exclusion would continue to

apply to an exempt MTEF without an explicit

reservation in the rules of that provision of the

statute. CL 21–36 at 4. As the Commission

explained in the Notice of Proposed Rulemaking

and reiterated herein, ‘‘the scope and application of

the statutory exclusion in section 2(a)(1)(A)(ii) of

the Act * * * is in no way affected’’ by this

regulatory exemption. Thus, the determination of

whether or not a person or facility is a ‘‘board of

trade’’ for purposes of the Act, generally, and the

Treasury Amendment, specifically, should be made

without reference to the definition of ‘‘multilateral

transaction execution facility’’ under rule 36.1(b),

which operates in the context of exemptions for

markets to which access is limited to eligible

participants.

23 In a companion notice of final rulemaking

published in this edition of the Federal Register

entitled ‘‘Rules Relating to Intermediaries of

Commodity Interest Transactions,’’ the term

‘‘institutional customer’’ is used rather than

‘‘eligible participant.’’ These terms can be used

interchangeably.

24The Commission also expects, however, on a

case-by-case basis, that the surveillance history and

the self-regulatory undertakings of a particular

exchange or facility could make it possible to

include a specific contract traded on that facility

within the DTF category even if the underlying

commodity does not meet the general eligibility

criteria. An exchange or facility seeking a case-bycase determination would be recognized as a DTF

for that contract or contracts only upon CFTC

approval.

25Amendments to the Commission’s rules

governing intermediaries are published today in a

separate release in this edition of the Federal

Register. Although those amendments apply to all

categories of intermediaries irrespective of where

they choose to transact business, certain proposals

differentiate between intermediation on various

types of markets and for different types of

customers.

26They are wheat, cotton, rice, corn, oats, barley,

rye, flaxseed, grain sorghums, mill feeds, butter,

eggs, potatoes, wool, wool tops, fats and oils,

cottonseed meal, cottonseed, peanuts, soybeans,

soybean meal, livestock, livestock products, and

frozen concentrated orange juice.

27Many of these trading facilities are expected to

replicate electronically various aspects of today’s

commercial markets, including trading exclusively

between principals, and direct negotiation and

documentation of trades. In addition, these facilities

often do not provide clearing arrangements for

contracts.

bids or offers of other non-market maker

participants’’ should be deleted. It

reasons that ‘‘the Commission’s

approach could be read to allow a

futures exchange * * * to decide to use

a single market-maker or specialist

system, like many securities exchanges,

and avoid being considered to be an

MTEF.’’ CL 21–36 at 4. However, under

the proposed exclusion there can be but

one counterparty to all market

participants. That is quite different from

using one or more specialists in a

multilateral trading setting. In that

structure, the bids and offers of nonspecialists are permitted to interact with

each other. The Commission believes

that this is a valid and logical

distinction between bilateral and

multilateral trading structures and is

adopting the proposed language as final.

The CBT also questioned whether the

definition of MTEF in proposed rule

36.1(b) would affect the Commission’s

view of the scope of the Treasury

Amendment exclusion in section

2(a)(1)(A)(ii) of the Act. CL 21–36–4. As

the Commission stated in the Notice of

Proposed Rulemaking,

the definition of MTEF in proposed § 36.1(b)

applies only to those rules in which it is

cited. It is not intended to modify, alter,

amend or interpret any other provision of the

Act or the Commission’s rules. For example,

the proposed § 36.1(b) definition of MTEF

does not affect the meaning or application of

the statutory term, ‘‘board of trade.’’ 7 U.S.C.

1a(1). Thus, the scope and application of the

statutory exclusion in section 2(a)(1)(A)(ii) of

the Act, popularly known as the ‘‘Treasury

Amendment,’’ which depends in part on the

meaning of ‘‘board of trade,’’ is in no way

affected by the Commission’s proposed

adoption of a definition of MTEF under

§ 36.1(b) for purposes of the exemptions in

part 35 and part 36 of its rules.

65 FR at 38989.22

Finally, commenters suggested a

number of technical modifications to

the rules. The CBT suggested that the

Commission modify the final rules to

clarify that it is the participant to whom

notice is provided under proposed rule

36.2(f)(1) and that the separate trading

location (or pit) required for trading on

exempt MTEFs under proposed rule

36.2(f)(2) may nevertheless adjoin the

location wherein Commissionrecognized markets are traded. CL 21–36

at 5. The Commission agrees with these

suggestions and is modifying the final

rules accordingly. In addition, the

Minneapolis Grain Exchange (MGE), CL

21–24 at 4, suggested that the

Commission modify proposed rule

36.2(e)’s requirement that an exempt

MTEF be legally separate from

Commission-recognized markets. Upon

further consideration of the issue, and

based upon the fact that many of the

exchanges historically overseen by the

Commission have housed both

designated contract markets and

markets for trading spot or forward

contracts without adverse consequence,

the Commission is deleting that

requirement from the final rules.

B. Derivatives Transaction Facilities.

The Commission also proposed a new

exemptive category, ‘‘Derivatives

Transaction Facilities,’’ which provides

for an intermediate level of regulation.

This intermediate level of regulation

was proposed to be available for two

separate types of markets. Although

many of the proposed rules are common

to both types of markets, some of the

proposed rules were tailored to apply to

one or the other market.

The first type of DTF proposed by the

Commission was for (primarily)

‘‘eligible-participants.’’23 Under the

provisions of proposed part 37, these

markets or similar facilities, including

the current boards of trades, would be

eligible to become a DTF regardless of

the method of transmitting bids and

offers or matching system used, either

on a case-by-case determination or if the

contracts traded were on the list of

commodities eligible to trade as an

exempt MTEF.24 The Commission

proposed that such ‘‘eligible participant

DTFs’’ would have the choice of

whether or not to permit access to the

market by non-eligible traders. If they

did permit access to non-eligible

traders, a number of additional

requirements were proposed to apply,

including enhanced disclosure and

higher net capital requirements for the

carrying FCM.25

The Commission proposed a second

type of DTF under proposed part 37 for

facilities that restricted participation to

‘‘eligible commercial participants.’’ This

type of ‘‘commercial-participant DTF’’

would be eligible to trade contracts on

all commodities other than those

domestic agricultural commodities

enumerated in section 1a(3) of the Act,26

any securities or indices thereof subject

to section 2(a)(1)(B)(ii) of the Act or any

exempt securities or indices thereof

included in section 2(a)(1)(B)(v) of the

Act. This type of eligible commercialsonly market structure lessens many of

the regulatory concerns regarding

manipulation ordinarily present with

contracts for tangible commodities and

the regulations that are applicable to

them have been tailored to this specific

type of market.27

Although a few commenters objected

to the DTF rules on jurisdictional

grounds, many more commenters

supported the concept of providing for

an intermediate level of regulation.

These commenters included both those

interested in the eligible-participant

DTF as well as those interested in the

commercial-participant DTF. For

example, Cargill stated that the ‘‘threetier system seems to provide adequate

regulation for a wide range of financial

products and market participants

depending on the relative sophistication

of the participants.’’ CL 21–49 at 2. The

Coalition stated that it supports the

Commission’s efforts to create an

intermediate category of regulated

trading facility subject to less regulation

than an RFE and more regulation than

an exempt MTEF. The Coalition went

on to say that the tiered approach

recognizes that there is a wide range of

Federal Register / Vol. 65, No. 240 / Wednesday, December 13, 2000 / Rules and Regulations 77969

28Certain sections of the Act, including the fraud

and manipulation provisions of the Act and the

Commission’s regulations are reserved in rule 37.8

and would continue to apply.

29As noted above, the legislative history states

that the Commission in exercising its section 4(c)

exemptive authority is not required to make an

initial determination that the agreement,

instrument, or transaction for which an exemption

is sought is subject to the Act. Accordingly, in

carrying out this mandate, when the Commission

exempted certain swap agreements in 1993,

pursuant to section 4(c) of the Act, it stated:

The issuance of this rule (Rule 35.2) should not

be construed as reflecting any determination that

the swap agreements covered by the terms hereof

are subject to the Act, as the Commission has not

made and is not obligated to make any such

determination.

58 FR 5587, 5588 (Jan. 22, 1993). See also Order

Granting the London Clearing House’s Petition for

an Exemption Pursuant to Section 4(c) of the

Commodity Exchange Act, 64 FR 53346 (Oct. 1,

1999); Exemption for Certain Contracts Involving

Energy Products, 58 FR 21286, 21288 (Apr. 20,

1993); Regulation of Hybrid Instruments, 58 FR

5580, 55821 n. 2 (Jan. 22, 1993). The Commission

is following this same mandate with respect to this

exemption for DTFs.

30The eight groups are: the American Farm

Bureau Federation, American Soybean Association,

National Association of Wheat Growers, National

Cattlemen’s Beef Association, National Corn

Growers Association, National Farmers Union,

Continued

types of markets, trading systems and

market participants, and that it will

facilitate market innovation. CL 21–65

at 16. The Association for Investment

Management and Research (AIMR)

opined that the tiered approach to

regulation recognizes different

operational profiles and risks inherent

to individual participants. CL 21–64 at

3.

Commenters also suggested that the

Commission reconsider various specific

aspects of the rules as proposed. These

suggestions clustered around how

various commodities, including in

particular, domestic agricultural

commodities, should fit within the

framework, how eligible participants

should be defined, under what

conditions non-eligible participants

should have access, how the core

principles should be enforced and what

further tailoring might be appropriate

for regulating commercial-participant

DTFs. Each of these issues is discussed

in greater detail below.

1. Jurisdictional Issues.

Although contracts, agreements or

transactions traded on a DTF would be

exempt from many of the Act’s

provisions and Commission

regulations,28 the exemption is

contingent upon compliance with the

conditions set forth in part 37. A market

that applies to the Commission for

recognition, and is so recognized by the

Commission, is bound to comply with

applicable provisions of the Act and

Commission rules as a condition of this

exemption.

Notwithstanding the requirement that

a market or facility must apply to the

Commission for recognition in order for

the part 37 exemption to pertain,

Mercatus questioned how commercial

markets for physical commodities

would be treated in this regime, and

suggested that the Commission provide

further guidance on the reach of the

proposed part 37 in this area. CL 21–57

at 6. As the Commission noted in

proposing part 37 (65 FR at 38989), and

reiterates here, in exercising its section

4(c) exemptive authority to date, the

Commission has not made a

determination that the transactions

being exempted were, or were not,

subject to the Commission’s jurisdiction

under the CEA.29 Rather, the

Commission has exercised its section

4(c) authority to provide legal certainty

for instruments that may be within its

jurisdiction. However, the Commission

will not entertain applications for

recognition from markets or facilities

offering transactions that clearly are

outside of its jurisdiction.

The Coalition directly addressed this

issue and supports the Commission’s

view. It reasoned that

the Commission would not be authorized to

exercise jurisdiction over activities that are

clearly outside its jurisdiction under the

CEA. Examples of this would include trading

in equity options and spot transactions.

At the same time, the conferees to the

Futures Trading Practices Act of 1992 (the

‘‘FTPA’’) expressly authorized the

Commission to exercise its exemptive

authority under Section 4(c)(1) of the CEA

without determining whether the exempted

transactions are subject to the CEA. And they

authorized the Commission to do so on such

terms and conditions as the Commission

deems appropriate. The conferees

specifically so provided to enable the

Commission to act without making

consequential jurisdictional determinations

that might create legal uncertainty for, or

imply the illegality of, other transactions.

For precisely the reasons motivating the

FTPA conferees, the Coalition believes that

the Commission is authorized to and should

accept requests by trading facilities who wish

to be registered as DTFs and who request that

the Commission not make any determination

that the underlying transactions are futures

contracts or commodity options. The

Coalition agrees with the Commission’s

implicit judgment that this approach will

minimize the adverse jurisdictional

implications, and therefore the legal

uncertainty, that might otherwise arise if one

trading facility elects to pursue DTF

registration in circumstances where other,

possibly analogous trading facilities do not.

However, as suggested by the immediately

preceding discussion, the Commission

should only so proceed in cases where a bona

fide issue as to its jurisdiction exists and

should not so proceed in any case where it

is clear that the Commission lacks

jurisdiction.

CL 21–65 at 17–18.

As the Commission noted above with

regard to the application of the part 36

exemption, this framework has no

applicability to markets or facilities that

clearly are outside of the scope of the

Act and the Commission’s jurisdiction.

Thus, the availability of part 37

recognition to those markets that apply

in no way carries a negative legal

inference or uncertainty for any other

market. Accordingly, the Commission is

of the view that providing legal

certainty through this part 37 exemptive

relief to markets or facilities that may be

subject to the Act is consistent with

Congress’ mandate to the Commission

and is in the public interest.

2. Commodities

A number of commenters

recommended that the framework be

modified with regard to its application

to the agricultural commodities

enumerated in section 1a(3) of the Act.

The Commission proposed that

contracts on those commodities not be

permitted to trade on a commercialparticipant DTF, and that they be

permitted to trade on an eligibleparticipant DTF only on a case-by-case

determination by the Commission.

The response of commenters

representing various agricultural

interests was divided. National Grain

and Feed Association (NGFA) argued

that agricultural markets should be

regulated in precisely the same manner

as markets for financial commodities.

The American Cotton Shippers (Cotton

Shippers) argued that any differences in

regulation of agricultural commodities

penalizes these markets by denying

them the benefit of potential marketing

innovations. CL 21–12 at 3–5. MGE and

the National Grain Trade Council

(NGTC) also argued that there should be

no distinction in the regulatory

framework for the enumerated

agricultural commodities. CL 21–24 at

1–2; CL 21–46. An FCM, F.C. Stone,

contended that agribusiness firms have

substantial risk management experience

and can themselves weigh the risks of

using a particular trading facility. CL

21–59 at 3.

A significant number of commenters

favored permitting enumerated

agricultural commodities to trade on an

eligible-participant DTF on a case-bycase determination, as provided in the

proposed rules. In a joint comment

letter, eight agricultural producer

groups 30 supported a case-by-case

77970 Federal Register / Vol. 65, No. 240 / Wednesday, December 13, 2000 / Rules and Regulations

National Grain Sorghum Producers and National

Pork Producers Council, and will be referred to

hereafter as ‘‘agricultural producer groups.’’

31Treasury similarly commented with respect to

whether government securities should be permitted

to trade on a DTF. It recommended that continued

application of the segregation of customer funds

requirements, certain adjustments to capital

requirements for FCMs executing trades for retail

customers and large trader reporting be conditions

of permitting government securities to trade on a

DTF. The Commission will certainly consider these

views if any such request to trade government

securities on a DTF is received. Moreover,

consistent with current practice under the Act, the

Commission will continue to keep Treasury

apprised of new contracts involving government

securities to be listed on both DTFs and RFEs. 32 GTX also added that, in its view,

telecommunication minutes and other

telecommunication products should qualify as such

a market. The Commission is not making such a

determination in this rulemaking. That decision is

better made as an individualized determination

where a factual record can be developed and public

comment specifically sought on the issue.

33 In this regard, deliverable supply represents the

amount of the commodity meeting the contract’s

specifications at the delivery locations that is

available for delivery at its economic value in

normal cash marketing channels.

34This requirement is not intended to preclude a

market experienced in the trading of only cash or

other instruments from making the necessary

demonstrations. Such facilities may rely on that

market experience in making the necessary

demonstration.

Commission determination of eligibility

for DTF trading of individual

agricultural commodities. They

emphasized, however, that the

Commission should provide notice and

accept public comment as part of its

deliberative process. They further

cautioned that such a determination

should include appropriate conditions

in addition to the seven DTF core

principles. CL 21–60 at 1. The NGTC

concurred, suggesting that DTFs be

permitted to trade agricultural

commodities conditioned upon

enhanced surveillance (RFE Core

Principle 3), position limits (RFE Core

Principle 4), and such other

requirements that the Commission

concludes are essential to market

integrity. Cargill, while recognizing that

certain agricultural commodities may be

subject to manipulation, nevertheless

recommended that the CFTC should

retain flexibility to address this issue by

spelling out criteria that would have to

be met for such a commodity to achieve

DTF status. CL 21–49 at 2–3.

The final rules, as proposed, provide

that the Commission may determine on

a case-by-case basis to permit any

commodity, including the enumerated

agricultural commodities, to trade on an

eligible-participant DTF. The

Commission remains convinced, as do

many commenters, that this strikes the

appropriate balance between caution

and flexibility to respond to future

developments. Moreover, the

commenters’ suggestions that any caseby-case determination include

particular, tailored conditions to the

general core principles are well-taken.

In this regard, the Commission is of the

view that, at a minimum, any DTF

trading a commodity on a case-by-case

basis will be required to retain the large

trader reporting system that pertains to

RFEs. The Commission will determine

additional requirements, if any, during

each individualized determination. In

this regard, the procedures to be used by

the Commission in such case-by-case

determinations will indeed include

public notice and an opportunity for

public comment.31

Commission rule 37.2(a)(2)(i)

provides that commodities eligible

through a case-by-case determination to

trade on a DTF ‘‘have a sufficiently

liquid and deep cash market and a

surveillance history based on actual

trading experience to provide assurance

that the contract is highly unlikely to be

manipulated.’’ The Global TeleExchange

(GTX) commented that the Commission

should articulate the standards that it

will use to judge whether there is a

‘‘sufficiently liquid and deep cash

market’’ to warrant approving a contract

for DTF trading. CL 21–40 at 4. The

Commission is not establishing

quantitative thresholds or criteria for

DTF inclusion a priori, because the

appropriate standards necessarily would

differ across markets and time, and the

adoption of specific, detailed standards

would deny the Commission and

applicants needed flexibility.32

In making a determination whether a

contract is highly unlikely to be

manipulated and thus eligible for DTF

trading through an individualized

determination, the Commission will

consider both the liquidity and depth of

the underlying cash market and the

actual trading experience of the

contract, including, where relevant, the

facility’s surveillance history in

monitoring the market and in

addressing market problems. Sufficient

liquidity and depth of the underlying

commodity can be demonstrated by

looking at a number of specific factors.

These include: (1) A high level of

liquidity; (2) bid-ask spreads that are

narrow relative to traded values; (3)

relatively frequent transactions

involving participants that represent

major segments of the industry; (4) the

absence of material impediments to

participation by commercial entities; (5)

transfer of ownership that is easily and

readily accomplished at minimal cost;

and (6) a pattern of pricing that exhibits

continuity and the absence of frequent,

sharp price changes such that a person

cannot readily move materially the price

of the product in normal cash market

channels. Facilities seeking recognition

as a DTF should provide to the

Commission information on these

factors. Actual trading experience

acceptable for DTF eligibility can be

based upon a history that the contract

terms and conditions provide for a

deliverable supply that is adequate to

minimize the threat of market abuses

such as price manipulation and

distortions, congestion, and defaults,33

and by having in place appropriate

procedures effectively to oversee the

market, including a large trader system,

as well as a history of active

surveillance to prevent or mitigate

market problems.34

3. Access by Non-Eligible Participants

Only eligible participants (i.e.,

institutional traders) would have

unrestricted access to an eligibleparticipant DTF. Non-eligible

participants may access the market, but

only through a registered FCM with $20

million in net capital that is a clearing

member of a contract market or RFE.

See, rule 37.2(a)(2)(ii). A number of

commenters opposed this requirement.

The CBT contended that this

requirement is overly burdensome and

does not further the Commission’s

stated goal that DTF transactions ‘‘be

transacted through FCMs that are more

capable of properly maintaining such

accounts and handling the associated

risk.’’ CL 21–36 at 7. It further reasoned

that net capital is a poor proxy for an

FCM’s trading capabilities or level of

regulatory compliance and that the rule

favored large FCMs at the expense of

smaller FCMs. Accord, CL 21–24. The

CME disagreed with the premise of the

rule that transactions on a DTF entail a

higher degree of financial risk than do

transactions on an RFE, especially in the

context of futures based on liquid

financial instruments carrying little risk

of manipulation. CL 21–51 at 8. NGTC

also questioned the relationship

between an FCM’s capitalization and its

fitness to handle retail accounts on a

DTF and argued that the $20 million

threshold requirement was inconsistent

with other CFTC capital requirements.

CL 21–46 at 4–6.

Although adjusted net capital may be

an imprecise measure of an FCM’s

capability to service accounts, the

Commission nevertheless believes that

the capital requirement proposed to be

required of FCMs who trade on DTFs for

non-institutional customers is

appropriate at this time. Because of the

absence of restrictions on the type of

Federal Register / Vol. 65, No. 240 / Wednesday, December 13, 2000 / Rules and Regulations 77971

35 In addition, the Commission is amending the

definition of ‘‘rules’’ under Commission rule

1.41(a)(1) specifically to include the term ‘‘trading

protocols.’’

trading mechanisms that could be used

by a DTF, and the possibility of a greater

number of such competing markets

trading similar products, filling noninstitutional customer orders at the best

price would likely require the FCM to

have a more extensive and sophisticated

infrastructure and greater trading

resources than an FCM operating in a

traditional setting. Accordingly, the

Commission, at this time, is adopting

the capital-related access restriction as

proposed. The Commission will

consider further appropriate measures

to permit additional FCMs to handle

non-institutional customers’ access to

DTFs as experience is gained under the

rules.

The Managed Funds Association

(MFA) argued that customers trading

through registered CTAs should have

trading access to DTFs without regard to

their individual financial qualifications.

In particular, MFA suggested that a CTA

with at least $25 million under

management should be permitted to

engage in transactions on behalf of their

clients on all eligible-participant DTFs.

CL 21–31 at 5. Although the

Commission is not prepared at this time

to treat a CTA’s customers as eligible

participants without limitation on the

basis of the CTA’s management of the

account, the Commission does recognize

that CTAs provide expertise and

professional management to their

customers. In recognition of this role,

the Commission is revising proposed

rule 37.2(a)(2)(ii) to permit CTAs, with

at least $25 million under management

and having non-institutional clients, to

access DTFs that permit noninstitutional participants on behalf of

both their institutional and noninstitutional customers through

accounts carried by any registered FCM.

The Commission will reconsider this

issue when it looks more broadly at

revising current rules applicable to

CTAs and commodity pool operators.

NYMEX expressed concern that the

proposed requirement that non-eligible

traders access a DTF through an FCM

may not address adequately electronic

systems with direct customer order

entry on which FCM credit filters are

resident. The Commission agrees, and is

modifying 37.2(a)(2)(ii) to make it clear

that while the accounts of non-eligible

traders must be carried by registered

FCMs, they may have direct trading

access to the DTF if a credit filter is

required to be used by the FCM,

regardless of where the filter is resident.

4. Commercial-Participant DTF

The Commission proposed that an

intermediate level of regulation also

apply to commercial-participant DTFs.

The proposed rules applicable to

commercial-participant DTFs, although

having common elements with eligibleparticipant DTFs, also have a number of

special features. For example, the

proposed core principles for DTFs may

include two alternatives, with the

proviso that they apply to the market

‘‘as applicable.’’ See, e.g., Core Principle

2, rule 37.4(b). Only one of the

alternatives may be appropriate for a

particular facility, and should be

understood to apply in that manner.

One commenter, a company

beginning an electronic platform for

trading ‘‘physical commodities and

derivative products * * * among

commercial participants,’’ opined that

‘‘the overall approach * * * will result

in the imposition of excessive and

unwarranted burdens on Commercial

DTFs.’’ Intercontinental Exchange, LLC

(Intercontinental) CL 21–22 at 2. A

second letter from a group of oil and gas

producers, refiners, processors, and

marketers and electric utilities and

marketers (Energy Group) raised many

of the same issues as did

Intercontinental. CL 21–23. Specifically,

these letters suggested that the

Commission provide for a streamlined

review procedure for recognition of a

DTF within a fixed time period. The

letters further stated that the DTF may

not have ‘‘exchange-style memberships

or rules. Any substantive review of

commercial DTFs, their owners or

operators, therefore, or any review of

rules or principles applicable to trading

on or through such facilities would be

inappropriate and unwarranted and will

render the DTF framework completely

unworkable.’’ CL 21–22 at 3. They also

noted that electronic platforms may

have ‘‘trading protocols, product

descriptions, fee schedules, user guides

and similar trading or transaction

related documents or information’’

rather than trading rules. Id.

The proposed rules, however,

recognized this distinction and

provided that the facility have rules or

terms and conditions governing trading

procedures. See, e.g., proposed rule

37.3(a)(2). The reference to ‘‘terms and

conditions’’ was intended to apply to

trading platforms that did not have

exchange-style rules and instead

incorporated their trading procedures as

terms of their operating agreements.

However, ‘‘terms and conditions’’ is

already a defined term under

Commission rule 1.41(a)(2). To provide

greater clarity of the Commission’s

intent, the final rules refer to ‘‘rules,

which may be trading protocols.’’

Trading protocols include the methods

and conditions for trading that may be

included in a user’s guide or operator’s

manual, customer agreements, screen

trading prompts or other similar

documents or writings.35

Intercontinental also opined that the

reservation of various sections of the

Act in proposed rule 37.5(a) potentially

would subject a DTF to a number of

additional obligations beyond those

included in the rules themselves. CL

21–22 at 4. The Commission’s intent,

however, in reserving various sections

of the Act in part 37 was not to import

additional regulatory obligations into

the part 37 rules. Rather, its reservation

of various sections of the Act is to

establish legal authority for

promulgating these regulatory

requirements. By reserving these

sections of the Act, the Commission

does not intend to incorporate

regulatory requirements for DTFs

beyond those specified in part 37.

Moreover, the Commission intends that

the reserved sections of the Act be

interpreted as applying to DTFs as the

difference in the contexts require. Some

of the Act’s provisions, such as section

4c(a) of the Act are reserved ‘‘as

applicable,’’ depending upon the

particular characteristics of a trading

facility. The Commission will confirm

whether that section of the Act applies

to a particular facility in its Order

granting recognition to the facility.

In contrast to the reservation of

provisions of the Act effectuating the

regulatory conditions of the exemption,

the Commission has deleted from the

final rules in parts 37, 38, and 39

specific reservation of various

enforcement provisions that it had

proposed specifically to retain. The

Commission has determined that such

specific reservations are unnecessary.

Rather, such specific reservations do not

affect the Commission’s existing

authority to investigate violations and to

bring enforcement actions. See, section

4(d) of the Act.

In order to conform the regulatory

requirements of the commercialparticipant DTF more closely to cash

market practices, the Commission is

deleting the proposed requirement that

participants respond to special calls for

information about their trading

activities. The Commission will rely

instead on its investigative authority,

which also applies to a person’s cash

market activities. Moreover, the

Commission is not requiring that a nonU.S. participant appoint an agent for

receipt of service of process within the

United States or that the DTF act in that

77972 Federal Register / Vol. 65, No. 240 / Wednesday, December 13, 2000 / Rules and Regulations

36This determination is based on the important

role that floor brokers and floor traders, which are

Commission registrants, may fulfill in trading on a

Commission-recognized market under the part 37

exemption. For this reason, the Commission does

not agree, as NYMEX suggests, that floor trades or

floor brokers should be eligible participants for

purposes of parts 35 and 36 under conditions other

than currently provided.

37The Commission has made clear in the rule

37.1(a) scope provision that the part 37 rules apply

to a ‘‘a board of trade operating as a derivatives

transaction facility.’’ Moreover, DTFs, as a

condition of the part 37 rules, generally would be

considered under proposed rule 37.1(a) to be

subject to the Act’s provisions as though the DTF

were a ‘‘designated contract market’’ under the Act.

As a board of trade within the meaning of that term

under the Act (and as a contract market by

operation of part 37), a DTF on which futures

transactions are traded would be covered by the

provisions of Subchapter IV of Chapter 7, Title 11

of the Bankruptcy Code. Similarly, DTFs should be

considered ‘‘contract markets’’ for the purpose of,

for example, Sections 556 and 761 of the

Bankruptcy Code, and 12 U.S.C. 4402. The

Commission has modified final rule 38.1(b) to make

a similar clarification relating to RFEs.

capacity. Instead, the Commission is

requiring that the commercialparticipant DTF provide notice to its

non-U.S. participants of

communications from the Commission.

In the event that a non-U.S. participant

fails to comply with such a Commission

communication, the Commission may

direct recognized DTFs to deny the

participant further trading access.

Compare, 17 CFR 21.03. By modifying

the final rules in this way, the

Commission is bringing the rules for

commercial-participant DTFs into closer

alignment with the operation of related

cash markets, and the requirements on

participants on commercial-participant

DTFs, by and large, will be no greater

or no different than is applicable to cash

market trading.

Finally, both comment letters

suggested that the rules applicable to

DTFs be located entirely within part 37

without cross-referencing other rules.

The Commission has modified the final

rules to reduce the number of crossreferences within part 37. Accordingly,

the final rules have been reorganized to

include a new rule 37.5 relating to

information requirements (formerly in

proposed part 20) and has divided the

requirements for recognition into two

sections. These modifications to the

final rules change the substance of the

rules only as discussed above. A

number of voluntary provisions remain

as cross-references to other rules.

Several commenters raised issues

regarding the proposed definition of

‘‘eligible commercial participant.’’ Both

NYMEX and the Commodity Floor

Brokers and Traders Association

expressed concern that exchange locals

were not included within the category

of eligible commercial participants.

They reasoned that locals provide the

same market making function as do

dealers, a category included within the

definition of eligible commercial

participant. NYMEX noted that

professional floor traders provide

approximately 43–49% of the trading

volume in NYMEX energy contracts. CL

21–47 at 4. NYMEX further noted that

unless floor traders were included, the

commercial-participant DTF model

would ‘‘be used to exclude * * *

another business model [exchanges] that

is generally comparable but for the

sharing of market making

responsibilities among a group of

professional market makers rather than

concentration of this function in a single

dealer.’’ Id. at 10. The CBT concurred,

stating that ‘‘[c]ertainly floor brokers

and floor traders that trade regularly on

exchange markets should be considered

to be as sophisticated as any market

participants. For that reason, in the

Commission’s current part 36 rules,

floor brokers and traders are defined to

be eligible participants without regard

to any total or net asset test.’’ CL 21–36

at 6. The Commission agrees that

Commission registrants, particularly

floor brokers and floor traders should be

included as eligible to trade in a DTF

with a guarantee of their obligations by

a futures commission merchant, as

suggested by NYMEX.36

These rules establish an intermediate

level of regulation for DTFs appropriate

to the commodities traded and the

participants trading thereon. DTFs have

great flexibility in determining the

trading systems and mechanisms that

they will use. Accordingly, and in light

of their institutional nature, participants

trading on DTFs are expected to exercise

the appropriate degree of understanding

in making use of these facilities.

Notwithstanding part 37’s greater degree

of regulatory flexibility, the Commission

retains its enforcement responsibility to

ensure compliance with the

fundamental regulatory goals of the Act,

as included within these rules. The

Commission believes that it has retained

the tools necessary to accomplish this

mandate and by adopting a more

flexible regulatory approach is not

thereby indicating any diminishment in

its resolve effectively to enforce

compliance.

5. Procedures for Recognition

A board of trade, facility, or entity

seeking recognition as a derivatives

transaction facility would be deemed to

be recognized thirty days after the

Commission received the application if

the application met the conditions for

recognition pursuant to §§ 37.3 and 37.4

and the applicant and/or its rules or

procedures do not violate the Act or the

Commission’s regulations.37 An entity

seeking recognition as a DTF may

request that the Commission approve its

initial set of rules, which may be trading

protocols, and any subsequent rules or

rule amendments under section

5a(a)(12)(A) of the Act and Commission

regulations thereunder. However, the

DTF is only required to notify the

Commission of rules and rule

amendments, which include trading

protocols, in the same manner that it

notifies market participants, but no later

than close of business on the day

preceding implementation.

Several commenters raised issues

regarding the procedures for

recognition. Kiodex, a risk management

services firm, suggested that the

applicant have an opportunity to correct

a deficiency before the ‘‘Commission

convert the review into a full-scale

designation proceeding.’’ CL 21–29 at 4.

However, proposed rule 37.4(c) merely

provided that upon termination of

review under the thirty-day period, the

application would be subject to the

‘‘procedures specified in section 6 of the

Act.’’ That provision merely

incorporates the time periods and other

procedures from section 6; it is not

intended to convert the application or

its review into one for contract market

designation.

On a related point, the CBT suggested

a technical modification to clarify that

a board of trade or other entity that files

for recognition as a DTF by certification

is not required to demonstrate that it

satisfies conditions for recognition

under part 37. CL 21–36 at 10. As both

the proposed and final rules provide,

however, the filing by a facility which

is already a designated contract market

need only include the DTF’s rules and

its certification that it meets the

conditions for recognition as a DTF

under the part 37 rules.

Intercontinental suggested that the

Commission specifically retain the

flexibility to grant recognition to new

facilities at various stages of readiness.

CL 21–22 at 1–3. The Commission

agrees, and has modified rule 37.4 as

proposed to provide that the

Commission may determine to

recognize a DTF upon conditions. These

might relate either to additional

regulatory undertakings by a particular

facility, or to recognition of a facility

pending its subsequent fulfillment of a

regulatory requirement. This flexibility

will enable new entrants to apply for

recognition before development of their

trading system is complete and to be

recognized contingent upon their

Federal Register / Vol. 65, No. 240 / Wednesday, December 13, 2000 / Rules and Regulations 77973

38The Commission has modified the final

application guidances to make clear that DTFs and

RFEs must disclosure limitations of liability, if any.

Such limitations of liability, consistent with

longstanding Commission policy, may not limit

liability for violations of the Act or Commission

rules, fraud, or wanton or willful misconduct.

39The National Futures Association (NFA)

advocated that its member rules be the primary

means of developing best practice or other

interpretative guidance for core principles applying

the framework. The Commission appreciates the

NFA’s willingness to assist in interpreting

Commission rules and in certain instances, where

the parts of the framework involve NFA’s member

rules, the Commission may ask for NFA’s

interpretative assistance. However, it would be

inappropriate for NFA to assume that role for areas

of the framework that do not involve its

membership, particularly for example, where a

trading facility does not permit intermediation.

40As pointed out in the Federal Register release

proposing part 38, the NFA currently is the only

such registered organization. See 65 FR at 38991.

41Specifically, for example, Cargill supported the

basic structure of the regulatory relief for organized

Continued

meeting all of the recognition

requirements.38

6. Enforcement of Core Principles

Several letters raised concerns

regarding the interpretation,

enforcement and oversight of core

principles. NYMEX suggested that the

guidance with respect to Core Principle

6 which provides that rule 1.31 is the

acceptable practice should be amended

to read ‘‘an acceptable but nonexclusive means regarding the form and

manner for keeping records.’’ CL 21–47

at 11. The Commission appreciates that

the current wording does not appear to

offer a high degree of flexibility in

meeting this core principle. However,

rule 1.31 was recently amended (64 FR

28910) and in its amended form

provides a degree of flexibility in

compliance. Moreover, rule 1.31’s

provisions are consistent with the

record-keeping requirements of the

Securities and Exchange Commission

(SEC). In light of the importance of

recordkeeping to the Commission’s

ability to fulfill its oversight function

and the high number of Commission

registrants that must also comply with

similar SEC requirements, the

Commission is adopting the guidance as

proposed and will provide further

guidance on acceptable record-keeping

practices after additional study of the

issue.

The CBT opined that ‘‘safeguards

should be provided to ensure that

flexible standards do not become a

license for the CFTC to dictate to

exchanges.’’ CL 21–1 at 2–3. In contrast,

Mercatus objected to the use of core

principles as too vague. See CL 21–57 at

7, 10. See also CL 21–45 at 3. The

Commission finds both of these

arguments unpersuasive. First, the core

principles are specifically designed to

afford flexibility to trading facilities to

design innovative trading mechanisms

in an expeditious manner. Second, this

flexibility should not be confused with

vagueness. While not like typical

prescriptive regulations, the core

principles nevertheless do set forth

specific standards to be satisfied by

those seeking to gain and maintain

recognition. Finally, any interpretative

advice, assistance or direction provided

by the Commission would constitute

guidance only. It does not preclude any

facility from complying with the core

principle in some other manner.

Accordingly, the framework does not

place the burden of proof upon those

covered by the framework to

demonstrate why a particular practice

that differs from the specific guidance

offered in a statement of acceptable

practices complies with a particular

core principle. See, CL 21–57 at 7. If, as

a practical matter, a disagreement on the

interpretation of any core principle

could not be addressed through

informal mechanisms, the burden of

proof to establish a violation of a core

principle would not differ from the

Commission’s current burden, and

would rest with the Commission in any

formal regulatory or enforcement

proceeding.

Nevertheless, the CBT and CME

called for a ‘‘mechanism’’ for resolving

disagreements over interpretation of

core principles short of the CFTC taking

punitive action. CL 21–51 at 5. CBT

suggested, for example, that all

adjectives, such as ‘‘appropriate,’’

‘‘periodically,’’ ‘‘proper,’’ and ‘‘timely’’

be removed from the core principles and

that the Commission ‘‘structure an

alternative dispute resolution

mechanism to resolve disagreements

about the application of core

principles.’’ CL 21–36 at 10. The

Commission appreciates the concerns of

these commenters. By moving from

prescriptive rules to more general core

principles, self-regulatory organizations

will have not only greater flexibility in

how they meet the regulatory

requirements, but more responsibility,

as well. Purging the core principles of

adjectives will not address the issue of

whether the self-regulatory

organizations act in a manner consistent

with these internationally accepted

norms for the conduct of trading

facilities. The Commission fully expects

that as self-regulators, the entities

covered by the framework will strive to

act at the highest ethical and

professional standards for the protection

of customers and the integrity of the

market.

Finally, trading facilities must

recognize that the requirements

contained in the core principles may

involve many interested parties, not just

a facility’s members or owners.

Accordingly, as FIA suggested, when

issuing interpretative guidance having

industry-wide application, the

Commission will follow the notice and

public comments procedures of the

Administrative Procedure Act, as

appropriate. CL 21–45 at 5.39

C. Recognized Futures Exchanges

The Commission further proposed to

recognize all currently designated

contract markets, except for those

designated as contract markets in

section 2(a)(1)(B) commodities, as

‘‘Recognized Futures Exchanges’’ under

proposed part 38. To provide recognized

futures exchanges with greater

operational flexibility, part 38, as

proposed, would replace many

prescriptive rules with performancebased rules, or core principles.

Moreover, Commission review would

not be required for new contracts or for

rules and rule amendments prior to

listing or implementation, except for the

terms and conditions of agricultural

commodities enumerated in section

1a(3) of the Act. Furthermore, the

exchanges would not be required to be

responsible for auditing intermediaries’

sales practices. Instead, enforcement

could be the responsibility of a

registered futures association.40

The preamble to proposed part 38

noted that RFE markets can list for

trading contracts on any commodity,

including those having potentially a

greater risk of price manipulation. In

addition, because they could permit

unconditioned access to both

institutional and non-institutional

traders, they raise greater concerns

regarding customer protection than do

DTFs. 65 FR at 38991. Therefore, as the

preamble noted, the proposed rules in

part 38 preserve a higher level of market

surveillance, position reporting

obligations, customer protections and

financial safeguards than do the

proposed rules for DTFs. Id. A number

of commenters questioned these

requirements as incorporated in the core

principles that are applicable to RFEs.

1. RFEs as a Means of Regulatory

Reform

As was the case with commenters on

the proposed DTF category, many

commenters supported the general

concept of changing from prescriptive

regulations to broad, flexible core

principles for RFEs.41 Some

77974 Federal Register / Vol. 65, No. 240 / Wednesday, December 13, 2000 / Rules and Regulations

futures exchanges. CL 21–49 at 2. NYMEX strongly

supported the overall design of the proposal. CL

21–47 at 1. CME strongly supported the

Commission’s approach in moving from

prescriptive regulations to core principles. CL 21–

51 at 5. NYBOT stated that the proposed framework

struck a measured balance between self-regulation

and federal oversight in many respects. CL 21–27

at 1.

42The SUA expressed the additional concern that

if liquidity in silver trading at RFEs using openoutcry diminishes due to interest in electronic

platforms, procedures should be in place for making

pricing data from electronic trading platforms

available to the public on a timely basis. CL 21–39

at 3.

43Under Rule 38.3(f), as modified in the final

rules, RFEs are required to carry out international

financial and surveillance information sharing

arrangements. The Commission points out that, at

this time, the International Information Sharing

Agreement and Memorandum of Understanding

developed by the FIA Global Task Force on

Financial Integrity is one such arrangement.

44AIMR also suggested that Core Principle 4

(Position Limits) be modified only to require RFEs

to hold members accountable for their positions.

However, position limits are a necessary tool for

preventing market manipulation or distortion in

many markets and the Commission therefore

declines to modify the core principle as proposed.

However, the Commission in its proposed statement

of acceptable practices specifically determined that

exchange position accountability rules are an

acceptable means of meeting the core principle for

various types of markets. 65 FR at 39005.

45Core Principle 8 requires an RFE to ‘‘provide

a competitive, open and efficient market.’’ A

primary goal of the Commission’s framework is to

ensure that prices discovered in futures and

derivatives markets are accurate and reflective of

current supply and demand conditions in the

markets. Core Principle 8 specifically includes the

concept of ‘‘efficient’’ markets in order to make

clear that trading systems that discover prices

reflective of the forces of supply and demand and

accurately reflect publicly held information may

include certain practices, such as block trades, that

permit large traders to enter the market with a

single trade as opposed to having to execute

commenters expressed concern,

however, that the RFE proposal would

permit greater deregulation than

appropriate for these commodities and

market participants. For example, the

Silver Users Association (SUA)

maintained that any change in the

regulatory structure for silver trading

must provide clear assignment of

responsibility for trading facility

operators, and procedures for market

participants to obtain redress for

improper actions.42 The agricultural

producer groups urged that new

agricultural contracts and amendments

to such contracts continue to be subject

to Commission review prior to their

trading. CL 21–60 at 1. Two

commenters, Mercatus and CBT,

questioned whether the proposed

framework for RFEs was sufficiently

deregulatory in nature. CL 21–36 at 12.

The Commission remains convinced,

and most commenters agreed, that the

use of core principles supplemented by

statements of acceptable practices

strikes the right balance between the

need for appropriate regulation and for

flexibility. The proposed rules for RFEs

are not intended to remove

internationally accepted standards for

market or financial integrity or for the

protection of customers trading on

futures exchanges. Rather, they are

intended to offer U.S. exchanges greater

flexibility in meeting those

requirements. As the Commission

noted:

[t]hese proposed rules * * * [are] intended

to provide greater flexibility in meeting

technological and competitive challenges. At

the same time, the Commission will retain its

oversight authority to ensure the integrity of

markets and prices, to deter manipulation, to

protect the markets’ financial integrity, and

to protect customers.

65 FR at 38987. This approach, although

providing exchanges a high degree of

flexibility to meet these challenges, is

not intended to relieve U.S. exchanges

from their obligations to comply with

the policies and requirements of the

Act, nor to operate in a manner that fails

to meet ‘‘internationally-accepted

guidance regarding appropriate

regulatory measures for exchange-traded

derivatives markets.’’ 43 65 FR at 38987.

2. Comments Concerning the Core

Principles

A number of commenters offered

suggested changes to the core

principles. The Commission has

considered these comments within the

overall goal that the core principles

establish broad, flexible requirements,

that at the same time are specific

enough to provide notice of the required

performance by the recognized entity. In

this regard, the final version of

Appendix A to part 38 herein, clarifies

that the guidance offered on the means

of complying with the core principles is

for illustrative purposes only and is not

intended to be a mandatory checklist for

compliance.

Specifically, AIMR suggested that

Core Principle 3 (Position Monitoring

and Reporting) should simply require

exchanges to have the process and rules

necessary to deter market manipulation.

CL 21–64 at 4. That formulation,

however, fails to capture the breadth of

an RFE’s responsibility under the Act.

Both prevention of price manipulation

and assurance of market and price

integrity are fundamental public policy

interests of the Act. Accordingly, the

Commission believes that it is vital that

RFEs have more than just rules and a

process to deter manipulation, as

suggested by AIMR. The Commission

therefore is retaining the language of

Core Principle 3, which requires an RFE

to monitor ‘‘on a routine and nonroutine basis as necessary to prevent

manipulation, price distortion, and

disruptions of the delivery or cash

settlement process.’’ 44

NYBOT and CBT expressed concerns

about Core Principle 7, which relates to

transparency. NYBOT raised the

concern that the required level of

transparency under Core Principle 7

should be appropriate to the method of

order execution, explaining that some

aspects of transparency are affected by

whether trading is electronic or openoutcry (e.g., bids and offers are not

automatically captured in open-outcry

trading). CL 21–7 at 3, CL 21–27 at 2.

However, technology is rapidly

transforming futures markets and the

core principles are intended to be

understood broadly and applied flexibly

in each particular market context.

Accordingly, the Commission believes

that the transparency requirement, as

proposed, provides the necessary

guidance for both open-outcry and

electronic markets. The CBT suggested

that the Commission revise the DTF

Transparency Core Principle to mirror

the proposed RFE Transparency Core

Principle, commenting that DTFs appear

to have the more onerous transparency

burden. CL 21–36 at 10. The material

difference between the two core

principles is that the DTF Transparency

Core Principle requires disclosure of

information to both market participants

and the public. That requirement is

particularly necessary at the DTF level

in light of the framework’s greater

reliance on disclosure rather than merittype regulation.

Upon further consideration, however,

the Commission believes that the

Transparency Core Principle proposed

to apply to DTFs should be applied at

the RFE level, as well. The RFE

Transparency Core Principle as

proposed could result in permitting an

inappropriate reduction in the

information currently available to

market participants. Therefore, under

the final Transparency Core Principle,

both RFEs and DTFs must provide

information to market participants, on a

fair, equitable and timely basis,

regarding prices, bids and offers, as well

as other pertinent information as

appropriate to the market. This

additional language is not intended to

interfere with the current practice of

futures exchanges of selling price and

other market information through

various information vendors.

FIA suggested in its comment that the

guidance regarding price and reporting

time as it relates to block trading should

be eliminated from Appendix A, Core

Principle 8.45 CL 21–45 at 6–7. The

Federal Register / Vol. 65, No. 240 / Wednesday, December 13, 2000 / Rules and Regulations 77975

numerous small trades. By including ‘‘efficiency’’

in addition to open and competitive markets, the

Commission is promoting a flexible standard that

protects the price discovery process of the markets

while permitting a variety of trading practices.

46AIMR recommended that the Commission

reword Core Principle 8 as an RFE should not only

provide for, but should also facilitate the

appearance of, a competitive, open and efficient

market (trading system). CL 21–64 at 4. The final

version of Core Principle 8 does not include the

additional language proposed by AIMR. The

Commission believes that provision of an open and

competitive market would also promote the

appearance of such a market, without the need

explicitly to so require.

47Section 15 of the Act is also reserved under

rule 38.6(a). Section 15 of the Act requires the

Commission to take into consideration the public

interest to be protected by the antitrust laws and to

endeavor to take the least anticompetitive means of

achieving the objectives of the Act in issuing any

order, adopting any regulation, or approving any

rule.

48See CL 21–7 at 2, 4; CL 21–24 at 3–4; CL 21–

36 at 11; CL 21–51 at 5.

49See CL 21–52 at 1–2 (National Cattlemen’s Beef

Association); CL 21–54 at 1 (The National Cotton

Council of America, ‘‘National Cotton Council’’); CL

21–60 at 1–2 (agricultural producers groups).

50The comment letter stated that the agricultural

organizations were concerned that exchanges could

use the ability to offer a new contract with one

day’s notice to avoid prior review and approval for

amendments and changes to agricultural contracts.

It could also cause market fragmentation, since new

trading facilities might test new contracts on the

market without a thorough prior business analysis.

51Amendments to Commission rule 1.41 were

proposed as part of the new regulatory framework.

These amendments, appearing in the final version

in this Federal Register release, allow an RFE to

make modifications to its rules (other than terms or

conditions of contracts on the commodities

enumerated in section 1a(3) of the Act) by

certification to the Commission that the new or

amended rule does not violate the Act or the

Commission’s regulations. Upon the adoption of the

attached amendments to Commission rule 1.41, the

Commission’s earlier certification proposal,

published as a proposed rule on November 26, 1999

(64 FR 55428), will be unnecessary. Therefore, the

Commission is withdrawing proposed rule 1.41(z)

at this time.

52See, e.g., CL 21–24 at 4 (assertions by MGE that

rules should not be stayed absent sufficient

evidence that market participants will suffer

material harm). See also CL 21–27 at 3 (conclusions

by NYBOT that staying a rule pending a proceeding

to disapprove or amend it could take months, and

the uncertainty thus created would deter traders);

CL 21–36 at 11–12 (statement by CBT that it could

be detrimental for the Commission to retain

authority to impose a stay during a proceeding to

disapprove, alter, or amend an RFE rule as stays

could disrupt the marketplace); CL 21–51 at 5

(observation by CME that the Commission should

not retain authority to stay operation of an exchange

rule as, in an emergency situation, the Commission

could act under section 8a(9) of the Act, without

advance notice or a hearing).

Commission understands the difficulties

in implementing both the ‘‘fair and

reasonable price’’ and ‘‘transparency’’

guidance. Nevertheless, current block

trading provisions meet both such

criteria, and the Commission believes it

appropriate to retain them at this time.

In this regard, the Commission notes

that the reporting time provision is not

the ‘‘specific timing requirement’’

referred to by FIA, but a provision for

transparency of the block trade,

directing that the trade be reported

‘‘within a reasonable period of

time.’’(emphasis added). 65 FR at 39006.

Without such transparency, the market’s

price discovery role would be harmed.

The Commission may reconsider this

guidance in the future if, in practice,

these criteria prove to be unworkable.46

NYBOT suggested that requiring all

RFEs on which intermediaries trade to

have relevant rules under Core Principle

10 (Financial Standards) would impose

a new, onerous burden, and might result

in conflicting rules being implemented

at different RFEs. NYBOT states that

segregation of customer and proprietary

funds and custody and investment of

customer funds are currently governed

by Commission rules implemented

under the auspices of a designated selfregulatory organization. CL 21–7 at 2.

The adoption of Core Principle 10 is not

intended to impose a ‘‘new, onerous

burden’’ on exchanges, to change

current systems in place for the

oversight of intermediaries nor to

discourage the voluntary harmonization

of rules by the exchanges through the

operation of organizations such as the

Joint Audit Committee.

The Commission has modified Core

Principle 15 in response to concerns

that it inadvertently could impose a

duty different in form or degree from the

antitrust statutes and court decisions

construing them. See, e.g., comment of

the Board of Trade Clearing

Corporation, CL 21–20 at 13. Final Core

Principle 15 requires that RFEs operate

in a manner consistent with the public

interest to be protected by the antitrust

laws. The Commission itself remains

subject to the requirements of section 15

of the Act, and will continue to take into

consideration the public interest to be

protected by the antitrust laws and to

endeavor to take the least

anticompetitive means of achieving the

objectives of the Act in requiring or

approving any bylaw, rule or regulation

of any facility recognized under this

framework.47

3. New Products and Rules and

Amendments Thereof

The Commission proposed that

alteration by RFEs of the terms and

conditions of futures contracts on the

enumerated agricultural contracts be

subject to prior review and approval by

the Commission. The NYBOT, MGE,

CBT, and CME opposed this provision,

arguing that RFEs should be permitted

to alter the terms or conditions of

agricultural contract terms and

conditions by self-certification, the same

process permitted for contracts on all

other commodities.48 In contrast to the

exchange commenters, a number of

commenters representing agricultural

interests specifically supported

retention of the proposed 45-day prior

approval requirement for changes to the

terms and conditions of existing

agricultural contracts.49 Concern was

also raised by the National Cotton

Council and the agricultural producers

groups regarding the certification

process for new contracts. CL 21–54 at

1. They suggested that Commission

prior approval under a 45-day review

period be required for new agricultural

contracts, as well as for alterations of

existing contracts.50 CL 21–60 at 2.

The Commission concurs with the

agricultural producers groups that, as

‘‘agricultural futures markets serve as

the price discovery mechanism for

agricultural commodities, any changes

to these markets can have a significant

impact on farmers and ranchers.’’ CL

21–60 at 2. In light of their reliance on

the existing futures markets for price

discovery, the Commission concurs that

agricultural producers, processors and

merchants have an interest in

commenting on significant alterations to

the terms of contracts prior to their

implementation. Accordingly, the

Commission is adopting the prior

approval provision for amendments to

contract terms and conditions, as

proposed. However, the Commission

does not agree that the same

opportunity for comment is necessary

for new contracts, upon which

producers have not previously relied.

The success of a new contract will rest

on its attractiveness to market

participants and the marketplace will

determine whether the terms and

conditions of a new contract offer a

reliable price discovery mechanism.

Accordingly, the Commission has

decided to permit an RFE to list new

agricultural contracts by selfcertification, as proposed.

Several commenters opposed

Commission authority to stay the

effectiveness of rules implemented by

exchange certification during a

Commission action to disapprove those

rules. See, rule 1.41(c)(4) as amended.51

They argued that such stays could

disrupt the marketplace.52 However,

under the rule, the Commission would

only be able to stay a proposed rule

incident to disapproval proceedings and

the stay determination would not be

delegable to Commission staff. The

Commission anticipates that it will stay

implementation of an RFE rule only in

limited and egregious situations, where,

for example, one or more core principles

77976 Federal Register / Vol. 65, No. 240 / Wednesday, December 13, 2000 / Rules and Regulations

53For example, a rule that altered a trade

matching algorithm to give one class of participants

a significant and improper ongoing advantage over

another or that had a continuing significant adverse

affect on customers could be the subject of a stay.

In contrast, such a rule might not be a proper basis

for a market emergency, as it might not result in a

situation where action was necessary to ensure that

the market accurately reflected the forces of supply

and demand. The term ‘‘emergency’’ as defined in

the Act means, in addition to threatened or actual

market manipulations and corners, any act of the

United States or a foreign government affecting a

commodity or any other major market disturbance

which prevents the market from accurately

reflecting the forces of supply and demand for such

commodity. See section 8a(9) of the Act.

54See, e.g., CL 21–65 at 22.

55Similarly, the Commission believes that

transactions on recognized DTFs and RFEs should

be subject to the same tax treatment as transactions

on formally designated contract markets. 56See 7 U.S.C. 6(c).

57 47 FR 18618–21 (Apr. 30, 1982).

58 47 FR 18618, 18619 (discussing contract

markets); 47 FR 18619–20 (discussing FCMs and

CPOs).

were being violated, but that the

Commission’s emergency authority

would not apply.53 In such serious

situations, the Commission believes that

the unavailability of a stay could cause

significantly more disruptive effects

than imposition of a stay in appropriate

situations. In those rare instances, the

absence of a stay could cause

significantly greater harm to the market

than its use. The Commission has

determined that this authority is central

to its ability to oversee the operation of

RFEs consistent with its responsibilities

under the Act.

4. Bankruptcy Status

Several commenters requested that

the Commission clarify that transactions

on both DTFs and RFEs continue to

enjoy the same Bankruptcy Code status

as transactions on a designated contract

market.54 As noted above, recognized

RFEs and DTFs are both ‘‘boards of

trade’’ within the meaning of the Act,

and pursuant to these regulations, are

deemed to be subject to all provisions of

the Act and Commission rules

applicable to a ‘‘designated contract

market.’’ See, e.g., rule 38.1(b).

Moreover, final part 38 explicitly

reserves the applicability of part 190 to

part 38 transactions. Accordingly, as

explained in footnote 37 above, as a

board of trade within the meaning of

that term under the Act (and as a

contract market by operation of part 38),

transactions on RFEs (and DTFs) would

be covered by the provisions of

Subchapter IV of Chapter 7, Title 11 of

the Bankruptcy Code, which apply to

futures contracts (or options) traded on

or subject to the rules of a board of trade

or contract market.55

III. Section 4(c) Findings

These rule amendments are being

promulgated under section 4(c) of the

Act, which grants the Commission

broad exemptive authority. Section 4(c)

of the Act provides that, in order to

promote responsible economic or

financial innovation and fair

competition, the Commission may by

rule, regulation or order exempt any

class of agreements, contracts or

transactions, either unconditionally or

on stated terms or conditions from any

of the requirements of any provision of

the Act. For any exemption granted

pursuant to 4(c), the Commission must

find that the exemption would be

consistent with the public interest. For

any exemption granted pursuant to 4(c)

from the requirements of section 4(a),

the Commission must further find that

the section 4(a) requirement(s) should

not be applied to the agreement,

contract or transaction to be exempted,

that the exemption would be consistent

with the public interest and the

purposes of the Act, that the agreement,

contract, or transaction to be exempted

would be entered into solely between

appropriate persons and that the

exemption will not have a material

adverse effect on the ability of the

Commission or any contract market to

discharge its regulatory or selfregulatory duties under the Act.56

The Commission specifically

requested the public to comment on

these issues. The Commission finds and

the commenters overwhelmingly

concurred that the proposed regulatory

framework would be in the public

interest. As explained above, these

proposed rules establish a new

regulatory framework. The proposed

framework is intended to promote

innovation and competition in futures

trading and to permit the markets the

flexibility to respond to technological

and structural changes. Consequently,

the Commission finds that section 4(a)

requirements should not be applied to

agreements, contracts or transactions

executed pursuant to parts 36, 37 or 38

except as provided for in each part,

respectively. Moreover, the proposed

framework establishes three regulatory

tiers with regulations tailored to the

nature of the commodities traded and

the nature of the market participant. As

the Commission explained above, access

to each of the tiers is dependent upon

the appropriateness of the participant.

Accordingly, and for the reasons

detailed above, the Commission finds

that each class of participant eligible to

participate in a specific tier is

appropriate for that exemptive relief.

Finally, the exemptions for parts 37 and

38 are upon stated terms. As detailed

above, these terms include application

of regulatory and self-regulatory

requirements tailored to the nature of

the market. In light of these conditions,

this exemptive relief would have no

adverse effect on any of the regulatory

or self-regulatory responsibilities

imposed by the Act and the exemptions

are consistent with the purposes of the

Act.

IV. Related Matters

A. Regulatory Flexibility Act

The Regulatory Flexibility Act (RFA),

5 U.S.C. 601, et seq. (1994 & Supp. II

1996), requires federal agencies, in

promulgating rules, to consider the

impact of those rules on small entities.

The rules adopted herein would affect

contract markets, FCMs, CTAs, Floor

Brokers and Floor 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.57 In its previous determinations,

the Commission has concluded that

contract markets and registered FCMs

are not small entities for the purpose of

the RFA.58 With respect to CTAs, Floor

Brokers and Floor Traders, the

Commission has stated that it is

appropriate to evaluate within the

context of a particular rule proposal

whether some or all of the affected

entities should be considered small

entities and, if so, to analyze the

economic impact on them of any rule.

In this regard, the rules being adopted

herein would allow qualifying CTAs,

floor brokers and floor traders to access

trading in less regulated futures markets

than is currently the case; consequently,

these rules should not have any, or

result in only a de minimus, increase in

the regulatory requirements that apply

to CTAs, Floor Brokers and Floor

Traders. Accordingly, the Commission

does not expect the rules, as adopted

herein, to have a significant economic

impact on a substantial number of small

entities. Furthermore, no comments

were received from the public on the

RFA and its relation to the proposed

rules. Therefore, the Chairman, on

behalf of the Commission, hereby

certifies, pursuant to 5 U.S.C. 605(b),

that the action taken herein will not

have a significant economic impact on

a substantial number of small entities.

B. Paperwork Reduction Act of 1995

These parts 15, 37, 38 contain

information collection requirements. As

required by the Paperwork Reduction

Act of 1995 (Pub. L. 104–13 (May 13,

Federal Register / Vol. 65, No. 240 / Wednesday, December 13, 2000 / Rules and Regulations 77977

1996)), the Commission has submitted a

copy of these proposed parts to the

Office of Management and Budget

(OMB) for its review (44 U.S.C. 3504(h)).

No comments were received in response

to the Commission’s invitation in the

NPRM to comment on any potential

paperwork burden associated with these

regulations.

List of Subjects

17 CFR Part 1

Commodity futures, Consumer

protection, Contract markets,

Designation application, Reporting and

recordkeeping requirements.

17 CFR Part 5

Authority delegations (Government

agencies), Commodity futures, Contract

markets, Designation application,

Reporting and recordkeeping

requirements.

17 CFR Part 15

Commodity futures, Contract markets,

Reporting and recordkeeping

requirements.

17 CFR Part 36

Commodity futures, Commodity

Futures Trading Commission.

17 CFR Part 37

Authority delegations (Government

agencies), Commodity futures,

Commodity Futures Trading

Commission.

17 CFR Part 38

Commodity futures, Commodity

Futures Trading Commission.

17 CFR Part 100

Commodity futures, Commodity

Futures Trading Commission.

17 CFR Part 170

Authority delegations (Government

agencies), Commodity futures,

Reporting and recordkeeping

requirements.

17 CFR Part 180

Claims, Commodity futures,

Consumer protection, Reporting and

recordkeeping requirements.

In consideration of the foregoing, and

pursuant to the authority contained in

the Act and, in particular, sections 4, 4c,

4i, 5, 5a, 6 and 8a thereof, 7 U.S.C. 6,

6c, 6i, 7, 7a, 8, and 12a, the Commission

hereby amends 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, 2a, 4, 4a, 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, 23, and 24.

2. Section 1.37 is amended by adding

paragraphs (c) and (d) to read as follows:

§ 1.37 Customer’s or option customer’s

name, address, and occupation recorded;

record of guarantor or controller of

account.

* * * * *

(c) Each recognized futures exchange

shall keep a record in permanent form

which shall show the true name;

address; and principal occupation or

business of any foreign trader executing

transactions on the facility or exchange,

as well as the name of any person

guaranteeing such transactions or

exercising any control over the trading

of such foreign trader.

(d) Paragraph (c) of this section shall

not apply to a recognized futures

exchange on which transactions in

futures or option contracts of foreign

traders are executed through and the

resulting transactions are maintained in

accounts carried by a registered futures

commission merchant or introducing

broker subject to the provisions of

paragraph (a) of this section.

* * * * *

3. Section 1.41 is amended as follows:

a. By revising paragraph (a)(1),

b. By removing and reserving

paragraph (b), and removing paragarphs

(i) through (t),

c. By redesignating paragraph (e) as

paragraph (i) and revising it,

d. By revising paragraphs (c) and (d)

and adding (e), and

e. By amending paragraphs (f) and (g)

by adding the words ‘‘or recognized

futures exchange’’ after the words

‘‘contract market’’ each time they

appear, to read as follows:

§ 1.41 Contract market rules; submission

of rules to the Commission; exemption of

certain rules.

(a) * * *

(1) The term rule of a contract market

means any constitutional provision,

article of incorporation, bylaw, rule,

regulation, resolution, interpretation,

stated policy, term and condition,

trading protocol, agreement or

instrument corresponding thereto, in

whatever form adopted, and any

amendment or addition thereto or repeal

thereof, made or issued by a contract

market, or by the governing board

thereof or any committee thereof.

* * * * *

(b) [Reserved]

(c) Exemption from the rule review

procedure requirements of section

5a(a)(12)(A) of the Act and related

regulations. Notwithstanding the rule

approval and filing requirements of

section 5a(a)(12) of the Act, designated

contract markets, recognized futures

exchanges and recognized clearing

organizations may place a rule into

effect without prior Commission review

or approval if:

(1) The rule is not a term or condition

of a contract for future delivery of an

agricultural commodity listed in section

1a(3) of the Act;

(2) The entity has filed a submission

for the rule, and the Commission has

received the submission at its

Washington, D.C. headquarters and at

the regional office having jurisdiction

over the entity by close of business on

the business day preceding

implementation of the rule; and

(3) The rule submission includes:

(i) The label, ‘‘Submission of rule by

self-certification;’

(ii) The text of the rule (in the case of

a rule amendment, brackets must

indicate words deleted and

underscoring must indicate words

added);

(iii) A brief explanation of the rule

including any substantive opposing

views not incorporated into the rule;

and

(iv) A certification by the eligible

entity that the rule does not violate any

provision of the Act and regulations

thereunder.

(4) The Commission retains the

authority to stay the effectiveness of a

rule implemented pursuant to paragraph

(c)(1) of this section during the

pendency of Commission proceedings to

disapprove, alter or amend the rule. The

decision to stay the effectiveness of a

rule in such circumstances may not be

delegable to any employee of the

Commission.

(d)(1) Voluntary submission of rules

for fast-track approval. A designated

contract market, recognized futures

exchange, derivatives transaction

facility or recognized clearing

organization may submit any rule or

proposed rule (which may be terms or

conditions of trading or trading

protocols), except those submitted to the

Commission under paragraph (f) of this

section, for approval by the Commission

pursuant to section 5a(a)(12)(A) of the

Act, whether or not so required by

section 5a(a)(12) of the Act under the

following procedures:

77978 Federal Register / Vol. 65, No. 240 / Wednesday, December 13, 2000 / Rules and Regulations

(i) One copy of each rule submitted

under this section shall be furnished in

hard copy or electronically in a format

specified by the Secretary of the

Commission to the Commission at its

Washington, DC headquarters. If a hard

copy is furnished for submissions under

appendix A to part 5 of this chapter, two

additional hard copies shall be

furnished to the Commodity Futures

Trading Commission, Three Lafayette

Centre, 1155 21st Street NW.,

Washington, DC 20581. Each

submission under this paragraph (d)(1)

shall be in the following order:

(A) Label the submission as

‘‘Submission for Commission rule

approval’’;

(B) Set forth the text of the rule or

proposed rule (in the case of a rule

amendment, brackets must indicate

words deleted and underscoring must

indicate words added);

(C) Describe the proposed effective

date of a proposed rule and any action

taken or anticipated to be taken to adopt

the proposed rule by the contract

market, recognized futures exchange,

derivatives transaction facility or

recognized clearing organization or by

its governing board or by any committee

thereof, and cite the rules of the entity

that authorize the adoption of the

proposed rule;

(D) Explain the operation, purpose,

and effect of the proposed rule,

including, as applicable, a description

of the anticipated benefits to market

participants or others, any potential

anticompetitive effects on market

participants or others, how the rule fits

into the contract market, recognized

futures exchange, derivatives

transaction facility or recognized

clearing organization’s framework of

self-regulation, and any other

information which may be beneficial to

the Commission in analyzing the

proposed rule. If a proposed rule affects,

directly or indirectly, the application of

any other rule of the submitting entity,

set forth the pertinent text of any such

rule and describe the anticipated effect;

(E) Note and briefly describe any

substantive opposing views expressed

with respect to the proposed rule which

were not incorporated into the proposed

rule prior to its submission to the

Commission; and

(F) Identify any Commission

regulation that the Commission may

need to amend, or sections of the Act or

Commission regulations that the

Commission may need to interpret in

order to approve or allow into effect the

proposed rule. To the extent that such

an amendment or interpretation is

necessary to accommodate a proposed

rule, the submission should include a

reasoned analysis supporting the

change.

(ii) All rules submitted for

Commission approval under paragraph

(d)(1)(i) of this section shall be deemed

approved by the Commission under

section 5a(a)(12)(A) of the Act, forty-five

days after receipt by the Commission,

unless notified otherwise within that

period, if:

(A) The submission complies with the

requirements of paragraphs (d)(1)(i) (A)

through (F) of this section or, for

dormant contracts, the requirements of

§ 5.3 of this chapter;

(B) The submitting entity does not

amend the proposed rule or supplement

the submission, except as requested by

the Commission, during the pendency

of the review period; and

(C) The submitting entity has not

instructed the Commission in writing

during the review period to review the

proposed rule under the 180 day review

period under section 5a(a)(12)(A) of the

Act.

(iii) The Commission, within fortyfive days after receipt of a submission

filed pursuant to paragraph (d)(1)(i) of

this section, may notify the entity

making the submission that the review

period has been extended for a period

of thirty days where the proposed rule

raises novel or complex issues which

require additional time for review or is

of major economic significance. This

notification shall briefly describe the

nature of the specific issues for which

additional time for review is required.

Upon such notification, the period for

review shall be extended for a period of

thirty days, and, unless the entity is

notified otherwise during that period,

the rule shall be deemed approved at

the end of the enlarged review time.

(iv) During the forty-five day period

for fast-track review, or the thirty-day

extension when the period has been

enlarged under paragraph (d)(1)(iii) of

this section, the Commission shall

notify the submitting entity that the

Commission is terminating fast-track

review procedures and will review the

proposed rule under the 180 day review

period of section 5a(a)(12)(A) of the Act,

if it appears that the proposed rule may

violate a specific provision of the Act,

regulations, or form or content

requirements of this section. This

termination notification will briefly

specify the nature of the issues raised

and the specific provision of the Act,

regulations, or form or content

requirements of this section that the

proposed rule appears to violate. Within

fifteen days of receipt of this

termination notification, the designated

contract market, recognized futures

exchange, derivatives transaction

facility or recognized clearing

organization may:

(A) Withdraw the rule;

(B) Request the Commission to review

the rule pursuant to the one hundred

and eighty day review procedures set

forth in section 5a(a)(12)(A) of the Act;

or

(C) Request the Commission to render

a decision whether to approve the

proposed rule or to institute a

proceeding to disapprove the proposed

rule under the procedures specified in

section 5a(a)(12)(A) of the Act by

notifying the Commission that the

submitting entity views its submission

as complete and final as submitted.

(2) Voluntary submission of rules for

expedited approval. Notwithstanding

the provisions of paragraph (d)(1) of this

section, changes to terms and conditions

of a contract that are consistent with the

Act and Commission regulations and

with standards approved or established

by the Commission in a written

notification to the market or clearing

organization of the applicability of this

paragraph (d)(2) shall be deemed

approved by the Commission at such

time and under such conditions as the

Commission shall specify, provided,

however, that the Commission may at

any time alter or revoke the

applicability of such a notice to any

particular contract.

(e)(1) Notification of rule

amendments. Notwithstanding the rule

approval and filing requirements of

section 5a(a)(12) of the Act and of

paragraphs (c) and (d) of this section,

designated contract markets, recognized

futures exchanges and recognized

clearing organizations may place the

following rules into effect without prior

notice to the Commission if the

following conditions are met:

(i) The designated contract market,

recognized futures exchange, or

recognized clearing organization

provides to the Commission at least

weekly a summary notice of all rule

changes made effective pursuant to this

paragraph during the preceding week.

Such notice must be labeled ‘‘Weekly

Notification of Rule Changes’’ and need

not be filed for weeks during which no

such actions have been taken. One copy

of each such submission shall be

furnished in hard copy or electronically

in a format specified by the Secretary of

the Commission to the Commodity

Futures Trading Commission, Three

Lafayette Centre, 1155 21st Street NW.,

Washington, DC 20581; and

(ii) The rule change governs:

(A) Nonmaterial revisions.

Corrections of typographical errors,

renumbering, periodic routine updates

to identifying information about

Federal Register / Vol. 65, No. 240 / Wednesday, December 13, 2000 / Rules and Regulations 77979

approved entities and other such

nonsubstantive revisions of contract

terms and conditions that have no effect

on the economic characteristics of the

contract;

(B) Delivery standards set by third

parties. Changes to grades or standards

of commodities deliverable on futures

contracts that are established by an

independent third party and that are

incorporated by reference as terms of

the contract, provided that the grade or

standard is not established, selected or

calculated solely for use in connection

with futures or option trading;

(C) Index contracts. Routine changes

in the composition, computation, or

method of selection of component

entities of an index other than a stock

index referenced and defined in the

contract’s terms, made by an

independent third party whose business

relates to the collection or

dissemination of price information and

that was not formed solely for the

purpose of compiling an index for use

in connection with a futures or option

contract;

(D) Transfer of membership or

ownership. Procedures and forms for the

purchase, sale or transfer of membership

or ownership, but not including

qualifications for membership or

ownership, any right or obligation of

membership or ownership or dues or

assessments; or

(E) Administrative procedures. The

organization and administrative

procedures of a contract market’s

governing bodies such as a Board of

Directors, Officers and Committees, but

not voting requirements and procedures

or requirements or procedures relating

to conflicts of interest.

(2) Notification of rule amendments

not required. Notwithstanding the rule

approval and filing requirements of

section 5a(a)(12) of the Act and of

paragraphs (c) and (d) of this section,

designated contract markets, recognized

futures exchanges and recognized

clearing organizations may place into

effect without notice to the Commission,

rules governing:

(i) Administration. The routine, daily

administration, direction and control of

employees, requirements relating to

gratuity and similar funds, but not

guaranty, reserves, or similar funds;

declaration of holidays, and changes to

facilities housing the market, trading

floor or trading area; or

(ii) Standards of decorum. Standards

of decorum or attire or similar

provisions relating to admission to the

floor, badges, visitors, but not the

establishment of penalties for violations

of such rules.

* * * * *

(i) Membership lists. Upon request of

the Commission each designated

contract market, recognized futures

exchange or recognized clearing

organization shall promptly furnish to

the Commission a current list of the

facility’s or entity’s members or owners

subject to fitness requirements.

§§ 1.43, 1.45 and 1.50 [Removed]

4. In part 1, §§ 1.43, 1.45, and 1.50 are

proposed to be removed and reserved.

5. Part 5 is amended as follows:

PART 5—PROCEDURES FOR LISTING

NEW PRODUCTS

a. The authority citation for part 5

continues to read as follows:

Authority: 7 U.S.C. 6(c), 6c, 7, 7a, 8 and

12a.

b. The heading of part 5 is revised as

set forth above and §§ 5.1 through 5.3

are revised to read as follows:

§ 5.1 Listing contracts for trading by

exchange certification.

(a) Notwithstanding the provisions of

section 4(a)(1) of the Act or § 33.2 of this

chapter, a board of trade that has been

recognized by the Commission as a

recognized futures exchange under part

38 of this chapter may list for trading

contracts of sale of a commodity for

future delivery or commodity option

contracts, if the recognized futures

exchange:

(1) Lists for trading at least one

contract which is not dormant within

the meaning of § 5.3;

(2) In connection with the trading of

the contract complies with all

requirements of the Act and

Commission regulations thereunder

applicable to the recognized futures

exchange under part 38 of this chapter;

(3) Files with the Commission at its

Washington, D.C., headquarters either in

electronic or hard-copy form a copy of

the contract’s initial terms and

conditions and a certification by the

recognized futures exchange that the

contract’s initial terms and conditions

do not violate any requirement of part

38 of this chapter, any applicable

provision of the Act or of the rules

thereunder, and the filing is received no

later than the close of business of the

business day preceding the contract’s

initial listing; and

(4) Identifies the contract in its rules

as listed for trading pursuant to

exchange certification.

(b) The provisions of this section shall

not apply to:

(1) A contract subject to the

provisions of section 2(a)(1)(B) of the

Act;

(2) A contract to be listed initially for

trading that is the same or substantially

the same as one for which an

application for Commission review and

approval pursuant to § 5.2 was filed by

another board of trade while the

application is pending before the

Commission; or

(3) A contract to be listed initially for

trading that is the same or substantially

the same as one which is the subject of

a pending Commission disapproval

proceeding under section 6 of the Act,

to disapprove a term or condition under

section 5a(a)(12) of the Act, to alter or

supplement a term or condition under

section 8a(7) of the Act, to amend terms

or conditions under section 5a(a)(10) of

the Act, to declare an emergency under

section 8a(9) of the Act, or to any other

proceeding the effect of which is to

disapprove, alter, supplement, or

require a contract market or a

recognized futures exchange to adopt a

specific term or condition, trading rule

or procedure, or to take or refrain from

taking a specific action.

§ 5.2 Voluntary submission of new

products for Commission review and

approval.

(a) Cash-settled contracts. A new

contract to be listed for trading by a

recognized futures exchange under part

38 of this chapter or a recognized

derivatives transaction facility under

part 37 of this chapter shall be deemed

approved by the Commission ten

business days after receipt by the

Commission of the application for

contract approval, unless notified

otherwise within that period, if:

(1) The submitting entity labels the

submission as being submitted pursuant

to Commission rule 5.2—Fast Track

Ten-Day Review;

(2)(i) The application for approval is

for a futures contract providing for cash

settlement or for delivery of a foreign

currency for which there is no legal

impediment to delivery and for which

there exists a liquid cash market; or

(ii) For an option contract that is itself

cash-settled, is for delivery of a foreign

currency that meets the requirements of

paragraph (a)(2)(i) of this section or is to

be exercised into a futures contract

which has already been designated as a

contract market or approved under this

section;

(3) The application for approval is for

a commodity other than those

enumerated in section 1a(3) of the Act

or one that is subject to the procedures

of section 2(a)(1)(B) of the Act;

(4) The submitting entity trades at

least one contract which is not dormant

within the meaning of this part;

77980 Federal Register / Vol. 65, No. 240 / Wednesday, December 13, 2000 / Rules and Regulations

(5) The submission complies with the

requirements of Appendix A of this

part—Guideline No. 1;

(6) The submitting entity does not

amend the terms or conditions of the

proposed contract or supplement the

application for designation, except as

requested by the Commission or for

correction of typographical errors,

renumbering or other such

nonsubstantive revisions, during that

period; and

(7) The submitting entity has not

instructed the Commission in writing

during the review period to review the

application for designation under the

usual procedures under section 6 of the

Act.

(b) Contracts for physical delivery. A

new contract to be listed for trading by

a recognized futures exchange under

part 38 of this chapter or by a

derivatives transaction facility under

part 37 of this chapter shall be deemed

approved by the Commission forty-five

days after receipt by the Commission of

the application for contract approval,

unless notified otherwise within that

period, if:

(1) The submitting entity labels the

submission as being submitted pursuant

to Commission rule 5.2—Fast Track

Forty-Five Day Review;

(2) The application for contract

approval is for a commodity other than

those subject to the procedures of

section 2(a)(1)(B) of the Act;

(3) The submitting entity lists for

trading at least one contract which is

not dormant within the meaning of this

part;

(4) The submission complies with the

requirements of Appendix A to this

part—Guideline No. 1;

(5) The submitting entity does not

amend the terms or conditions of the

proposed contract or supplement the

application for designation, except as

requested by the Commission or for

correction of typographical errors,

renumbering or other such

nonsubstantive revisions, during that

period; and

(6) The submitting entity has not

instructed the Commission in writing

during the forty-five day review period

to review the application for designation

under the usual procedures under

section 6 of the Act.

(c) Notification of extension of time.

The Commission, within ten days after

receipt of a submission filed under

paragraph (a) of this section, or fortyfive days after receipt of a submission

filed under paragraph (b) of this section,

may notify the submitting entity that the

review period has been extended for a

period of thirty days where the

application for approval raises novel or

complex issues which require

additional time for review. This

notification will briefly specify the

nature of the specific issues for which

additional time for review is required.

Upon such notification, the period for

fast-track review of paragraphs (a) and

(b) of this section shall be extended for

a period of thirty days.

(d) Notification of termination of fasttrack procedures. During the fast-track

review period provided under

paragraphs (a) or (b) of this section, or

of the thirty-day extension when the

period has been enlarged under

paragraph (c) of this section, the

Commission shall notify the submitting

entity that the Commission is

terminating fast-track review procedures

and will review the proposed contract

under the usual procedures of section 6

of the Act, if it appears that the

proposed contract may violate a specific

provision of the Act, regulations, or

form or content requirements of

Appendix A to this part. This

termination notification will briefly

specify the nature of the issues raised

and the specific provision of the Act,

regulation, or form or content

requirement of Appendix A to this part

that the proposed contract appears to

violate. Within ten days of receipt of

this termination notification, the

submitting entity may request that the

Commission render a decision whether

to approve the designation or to

institute a proceeding to disapprove the

proposed application for designation

under the procedures specified in

section 6 of the Act by notifying the

Commission that the exchange views its

application as complete and final as

submitted.

(e) Delegation of authority. (1) The

Commission hereby delegates, until it

orders otherwise, to the Director of the

Division of Economic Analysis or to the

Director’s delegatee, with the

concurrence of the General Counsel or

the General Counsel’s delegatee,

authority to request under paragraphs

(a)(6) and (b)(5) of this section that the

recognized futures exchange or

derivatives transaction facility amend

the proposed contract or supplement the

application, to notify a submitting entity

under paragraph (c) of this section that

the time for review of a proposed

contract term submitted for review

under paragraphs (a) or (b) of this

section has been extended, and to notify

the submitting entity under paragraph

(d) of this section that the fast-track

procedures of this section are being

terminated.

(2) The Director of the Division of

Economic Analysis may submit to the

Commission for its consideration any

matter which has been delegated in

paragraph (e)(1) of this section.

(3) Nothing in the paragraph prohibits

the Commission, at its election, from

exercising the authority delegated in

paragraph (e)(1) of this section.

§ 5.3 Dormant contracts.

(a) Definitions. For purposes of this

section:

(1) The term dormant contract means

any commodity futures or option

contract:

(i) In which no trading has occurred

in any future or option expiration for a

period of six complete calendar months;

or

(ii) Which has been certified by a

recognized futures exchange or a

recognized derivatives transaction

facility to the Commission to be a

dormant contract market.

(2) [Reserved]

(b) Listing of additional futures

trading months or option expiration by

certification. A contract that has been

listed for trading initially under the

procedures of either §§ 5.1 or 5.2 that

has become dormant may be relisted for

trading additional months pursuant to

the procedures of § 1.41(c) of this

chapter by filing the bylaw, rule,

regulation or resolution to list

additional trading months or expirations

with the Commission as specified in

that section. Upon relisting, the contract

must be identified by the recognized

futures exchange as listed for trading by

exchange certification.

(c) Approval for listing of additional

futures trading months or option

expirations. A contract that has been

initially approved by the Commission

under § 5.2 and that has become

dormant may be relisted for trading

additional months pursuant to the

procedures of § 1.41(d) of this chapter

by filing the bylaw, rule, regulation or

resolution to list additional trading

months or expirations with the

Commission as specified in that section.

(1) Each such submission shall clearly

designate the submission as filed

pursuant to Commission Rule 5.3; and

(2) Include the information required

to be submitted pursuant to § 5.3 or an

economic justification for the listing of

additional months or expirations in the

dormant contract market, which shall

include an explanation of those

economic conditions which have

changed subsequent to the time the

contract became dormant and an

explanation of how any new terms and

conditions which are now being

proposed, or which have been proposed

for an option market’s underlying

futures contract market, would make it

reasonable to expect that the futures or

Federal Register / Vol. 65, No. 240 / Wednesday, December 13, 2000 / Rules and Regulations 77981

option contract will be used on more

than an occasional basis for hedging or

price basing.

(d) Exemptions. No contract shall be

considered dormant until the end of

sixty (60) complete calendar months:

(1) Following initial listing; or

(2) Following Commission approval of

the contract market bylaw, rule,

regulation, or resolution to relist trading

months submitted pursuant to

paragraph (c) of this section.

Appendices C and D [Removed and

Reserved]

c. Appendices C and D are removed

and reserved.

PART 15—REPORTS—GENERAL

PROVISIONS

6. The authority citation for Part 15 is

revised to read as follows:

Authority: 7 U.S.C. 2, 4, 5, 6(c), 6a, 6c(a)–

(d), 6f, 6g, 6i, 6k, 6m, 6n, 7, 9, 12a, 19 and

21.

7. Section 15.05 is amended by

revising the heading and by adding

paragraphs (e) through (h) to read as

follows:

§ 15.05 Designation of agent for foreign

brokers, customers of a foreign broker and

foreign traders.

* * * * *

(e) Any derivatives transaction facility

eligible under § 37.2(a)(2) of this chapter

or recognized futures exchange that

permits a foreign broker to intermediate

transactions in futures or option

contracts on the facility or exchange, or

permits a foreign trader to effect

transactions in futures or option

contracts on the facility or exchange

shall be deemed to be the agent of the

foreign broker and any of its customers

for whom the transactions were

executed, or the foreign trader for

purposes of accepting delivery and

service of any communication issued by

or on behalf of the Commission to the

foreign broker, any of its customers or

the foreign trader with respect to any

futures or option contracts executed by

the foreign broker or the foreign trader

on the derivatives transaction facility

eligible under § 37.2(a)(2) of this chapter

or recognized futures exchange. Service

or delivery of any communication

issued by or on behalf of the

Commission to a derivatives transaction

facility eligible under § 37.2(a)(2) of this

chapter or recognized futures exchange

pursuant to such agency shall constitute

valid and effective service upon the

foreign broker, any of its customers, or

the foreign trader. A derivatives

transaction facility eligible under

§ 37.2(a)(2) of this chapter or recognized

futures exchange which has been served

with, or to which there has been

delivered, a communication issued by

or on behalf of the Commission to a

foreign broker, any of its customers, or

a foreign trader shall transmit the

communication promptly and in a

manner which is reasonable under the

circumstances, or in a manner specified

by the Commission in the

communication, to the foreign broker,

any of its customers or the foreign

trader.

(f) It shall be unlawful for any

derivatives transaction facility eligible

under § 37.2(a)(2) of this chapter or

recognized futures exchange to permit a

foreign broker, any of its customers or

a foreign trader to effect transactions in

futures or option contracts unless the

derivatives transaction facility eligible

under § 37.2(a)(2) of this chapter or

recognized futures exchange prior

thereto informs the foreign broker, any

of its customers or the foreign trader in

any reasonable manner the derivatives

transaction facility eligible under

§ 37.2(a)(2) of this chapter or recognized

futures exchange deems to be

appropriate, of the requirements of this

section.

(g) The requirements of paragraphs (e)

and (f) of this section shall not apply to

any transactions in futures or option

contracts if the foreign broker, any of its

customers or the foreign trader has duly

executed and maintains in effect a

written agency agreement in compliance

with this paragraph with a person

domiciled in the United States and has

provided a copy of the agreement to the

derivatives transaction facility eligible

under § 37.2(a)(2) of this chapter or

recognized futures exchange prior to

effecting any transactions in futures or

option contracts on the derivatives

transaction facility eligible under

§ 37.2(a)(2) of this chapter or recognized

futures exchange. This agreement must

authorize the person domiciled in the

United States to serve as the agent of the

foreign broker, any of its customers or

the foreign trader for purposes of

accepting delivery and service of all

communications issued by or on behalf

of the Commission to the foreign broker,

any of its customers or the foreign trader

and must provide an address in the

United States where the agent will

accept delivery and service of

communications from the Commission.

This agreement must be filed with the

Commission by the derivatives

transaction facility eligible under

§ 37.2(a)(2) of this chapter or recognized

futures exchange prior to permitting the

foreign broker, any of its customers or

the foreign trader to effect any

transactions in futures or option

contracts. Unless otherwise specified by

the Commission, the agreements

required to be filed with the

Commission shall be filed with the

Secretary of the Commission at Three

Lafayette Centre, 1155 21st Street, N.W.,

Washington, D.C. 20581. A foreign

broker, any of its customers or a foreign

trader shall notify the Commission

immediately if the written agency

agreement is terminated, revoked, or is

otherwise no longer in effect. If the

derivatives transaction facility eligible

under § 37.2(a)(2) of this chapter or

recognized futures exchange knows or

should know that the agreement has

expired, been terminated, or is no longer

in effect, the derivatives transaction

facility eligible under § 37.2(a)(2) of this

chapter or recognized futures exchange

shall notify the Secretary of the

Commission immediately. If the written

agency agreement expires, terminates, or

is not in effect, the derivatives

transaction facility eligible under

§ 37.2(a)(2) of this chapter or recognized

futures exchange and the foreign broker,

any of its customers or the foreign trader

are subject to the provisions of

paragraphs (e) and (f) of this section.

(h) The provisions of paragraphs (e),

(f) and (g) of this section shall not apply

to a derivatives transaction facility or

recognized futures exchange on which

all transactions in futures or option

contracts of foreign brokers, their

customers or foreign traders are

executed through and the resulting

transactions are maintained in accounts

carried by a registered futures

commission merchant or introducing

broker subject to the provisions of Rules

15.05(a), (b), (c) and (d).

* * * * *

8. Part 36 is revised to read as follows:

PART 36—EXEMPTION OF

TRANSACTIONS ON MULTILATERAL

TRANSACTION EXECUTION

FACILITIES

Sec.

36.1 Definitions. As used in this part:

36.2 Exemption.

36.3 Enforceability.

Authority: 7 U.S.C. 2, 6, 6c, and 12a.

§ 36.1 Definitions.

As used in this part:

(a) Eligible participant means and

shall be limited to the parties or entities

listed in § 35.1(b)(1) through (11) of this

chapter; and

(b) Multilateral transaction execution

facility means an electronic or nonelectronic market or similar facility

through which persons, for their own

accounts or for the accounts of others,

77982 Federal Register / Vol. 65, No. 240 / Wednesday, December 13, 2000 / Rules and Regulations

enter into, agree to enter into or execute

binding contracts, agreements or

transactions by accepting bids or offers

made by one person that are open to

multiple persons who conduct business

through such market or similar facility,

but does not include:

(1) A facility whose participants

individually negotiate (or have

individually negotiated) with

counterparties the material terms

applicable to contracts, agreements, or

transactions between them, including

contracts, agreements, or transactions

conducted on the facility, and which are

subject to subsequent acceptance by the

counterparties;

(2) Any electronic communications

system on which the execution of a

contract, agreement or transaction

results from the content of bilateral

communications exchanged between the

parties and not by the interaction of

multiple orders within a predetermined,

non-discretionary automated trade

matching algorithm; or

(3) Any facility on which only a single

firm may participate as market maker

and participants other than the market

maker may not accept bids or offers of

other non-market maker participants.

§ 36.2 Exemption.

A contract, agreement or transaction

traded on a multilateral transaction

execution facility as defined in § 36.1(b)

is exempt from all provisions of the Act

and any person or class of persons

offering, entering into, rendering advice,

or rendering other services with respect

to such contract, agreement or

transaction is exempt for such activity

from all provisions of the Act (except in

each case the provisions enumerated in

§ 36.3(a)) provided the following terms

and conditions are met:

(a) Only eligible participants, either

trading for their own account or through

another eligible participant, have

trading access to the multilateral

transaction execution facility;

(b) The contract, agreement or

transaction listed on or traded through

the multilateral transaction execution

facility is based upon:

(1) A debt obligation other than an

exempt security under section 3 of the

Securities Act of 1933 or section 3a(12)

of the Securities Exchange Act of 1934;

(2) A foreign currency;

(3) An interest rate;

(4) A measure of credit risk or quality,

including instruments known as ‘‘total

return swaps,’’ ‘‘credit swaps’’ or ‘‘credit

spread swaps’’;

(5) An occurrence, extent of an

occurrence or contingency beyond the

control of the counterparties to the

transaction; or

(6) An economic or commercial index

or measure which is beyond the control

of the counterparties to the transaction,

and is not based upon prices derived

from trading in a directly corresponding

underlying cash market and for which

the related contract, agreement or

transaction is cash settled;

(c) If cleared, the submission of such

contracts, agreements or transactions for

clearance and/or settlement must be to

a clearing organization that is

authorized under § 39.2 of this chapter:

Provided, however, that nothing in this

paragraph precludes:

(1) Arrangements or facilities between

parties to such contracts, agreements or

transactions that provide for netting of

payment or delivery obligations

resulting from such contracts,

agreements, or transactions; or

(2) Arrangements or facilities among

parties to such contracts, agreements or

transactions, that provide for netting of

payments or deliveries resulting from

such contracts, agreements or

transactions;

(d) The multilateral transaction

execution facility on or through which

such contracts, agreements or

transactions are traded and the parties

to, participants in, or intermediaries in

such a facility that is exempt under this

section are prohibited from claiming

that the facility is regulated, recognized

or approved by the Commission; and

(e) The facility:

(1) If an electronic system that also

lists for trading products pursuant to

parts 37 or 38 of this chapter, must

provide notice to participants of the

agreements, contracts or transactions

traded on the facility pursuant to this

part 36 and that such transactions are

not subject to regulation under the Act;

or

(2) If providing a physical trading

environment, must provide that

products trading pursuant to parts 37 or

38 of this chapter be traded in a location

separate from, but which may adjoin,

the location for products traded

pursuant to this part 36.

(f) If the Commission determines by

order, after notice and an opportunity

for a hearing through submission of

written data, views and arguments, that

the facility serves as a significant source

for the discovery of prices for an

underlying commodity, the facility must

on a daily basis disseminate publicly

trading volume and price ranges and

other trading data appropriate to that

market as specified in the order.

(g) Any person or entity may apply to

the Commission for exemption from any

of the provisions of the Act (except

section 2(a)(1)(B)) for other

arrangements or facilities, on such terms

and conditions as the Commission

deems appropriate, including, but not

limited to, the applicability of other

regulatory regimes.

§ 36.3 Enforceability.

(a) Notwithstanding the exemption in

§ 36.2, sections 2(a)(1)(B), 4b, and 4o of

the Act and § 32.9 of this chapter as

adopted under section 4c(b) of the Act,

and sections 6(c) and 9(a)(2) of the Act

to the extent they prohibit manipulation

of the market price of any commodity in

interstate commerce or for future

delivery on or subject to the rules of any

contract market, continue to apply to

transactions and persons otherwise

subject to those provisions.

(b) A party to a contract, agreement or

transaction that is with a counterparty

that is an eligible participant (or

counterparty reasonably believed by

such party at the time the contract,

agreement or transaction was entered

into to be an eligible participant) shall

be exempt from any claim, counterclaim

or affirmative defense by such

counterparty under section 22(a)(1) of

the Act or any other provision of the

Act:

(1) That such contract, agreement or

transaction is void, voidable or

unenforceable, or

(2) To rescind, or recover any

payment made in respect of, such

contract, agreement or transaction,

based solely on the failure of such party

or such contract, agreement or

transaction to comply with the terms or

conditions of the exemption under this

part.

9. Chapter I of 17 CFR is amended by

adding new Part 37 as follows:

PART 37—EXEMPTION OF

TRANSACTIONS ON A DERIVATIVES

TRANSACTION FACILITY

Sec.

37.1 Scope and definitions.

37.2 Exemption.

37.3 General conditions for recognition as a

derivatives transaction facilities.

37.4 Conditions for recognition as a

derivatives transaction facility,

compliance with core principles.

37.5 Additional conditions for recognition

as a derivative transaction facility.

37.6 Information relating to transactions on

derivative transaction facilities.

37.7 Procedures for recognition.

37.8 Enforceability.

37.9 Fraud in connection with part 37

transactions.

Appendix A to Part 37—Application

Guidance.

Authority: 7 U.S.C. 2, 6, 6c, 6(c), 6(i) and

12a.

Federal Register / Vol. 65, No. 240 / Wednesday, December 13, 2000 / Rules and Regulations 77983

§ 37.1 Scope and definitions.

(a) Scope. (1) A board of trade

operating as a recognized derivatives

transaction facility and the products

listed for trading thereon under this

exemption shall be deemed to be subject

to all of the provisions of the Act and

Commission regulations thereunder

which are applicable to a ‘‘board of

trade,’’ ‘‘board of trade licensed by the

Commission,’’ ‘‘exchange,’’ ‘‘contract

market,’’ ‘‘designated contract market,’’

or ‘‘contract market designated by the

Commission’’ as though those

provisions were set forth in this section

and included specific reference to

contracts listed for trading by

recognized derivatives transaction

facilities pursuant to this section.

(2) The provisions of this section shall

not apply to a commodity or a contract

subject to the provisions of section

2(a)(1)(B) of the Act.

(b) Definitions. As used in this part:

(1) Eligible participant means, and

shall be limited to, the parties or entities

listed in § 35.1(b)(1) through (11) of this

chapter, Provided, however, that

notwithstanding the proviso of

§ 35.1(b)(10), a floor broker or floor

trader that is a natural person or

proprietorship shall be considered to be

an eligible participant for transactions

on a derivatives transaction facility

recognized under § 37.7 if the floor

broker or floor trader is registered in

such a capacity under the Act and its

trading obligations on the derivatives

trading facility are guaranteed by a

futures commission merchant.

(2) ‘‘Eligible commercial participant’’

means, and shall be limited to, a party

or entity listed in §§ 35.1(b)(1), (b)(2),

(b)(3), (b)(6) and (b)(8) of this chapter

that in connection with its business,

makes and takes delivery of the

underlying commodity and regularly

incurs risks in addition to price risk

related to such commodity, is a dealer

that regularly provides hedging, risk

management or market-making services

to the foregoing entities, or is a

registered floor trader or floor broker

trading for its own account, whose

trading obligations are guaranteed by a

futures commission merchant.

§ 37.2 Exemption.

Notwithstanding § 37.1(a)(1), a

contract, agreement or transaction

traded on a multilateral transaction

execution facility as defined in § 36.1(b)

of this chapter, the facility and the

facility’s operator are exempt from all

provisions of the Act and from all

Commission regulations thereunder for

such activity, except for those

provisions of the Act and Commission

regulations which, as a condition of this

exemption, are reserved in § 37.8(a),

provided the following terms and

conditions are met:

(a)(1) Commercial-participant

derivatives transaction facility. Only

eligible commercial participants trading

for their own account have trading

access to the derivatives transaction

facility for contracts, agreements or

transactions in any commodity except

for those listed in section 1a(3) of the

Act or an exempted security under

section 3 of the Securities Act of 1933

or section 3(a)(12) of the Securities

Exchange Act of 1934; or

(2)(i) Eligible-participant derivatives

transaction facility. The contract,

agreement or transaction listed on or

traded through the multilateral

transaction execution facility meets the

requirements set forth in § 36.2(b) of this

chapter or has been found by the

Commission on a case-by-case

determination to have a sufficiently

liquid and deep cash market and a

surveillance history based on actual

trading experience to provide assurance

that the contract is highly unlikely to be

manipulated; and

(ii) Non-eligible participants.

Participants that are not eligible

participants as defined in § 37.1(b)(1)

may have trading access only through:

(A) A registered futures commission

merchant that operates in accordance

with the provisions of § 1.17(a)(1)(ii) of

this chapter and that carries such

participant’s account, including access

directly through any credit filter on

which the futures commission merchant

affirmatively imposes credit standards;

or

(B) A commodity trading advisor that

operates in accordance with § 4.32 of

this chapter, where the participant’s

account is carried by any registered

futures commission merchant;

(b) The multilateral transaction

execution facility through which the

contract, agreement or transaction is

entered into has been recognized by the

Commission as a derivatives transaction

facility pursuant to § 37.7;

(c) A multilateral transaction

execution facility that applies to be, and

is, a recognized derivatives transaction

facility must comply with all of the

conditions of this part 37 exemption

and must disclose to participants

transacting on or through its facility that

transactions conducted on or through

the facility are subject to the provisions

of this part 37;

(d)(1) If intermediated, the

transactions of eligible participants

must be carried in accounts at a

registered futures commission

merchant;

(2) If cleared, the submission of such

contracts, agreements or transactions for

clearance and/or settlement must be to

a clearinghouse that is recognized by the

Commission under § 39.4 of this

chapter. Provided, however, that nothing

in this paragraph (d)(2) precludes:

(i) Arrangements or facilities between

parties to such contracts, agreements or

transactions that provide for netting of

payment or delivery obligations

resulting from such contracts,

agreements, or transactions; or

(ii) Arrangements or facilities among

parties to such contracts, agreements or

transactions, that provide for netting of

payments or deliveries resulting from

such contracts, agreements or

transactions; and

(e) The products if traded on an

electronic system must be clearly

identified as traded on a recognized

derivatives transaction facility or if

traded in a physical trading

environment must be traded in a

location separate from, but which may

adjoin the location for, the trading of

products pursuant to contract market

designation, or to parts 36 and 38 of this

chapter.

§ 37.3 General conditions for recognition

as a derivatives transaction facility.

To be recognized as a derivatives

transaction facility, the facility initially

must have:

(a) Rules, which may be trading

protocols, relating to trading on its

facility, including, depending on the

nature of the trading mechanism:

(1) Rules, which may be trading

protocols, to deter trading abuses, and

adequate power and capacity to detect,

investigate and take action against

violation of its trade rules or trading

protocols including arrangements to

obtain necessary information to perform

the functions in this paragraph (a)(1), or

(2) Use of technology that provides

participants with impartial access to

transactions and captures information

that is available for use in determining

whether violations of its rules or trading

protocols have occurred;

(b) Rules, which may be trading

protocols, defining, or specifications

detailing, the operation of the trading

mechanism or electronic matching

platform; and

(c) Rules, which may be trading

protocols, detailing the financial

framework applying to the transactions

or ensuring the financial integrity of

transactions entered into by, or through,

its facilities.

77984 Federal Register / Vol. 65, No. 240 / Wednesday, December 13, 2000 / Rules and Regulations

§ 37.4 Conditions for recognition as a

derivatives transaction facility, compliance

with core principles.

To be recognized as a derivatives

transaction facility, the facility, initially

and on a continuing basis, must meet

and adhere to the following core

principles:

(a) Enforcement. Effectively monitor

and enforce its rules, which may be

trading protocols, including, if

applicable, limitations on access.

(b) Market oversight. As appropriate

to the market and the contracts traded:

(1) Monitor markets on a routine and

nonroutine basis as necessary to ensure

fair and orderly trading, and have, and

where appropriate exercise, authority to

maintain a fair and orderly market; or

(2) Provide information to the

Commission as requested by the

Commission to satisfy its obligations

under the Act.

(c) Operational information. Disclose

to regulators and to market participants,

as appropriate, information concerning

trading terms, trading protocols,

contract terms and conditions, trading

mechanisms, financial integrity

arrangements or mechanisms, as well as

other relevant information.

(d) Transparency. Provide to market

participants on a fair, equitable and

timely basis information regarding

prices, bids and offers, and other

information appropriate to the market

and, as appropriate to the market, make

available to the public with respect to

actively traded products, to the extent

applicable, information regarding daily

opening and closing prices, price range,

trading volume and other related market

information.

(e) Fitness. Have appropriate fitness

standards for members, operators or

owners with greater than 10 percent

interest or an affiliate of such an owner,

members of the governing board, and

those who make disciplinary

determinations.

(f) Recordkeeping. Keep full books

and records of all activities related to its

business as a recognized derivatives

transaction facility, including full

information relating to data entry and

trade details sufficient to reconstruct

trading, in a form and manner

acceptable to the Commission for a

period of five years, during the first two

of which the books and records are

readily available, and which shall be

open to inspection by any representative

of the Commission or the U.S.

Department of Justice.

(g) Competition. Operate in a manner

consistent with the public interest to be

protected by the antitrust laws.

§ 37.5 Additional conditions for

recognition as a derivative transaction

facility.

To be recognized as a derivatives

transaction facility, initially and on a

continuing basis, the facility must:

(a) Products. Notwithstanding the

provisions of section 4(a)(1) of the Act

or § 33.2 of this chapter, notify the

Commission of the listing of new

contracts for trading, posting of new

product descriptions, terms and

conditions or trading protocols or

providing for a new system product

functionality, by filing with the

Commission at its Washington, D.C.

headquarters, a submission labeled

‘‘DTF Notice of Product Listing’’ that

includes the text of the contract’s terms

or conditions, product description,

trading protocol or description of the

system functionality or by electronic

notification of the foregoing at the time

traders or participants in the market are

notified, but in no event later than the

close of business on the business day

preceding initial listing, posting or

implementation of the trading protocol

or system functionality;

(b) Material modifications.

Notwithstanding the rule approval and

filing requirements of section

5a(a)(12)(A) of the Act, notify the

Commission prior to placing a material

rule, term or condition or trading

protocol into effect or amending a

material rule, term or condition or

trading protocol, by filing with the

Commission at its Washington, D.C.

headquarters a submission labeled,

‘‘DTF Rule Notice’’ which includes the

text of the rule or rule amendment, term

and condition or trading protocol

(brackets must indicate words deleted

and underscoring must indicate words

added) or by electronic notification of

the rule, term and condition or trading

protocol to be placed into effect or to be

changed, at the time and in the manner

traders or participants in the market are

notified, but in no event later than the

close of business on the business day

preceding implementation of the rule,

term and condition or trading protocol.

The derivatives transaction facility must

maintain documentation regarding all

changes to rules, terms and conditions

or trading protocols;

(c) Identify participants. Keep a

record in permanent form which shall

show the true name; address; and

principal occupation or business of any

foreign trader executing transactions on

the facility or exchange, as well as the

name of any person guaranteeing such

transactions or exercising any control

over the trading of such foreign trader.

Provided, however, this paragraph shall

not apply to a derivatives transactions

facility insofar as transactions in futures

or option contracts of foreign traders are

executed through and the resulting

transactions are maintained in accounts

carried by a registered futures

commission merchant or introducing

broker subject to § 1.37 of this chapter;

and

(d) Identify persons subject to fitness.

Upon request by the Commission,

furnish to the Commission a current list

of persons subject to the fitness

requirements in accordance with

§ 37.4(e).

§ 37.6 Information relating to transactions

on derivative transaction facilities.

(a) Special calls for information from

derivatives transaction facilities. Upon

special call by the Commission, a

derivatives transaction facility shall

provide to the Commission such

information related to its business as a

derivatives transaction facility,

including information relating to data

entry and trade details, in the form and

manner and within the time as specified

by the Commission in the special call.

(b) Notification of communications.

(1) Upon receipt of any communications

issued by or on behalf of the

Commission to any person who resides

or is domiciled outside of the United

States, its territories, or possessions,

relating to contracts, agreements, or

transactions effected on or through a

derivatives transaction facility, the

derivatives transaction facility shall

promptly notify such foreign person of,

and transmit the communication to such

foreign person, in a manner reasonable

under the circumstances, or as specified

by the Commission.

(2) If the Commission has reason to

believe that a person has not complied

with a communication issued by or on

behalf of the Commission pursuant to

paragraph (b)(1) of this section, the

Commission in writing may direct the

derivatives transaction facility on or

through which the person is or has

traded to deny that person further

trading access either directly or, if

applicable, through an intermediary or,

as applicable, to permit that person

access to trade for liquidation only.

(3) Any person that believes he or she

is or may be adversely affected or

aggrieved by action taken by the

Commission under paragraph (b)(2) of

this section, shall have the opportunity

for a prompt hearing after the

Commission acts pursuant to paragraph

(b)(2) of this section under the

procedures provided in § 21.03(g) of this

chapter.

(c) Special calls for information from

futures commission merchants. Upon

special call by the Commission, each

Federal Register / Vol. 65, No. 240 / Wednesday, December 13, 2000 / Rules and Regulations 77985

person registered as a futures

commission merchant that carries or has

carried an account for a customer on a

derivatives transaction facility shall

provide information to the Commission

concerning such accounts or related

positions carried for the customer on

that or other facilities or markets, in the

form and manner and within the time

specified by the Commission in the

special call.

(d) Special calls for information from

participants. Upon special call by the

Commission, any person who enters

into or has entered into a contract,

agreement or transaction on a

derivatives transaction facility eligible

under § 37.2(a)(2) shall provide

information to the Commission

concerning such contracts, agreements,

or transactions or related positions on

other facilities or markets, in the form

and manner and within the time

specified by the Commission in the

special call.

(e) Delegation of authority. The

Commission hereby delegates, until the

Commission orders otherwise, the

authority set forth in paragraphs (a)

through (d) of this section to the

Directors of the Division of Economic

Analysis and the Division of Trading

and Markets to be exercised separately

by each Director or by such other

employee or employees as the Director

may designate from time to time. The

Director of the Divisions of Economic

Analysis and Trading and Markets may

submit to the Commission for its

consideration any matter that has been

delegated in this paragraph. Nothing in

this paragraph prohibits the

Commission, at its election, from

exercising the authority delegated in

this paragraph.

§ 37.7 Procedures for recognition.

(a) Recognition by certification. A

board of trade, facility or entity that is

designated under sections 4c, 5, 5a(a) or

6 of the Act as a contract market in at

least one commodity which is not

dormant within the meaning of § 5.2 of

this chapter will be recognized by the

Commission as a derivatives transaction

facility upon receipt by the Commission

at its Washington, D.C. headquarters of

a copy of the derivatives transaction

facility’s rules, which may be trading

protocols, and a certification by the

board of trade, facility or entity that it

meets the conditions for recognition

under this part.

(b) Recognition by application. A

board of trade, facility or entity shall be

recognized or, as determined by the

Commission, recognized upon

conditions as a derivatives transaction

facility thirty days after receipt by the

Commission of an application for

recognition as a derivatives transaction

facility unless notified otherwise during

that period, if:

(1) The application demonstrates that

the applicant satisfies the conditions for

recognition under this part;

(2) The submission is labeled as being

submitted pursuant to this part 37;

(3) The submission includes a copy

of:

(i) The derivatives transaction

facility’s rules, which may be trading

protocols;

(ii) Any agreements entered into or to

be entered into between or among the

facility, its operator or its participants,

technical manuals and other guides or

instructions for users of such facility,

descriptions of any system test

procedures, tests conducted or test

results, and descriptions of the trading

mechanism or algorithm used or to be

used by such facility, to the extent such

documentation was otherwise prepared;

and

(iii) To the extent that compliance

with the conditions of recognition is not

self-evident, a brief explanation of how

the rules or trading protocols satisfy

each of the conditions for recognition

under §§ 37.3 and 37.4;

(4) The applicant does not amend or

supplement the application for

recognition, except as requested by the

Commission or for correction of

typographical errors, renumbering or

other nonsubstantive revisions, during

that period; and

(5) The applicant has not instructed

the Commission in writing during the

review period to review the application

pursuant to procedures under section 6

of the Act.

(6) Appendix A to this part provides

guidance to applicants on how the

conditions for recognition enumerated

in §§ 37.3 and 37.4 could be satisfied.

(c) Termination of part 37 review.

During the thirty-day period for review

pursuant to paragraph (b) of this section,

the Commission shall notify the

applicant seeking recognition that the

Commission is terminating review

under this section and will review the

proposal under the procedures of

section 6 of the Act, if it appears that the

application fails to meet the conditions

for recognition under this part. This

termination notification will state the

nature of the issues raised and the

specific condition of recognition that

the application appears to violate, is

contrary to or fails to meet. Within ten

days of receipt of this termination

notification, the applicant seeking

recognition may request that the

Commission render a decision whether

to recognize the derivatives transaction

facility or to institute a proceeding to

disapprove the proposed submission

under procedures specified in section 6

of the Act by notifying the Commission

that the applicant seeking recognition

views its submission as complete and

final as submitted.

(d) Delegation of authority. (1) The

Commission hereby delegates, until it

orders otherwise, to the Directors of the

Division of Trading and Markets and the

Division of Economic Analysis or their

delegatees, with the concurrence of the

General Counsel or the General

Counsel’s delegatee, authority to notify

the entity seeking recognition under

paragraph (b) of this section that review

under those procedures is being

terminated or to recognize the entity as

a derivatives transaction facility upon

conditions.

(2) The Directors of the Division of

Trading and Markets or the Division of

Economic Analysis may submit to the

Commission for its consideration any

matter which has been delegated in this

paragraph.

(3) Nothing in the paragraph prohibits

the Commission, at its election, from

exercising the authority delegated in

paragraph (d)(1) of this section.

(e) Request for Commission approval

of rules and products. (1) An entity

seeking recognition as a derivatives

transaction facility may request that the

Commission approve any or all of its

rules and subsequent amendments

thereto, including both operational rules

and the terms or conditions of products

listed for trading on the facility, at the

time of recognition or thereafter, under

section 5a(a)(12) of the Act and

§§ 1.41(d) and 5.2 of this chapter, as

applicable. A derivatives transaction

facility may label a product in its rules

as, ‘‘Listed for trading pursuant to

Commission approval,’’ if the product’s

terms or conditions have been approved

by the Commission.

(2) An entity seeking recognition as a

derivatives transaction facility may

request that the Commission consider

under the provisions of section 15 of the

Act any of the entity’s rules or policies,

including both operational rules and the

terms or conditions of products listed

for trading, at the time of recognition or

thereafter.

(f) Request for withdrawal of

application for recognition or

withdrawal of recognition. A recognized

derivatives transaction facility may

withdraw an application to be a

recognized derivatives transaction

facility or, once recognized, may

withdraw from Commission recognition

by filing with the Commission at its

Washington, D.C., headquarters such a

request. Withdrawal from recognition

77986 Federal Register / Vol. 65, No. 240 / Wednesday, December 13, 2000 / Rules and Regulations

shall not affect any action taken or to be

taken by the Commission based upon

actions, activities or events occurring

during the time that the facility was

recognized by the Commission.

§ 37.8 Enforceability.

(a) Notwithstanding the exemption in

§ 37.2, the following provisions of the

Act and Commission regulations

thereunder are reserved, and shall

continue to apply: sections 1a, 2(a)(1), 4,

4b, 4c(a) as applicable to the market,

4c(b), 4g, 4i, 4o, 5(6), 5(7), 5a(a)(1),

5a(a)(2), 5a(a)(8), 5a(a)(16), 5a(a)(17),

5a(b), 6(a), 6(c) to the extent it prohibits

manipulation of the market price of any

commodity in interstate commerce or

for future delivery on or subject to the

rules of any contract market, 8a(9), 8c(a)

as applicable to the market, 9(a)(2),

9(a)(3), 9(f), 14, 15, 20 and 22 of the Act

and §§ 1.3, 1.31, 1.41, 5.2, 15.05 as

applicable to the market, § 33.10, this

part 37 and part 190 of this chapter; and

for derivatives transaction facilities

eligible under § 37.2(a)(2), in addition to

the foregoing, the rule disapproval

procedures of section 5a(a)(12) of the

Act, section 9(a)(1) of the Act, and

sections 8c(b), 8c(c) and 8c(d) of the Act

and parts 15 through 21 of this chapter

as applicable to the market.

(b) For purposes of section 22(a) of the

Act, a party to a contract, agreement or

transaction is exempt from a claim that

the contract, agreement or transaction is

void, voidable, subject to rescission or

otherwise invalidated or rendered

unenforceable solely for failure of the

parties to a contract, agreement or

transaction, or the contract, agreement

or transaction itself, to comply with the

terms and conditions for the exemption

under this part or as a result of:

(1) A violation by the recognized

derivatives transaction facility of the

provisions of this part 37; or

(2) Any Commission proceeding to

disapprove a rule, term or condition

under section 5a(a)(12) of the Act, to

alter or supplement a rule, term or

condition under section 8a(7) of the Act,

to declare an emergency under section

8a(9) of the Act, or any other proceeding

the effect of which is to disapprove,

alter, supplement, or require a

recognized derivatives transaction

facility to adopt a specific term or

condition, trading rule or procedure, or

to take or refrain from taking a specific

action.

§ 37.9 Fraud in connection with part 37

transactions.

It shall be unlawful for any person,

directly or indirectly, in or in

connection with an offer to enter into,

the entry into, the confirmation of the

execution of, or the maintenance of any

transaction entered into pursuant to this

part—

(1) To cheat or defraud or attempt to

cheat or defraud any person;

(2) Willfully to make or cause to be

made to any person any false report or

statement thereof or cause to be entered

for any person any false record thereof;

or

(3) Willfully to deceive or attempt to

deceive any person by any means

whatsoever.

Appendix A to Part 37—Application

Guidance

This appendix provides guidance to

applicants for recognition as derivatives

transaction facilities under §§ 37.3 and 37.4.

Addressing the issues and questions set forth

in this appendix would help the Commission

in its consideration of whether the

application has met the conditions for

recognition. To the extent that compliance

with, or satisfaction of, a core principle is not

self-explanatory from the face of the

derivatives transaction facilities rules or

terms, the application should include an

explanation or other form of documentation

demonstrating that the applicant meets the

conditions for recognition.

Core Principle 1: Enforcement: Effectively

monitor and enforce its rules, which may be

trading protocols, including, if applicable,

limitations on access.

(a) A derivatives transaction facility should

have arrangements and resources and

authority for effectively and affirmatively

enforcing its rules, including the authority

and ability to collect or capture information

and documents on both a routine and nonroutine basis and to investigate effectively

possible rule violations.

(b) This should include the authority and

ability to discipline, and limit or suspend a

member’s or participant’s activities and/or

the authority and ability to terminate a

member’s or participant’s activities or access

pursuant to clear and fair standards.

Core Principle 2: Market Oversight. As

appropriate to the market and the contracts

traded: (1) Monitor markets on a routine and

nonroutine basis as necessary to ensure fair

and orderly trading, and have, and where

appropriate exercise, authority to maintain a

fair and orderly market; or (2) Provide

information to the Commission as requested

by the Commission to satisfy its obligations

under the Act.

(a) Arrangements and resources for

effective market surveillance programs

should facilitate, on both a routine and

nonroutine basis, direct supervision of the

market. Appropriate objective testing and

review of any automated systems should

occur initially and periodically to ensure

proper system functioning, adequate capacity

and security. The analysis of data collected

should be suitable for the type of information

collected and should occur in a timely

fashion. A derivatives transaction facility

should have the authority to collect the

information and documents necessary to

reconstruct trading for appropriate market

analysis as it carries out its market

surveillance programs. The derivatives

transaction facility also should have the

authority to intervene as necessary to

maintain an open and competitive market. In

carrying out this responsibility, the facility

should address access to, and use of, material

non-public information by members, owners

or operators, participants or facility

employees.

(b) Alternatively, and as appropriate to the

market, a derivatives transaction facility may

choose to satisfy Core Principle 2 by

providing information to the Commission as

requested by the Commission to satisfy its

obligations under the Act. The derivatives

transaction facility should have the authority

to collect or capture and retrieve all

necessary information.

(c) The Commission will collect reporting

data from eligible participants trading in a

derivatives transaction facility eligible under

§ 37.2(a)(2) only upon Special Call as

provided in § 37.6(d).

Core Principle 3: Operational Information:

Disclose to regulators and to market

participants, as appropriate, information

concerning trading terms, trading protocols,

contract terms and conditions, trading

mechanisms, financial integrity

arrangements or mechanisms, as well as

other relevant information.

A derivatives transaction facility should

have arrangements and resources for the

disclosure and explanation of trading terms,

trading protocols, contract terms and

conditions, trading mechanisms, system

functioning, system capacity, system

security, system testing and review, financial

integrity arrangements or mechanisms. The

facility must also disclose any limitations of

liability (which may not include limitations

of liability for violations of the Act or

Commission rules, fraud, or wanton or

willful misconduct. Such information may be

made publicly available through the

operation of a website by the derivatives

transaction facility.

Core Principle 4: Transparency: Provide to

market participants on a fair, equitable and

timely basis information regarding prices,

bids and offers, and other information

appropriate to the market and, as

appropriate to the market, make available to

the public with respect to actively traded

products, to the extent applicable,

information regarding daily opening and

closing prices, price range, trading volume

and other related market information.

All market participants should have

information regarding prices, bids and offers,

or other information appropriate to the

market readily available on a fair and

equitable basis. The derivatives transaction

facility should provide to the public

information regarding daily opening and

closing prices, price range, trading volume,

open interest and other related market

information for actively traded products.

Provision of information could be through

such means as provision of the information

to a financial information service or by

placement of the information on a facility’s

web site.

Core Principle 5: Fitness: Have appropriate

fitness standards for members, operators or

Federal Register / Vol. 65, No. 240 / Wednesday, December 13, 2000 / Rules and Regulations 77987

owners with greater than 10 percent interest

or an affiliate of such an owner, members of

the governing board, and those who make

disciplinary determinations.

A derivatives transaction facility should

have appropriate eligibility criteria for the

categories of persons set forth in the Core

Principle which would include standards for

fitness and for the collection and verification

of information supporting compliance with

such standards. Minimum standards of

fitness are those bases for refusal to register

a person under section 8a(2) of the Act. or

a history of serious disciplinary offenses,

such as those which would be disqualifying

under § 1.63 of this chapter. A demonstration

of the fitness of the applicant’s members,

operators or owners may include providing

the Commission with registration

information for such persons, certification to

the fitness of such persons, an affidavit of

such persons’ fitness by the facility’s Counsel

or other information substantiating the

fitness of such persons.

Core Principle 6: Recordkeeping: Keep full

books and records of all activities related to

its business as a recognized derivatives

transaction facility, including full

information relating to data entry and trade

details sufficient to reconstruct trading, in a

form and manner acceptable to the

Commission for a period of five years, during

the first two of which the books and records

are readily available, and which shall be

open to inspection by any representative of

the Commission or the U.S. Department of

Justice.

Commission rule 1.31 constitutes the

acceptable practice regarding the form and

manner for keeping records.

Core Principle 7: Competition: Operate in

a manner consistent with the public interest

to be protected by the antitrust laws.

An entity seeking recognition as a

derivatives transaction facility may request

that the Commission consider under the

provisions of section 15 of the Act any of the

entity’s rules, which may be trading

protocols or policies, and including both

operational rules and the terms or conditions

of products listed for trading, at the time of

recognition or thereafter. The Commission

intends to apply Section 15 of the Act to its

consideration of issues under the

Competition Core Principle in a manner

consistent with that previously applied to

contract markets.

10. Chapter I of 17 CFR is amended

by adding new Part 38 as follows:

PART 38—EXEMPTION OF

TRANSACTIONS ON A RECOGNIZED

FUTURES EXCHANGE

Sec.

38.1 Scope.

38.2 Exemption.

38.3 General conditions for recognition as a

recognized futures exchange.

38.4 Conditions for recognition as a

recognized futures exchange, compliance

with core principles.

38.5 Procedures for recognition.

38.6 Enforceability

38.7 Fraud in connection with part 38

transactions.

Appendix A to Part 38—Guidance for

Applicants and Acceptable Practices

Authority: 7 U.S.C. 2, 6, 6c, and 12a.

§ 38.1 Scope.

(a) Except for commodities subject to

paragraph (c) of this section, the

provisions of the exemption in § 38.2

shall apply to every board of trade that

has been designated as a contract market

in a commodity under section 6 of the

Act. Provided, however, nothing in this

provision affects the eligibility of

designated contract markets for

exemption under parts 36 or 37 of this

chapter.

(b) A board of trade operating as a

recognized futures exchange and the

products listed for trading thereon

under this exemption shall be deemed

to be subject to all of the provisions of

the Act and Commission regulations

thereunder which are applicable to a

‘‘board of trade,’’ ‘‘board of trade

licensed by the Commission,’’

‘‘exchange,’’ ‘‘contract market,’’

‘‘designated contract market,’’ or

‘‘contract market designated by the

Commission’’ as though those

provisions were set forth in this section

and included specific reference to

contracts listed for trading by

recognized futures exchanges pursuant

to this section.

(c) The provisions of this section shall

not apply to a commodity or a contract

subject to the provisions of section

2(a)(1)(B) of the Act.

§ 38.2 Exemption.

Notwithstanding § 38.1(b), a contract,

agreement or transaction traded on a

multilateral transaction execution

facility as defined in § 36.1(b) of this

chapter, the facility and the facility’s

operator is exempt from all provisions

of the Act and from all Commission

regulations thereunder for such activity,

except for those provisions of the Act

and Commission regulations which, as a

condition of this exemption, are

reserved in § 38.6(a), provided the

following terms and conditions are met:

(a) The multilateral transaction

execution facility on which the contract,

agreement or transaction is entered into

has been recognized by the Commission

as a recognized futures exchange

pursuant to § 38.5;

(b) A multilateral transaction

execution facility that applies to be, and

is, a recognized futures exchange must

comply with all of the conditions of this

part 38 exemption and must disclose to

participants transacting on or through

its facilities that transactions conducted

on or through the facility are subject to

the provisions of part 38;

(c)(1) If intermediated, the

transactions of participants must be

carried in accounts at a registered

futures commission merchant;

(2) If cleared, the submission of such

contracts, agreements or transactions for

clearance and/or settlement must be to

a clearinghouse which is recognized by

the Commission under part 39 of this

chapter. Provided, however, that nothing

in this paragraph precludes:

(i) Arrangements or facilities between

parties to such contracts, agreements or

transactions that provide for netting of

payment or delivery obligations

resulting from such agreements; or

(ii) Arrangements or facilities among

parties to such contracts, agreements or

transactions, that provide for netting of

payments or deliveries resulting from

such agreements; and

(d) The products if traded on an

electronic system must be clearly

identified as traded on a recognized

futures exchange or if traded in a

physical trading environment must be

traded in a location separate from, but

which may adjoin the location for, the

trading of products pursuant to parts 36

and 37 of this chapter;

§ 38.3 General conditions for recognition

as a recognized futures exchange.

To be recognized as a recognized

futures exchange, the exchange must

demonstrate initially that it has:

(a) A clear framework for conducting

programs of market surveillance,

compliance, and enforcement, including

having procedures in place to make use

of collected data for real-time

monitoring and for post-event audit and

compliance purposes to prevent market

manipulation;

(b) Rules relating to trading on the

exchange, including rules to deter

trading abuses, and adequate power and

capacity to detect, investigate and take

action against violations of its trading

rules, and a dedicated regulatory

department or delegation of that

function to an appropriate entity;

(c) Rules defining, or specifications

detailing, the manner of operation of the

trading mechanism or electronic

matching platform and a trading

mechanism or electronic matching

platform that performs as articulated in

the operational rules or specifications;

(d) A clear framework for ensuring the

financial integrity of transactions

entered into by or through the exchange;

(e) Established procedures for

impartial disciplinary committee(s) or

other similar mechanisms empowered

to discipline, suspend, and expel

members, or to deny access to

participants or, if provided for,

discipline participants; and

77988 Federal Register / Vol. 65, No. 240 / Wednesday, December 13, 2000 / Rules and Regulations

(f) Arrangements to obtain necessary

information to perform the functions in

this section, including the capacity and

arrangements to share financial and

surveillance information with other

derivative exchanges, both domestic and

international, and a mechanism to

provide to the public ready access to its

rules and regulations.

§ 38.4 Conditions for recognition as a

recognized futures exchange, compliance

with core principles.

To be recognized as a futures

exchange, the exchange initially, and on

a continuing basis, must meet and

adhere to the following core principles:

(a) Rule enforcement. Effectively

monitor and enforce its rules.

(b) Products. List contracts for trading

that are not readily susceptible to

manipulation.

(c) Position monitoring and reporting.

Monitor markets on a routine and

nonroutine basis as necessary to prevent

manipulation, price distortion, and

disruptions of the delivery or cash

settlement process.

(d) Position limits. Adopt position

limits on trading where necessary and

appropriate to lessen the threat of

market manipulation or congestion

during delivery months.

(e) Emergency authority. Exercise

authority to intervene to maintain fair

and orderly trading, including, where

applicable, authority to liquidate or

transfer open positions, to require the

suspension or curtailment of trading,

and to require the posting of additional

margin.

(f) Public information. Make

information concerning the contract

terms and conditions and the trading

mechanism, as well as other relevant

information, readily available to market

authorities, users and the public.

(g) Transparency. Provide market

participants on a fair, equitable and

timely basis information regarding, as

appropriate to the market, prices, bids

and offers, and other appropriate

information, and make available to the

public information regarding daily

opening and closing prices, price

ranges, trading volume, open interest

and other related market information.

(h) Trading system. Provide a

competitive, open and efficient market.

(i) Audit trail. Have procedures to

ensure the recording of full data entry

and trade details sufficient to

reconstruct trading, the quality of the

data captured, and the safe storage of

such information, and have systems to

enable information to be used in

assisting in detecting and deterring

customer and market abuse.

(j) Financial standards. Have,

monitor, and enforce rules regarding the

financial integrity of the transactions

that have been executed on the

exchange and, where intermediaries are

permitted, rules addressing the financial

integrity of the intermediary and the

protection of customer funds, as

appropriate, and a program to enforce

those requirements.

(k) Customer protection. Have,

monitor and enforce rules for customer

protection.

(l) Dispute resolution. Provide for

alternative dispute resolution

mechanisms appropriate to the nature of

the market.

(m) Governance. Have fitness

standards for members, owners or

operators with greater than ten percent

interest or an affiliate of such an owner,

members of the governing board, and

those who make disciplinary

determinations. The recognized futures

exchange must have a means to address

conflicts of interest in making decisions

and access to, and use of, material nonpublic information by the foregoing

persons and by exchange employees.

For mutually owned futures exchanges,

the composition of the governing board

must reflect market participants.

(n) Recordkeeping. Keep full books

and records of all activities related to its

business as a recognized futures

exchange in a form and manner

acceptable to the Commission for a

period of five years, during the first two

of which the books and records are

readily available, and which shall be

open to inspection by any representative

of the Commission or the U.S.

Department of Justice.

(o) Competition. Operate in a manner

consistent with the public interest to be

protected by the antitrust laws.

§ 38. 5 Procedures for recognition.

(a) Recognition by prior designation.

A board of trade, facility or entity that

is designated under sections 4c, 5, 5a(a)

or 6 of the Act as a contract market on

February 12, 2001 in at least one

commodity which is not dormant

within the meaning of § 5.3 of this

chapter is recognized by the

Commission as a recognized futures

exchange and each of the contracts

traded thereon that has been designated

by the Commission as a designated

contract market in a commodity may be

labeled in the recognized futures

exchange’s rules as listed for trading

pursuant to Commission approval.

(b) Recognition by application. A

board of trade, facility or entity shall be

recognized or, as determined by the

Commission, recognized upon

conditions as a recognized futures

exchange sixty days after receipt by the

Commission of an application for

recognition unless notified otherwise

during that period, if:

(1) The application demonstrates that

the applicant satisfies the conditions for

recognition under this part;

(2) The submission is labeled as being

submitted pursuant to this part 38;

(3) The submission includes a copy of

the applicant’s rules and, to the extent

that compliance with the conditions for

recognition is not self-evident, a brief

explanation of how the rules satisfy

each of the conditions for registration

under §§ 38.3 and 38.4;

(4) The applicant does not amend or

supplement the application for

recognition, except as requested by the

Commission or for correction of

typographical errors, renumbering or

other nonsubstantive revisions, during

that period; and

(5) The applicant has not instructed

the Commission in writing during the

review period to review the application

pursuant to procedures under section 6

of the Act.

(6) Appendix A to this part provides

guidance to applicants on how the

conditions for recognition enumerated

in §§ 38.3 and 38.4 could be satisfied.

(c) Termination of part 38 review.

During the sixty-day period for review

pursuant to paragraph (b) of this section,

the Commission shall notify the

applicant seeking recognition that the

Commission is terminating review

under this section and will review the

proposal under the procedures of

section 6 of the Act, if it appears that the

application fails to meet the conditions

for recognition under this part. This

termination notification will state the

nature of the issues raised and the

specific condition of recognition that

the application appears to violate, is

contrary to or fails to meet. Within ten

days of receipt of this termination

notification, the applicant seeking

recognition may request that the

Commission render a decision whether

to recognize the futures exchange or to

institute a proceeding to disapprove the

proposed submission under procedures

specified in section 6 of the Act by

notifying the Commission that the

applicant seeking recognition views its

submission as complete and final as

submitted.

(d) Delegation of authority. (1) The

Commission hereby delegates, until it

orders otherwise, to the Directors of the

Division of Trading and Markets and the

Division of Economic Analysis or their

delegatees, with the concurrence of the

General Counsel or the General

Counsel’s delegatee, authority to notify

the entity seeking recognition under

paragraph (b) of this section that review

under those procedures is being

Federal Register / Vol. 65, No. 240 / Wednesday, December 13, 2000 / Rules and Regulations 77989

terminated or to recognize the entity as

a recognized futures exchange upon

conditions.

(2) The Directors of the Division of

Trading and Markets or the Division of

Economic Analysis may submit to the

Commission for its consideration any

matter which has been delegated in this

paragraph.

(3) Nothing in the paragraph prohibits

the Commission, at its election, from

exercising the authority delegated in

paragraph (d)(1) of this section.

(e) Request for Commission approval

of rules and products. (1) An entity

seeking recognition as a recognized

futures exchange may request that the

Commission approve any or all of its

rules and subsequent amendments

thereto, including both operational rules

and the terms or conditions of products

listed for trading on the exchange, at the

time of recognition or thereafter, under

section 5a(a)(12) of the Act and §§ 1.41

and 5.2 of this chapter, as applicable. A

product the terms or conditions of

which have been approved by the

Commission may be labeled in its rules

as listed for trading pursuant to

Commission approval. In addition, rules

of the recognized futures exchange not

submitted pursuant to § 38.5(b)(3) shall

be submitted to the Commission

pursuant to § 1.41.

(2) An entity seeking recognition as a

recognized futures exchange may

request that the Commission consider

under the provisions of section 15 of the

Act any of the entity’s rules or policies,

including both operational rules and the

terms or conditions of products listed

for trading, at the time of recognition or

thereafter.

(f) Request for withdrawal of

application for recognition or

withdrawal of recognition. An entity

may withdraw an application to be a

recognized futures exchange or once

recognized, may withdraw from

Commission recognition by filing with

the Commission at its Washington, D.C.

headquarters such a request.

Withdrawal from recognition shall not

affect any action taken or to be taken by

the Commission based upon actions,

activities or events occurring during the

time that the exchange was recognized

by the Commission.

§ 38.6 Enforceability.

(a) Notwithstanding the exemption in

§ 38.2, the following provisions of the

Act and the Commission’s regulations

thereunder are reserved and shall

continue to apply, as applicable:

sections 1a, 2(a)(1), 4, 4a, 4b, 4c, 4g, 4i,

4o, 5(6), 5(7), 5a(a)(1), 5a(a)(2), 5a(a)(8),

the rule disapproval procedures of

5a(a)(12), 5a(a)(16), 5a(a)(17), 5a(b), 6(a),

6(c) to the extent it prohibits

manipulation of the market price of any

commodity in interstate commerce or

for future delivery on or subject to the

rules of any contract market, 8a(7),

8a(9), 8c(a), 8c(b), 8c(c), 8c(d), 9(a), 9(f),

14, 15, 20 and 22 of the Act and §§ 1.3,

1.31, 1.38, 1.41, 33.10, part 5, part 9,

parts 15 through 21, part 38 and part

190 of this chapter.

(b) For purposes of section 22(a) of the

Act, a party to a contract, agreement or

transaction is exempt from a claim that

the contract, agreement or transaction is

void, voidable, subject to rescission or

otherwise invalidated or rendered

unenforceable as a result of:

(1) A violation by the recognized

futures exchange of the provisions of

this part 38; or

(2) Any Commission proceeding to

disapprove a rule, term or condition

under section 5a(a)(12) of the Act, to

alter or supplement a rule, term or

condition under section 8a(7) of the Act,

to declare an emergency under section

8a(9) of the Act, or any other proceeding

the effect of which is to disapprove,

alter, supplement, or require a

recognized futures exchange to adopt a

specific term or condition, trading rule

or procedure, or to take or refrain from

taking a specific action.

§ 38.7 Fraud in connection with part 38

transactions.

It shall be unlawful for any person,

directly or indirectly, in or in

connection with an offer to enter into,

the entry into, the confirmation of the

execution of, or the maintenance of any

transaction entered pursuant to this

part:

(a) To cheat or defraud or attempt to

cheat or defraud any person;

(b) Willfully to make or cause to be

made to any person any false report or

statement thereof or cause to be entered

for any person any false record thereof;

or

(c) Willfully to deceive or attempt to

deceive any person by any means

whatsoever.

Appendix A to Part 38—Guidance for

Applicants and Acceptable Practices

1. This appendix provides guidance and

acceptable practices for the core principles

found in Part 38. Guidance to applicants for

recognition as recognized futures exchanges

under §§ 38.3 and 38.4 is offered under

subsection (a) following a core principle.

This appendix is only illustrative of the types

of matters an applicant may address, as

applicable, and is not intended to be a

mandatory checklist. Addressing the issues

and questions set forth in this appendix

would help the Commission in its

consideration of whether the application has

met the conditions for recognition. To the

extent that compliance with, or satisfaction

of, a core principle is not self-explanatory

from the face of the recognized futures

exchange’s rules or terms, the application

should include an explanation or other form

of documentation demonstrating that the

applicant meets the conditions for

recognition.

2. Acceptable practices meeting the

requirements of the core principles are set

forth in subsection (b). Recognized futures

exchanges that follow specific practices

outlined under subsection (b) for any core

principle in this appendix will meet the

applicable core principle. Except where

otherwise provided, subsection (b) is for

illustrative purposes only, and does not state

the exclusive means for satisfying a core

principle.

Core Principle 1: Rule Enforcement:

Effectively monitor and enforce its rules.

(a) Application Guidance.

(1) A recognized futures exchange should

have arrangements and resources for effective

trade practice surveillance programs, with

the authority to collect information and

documents on both a routine and non-routine

basis including the examination of books and

records kept by members/participants of the

exchange. The arrangements and resources

should facilitate the direct supervision of the

market and the analysis of data collected.

(2) A recognized futures exchange should

have arrangements, resources and authority

for effective rule enforcement. The

Commission believes that this should include

the authority and ability to discipline and

limit or suspend a member’s or participant’s

activities as well as the authority and ability

to terminate a member’s or participant’s

activities pursuant to clear and fair

standards.

(b) Acceptable Practices. An effective trade

practice surveillance program should

include:

(1) Maintenance of data reflecting the

details of each transaction executed on an

RFE;

(2) Electronic analysis of this data

routinely to detect potential trading

violations;

(3) Appropriate and thorough investigative

analysis of these and other potential trading

violations brought to its attention; and

(4) Prompt and effective disciplinary action

for any violation that is found to have been

committed. The Commission believes that

the latter element should include the

authority and ability to discipline and limit

or suspend a member’s or participant’s

activities pursuant to clear and fair

standards. See, e.g., 17 CFR part 8.

Core Principle 2: Products: List contracts

for trading that are not readily susceptible to

manipulation.

(a) Application Guidance. Applicants

should submit their initial product for listing

for Commission approval under § 5.2 and

Part 5, Appendix A, of this chapter.

Subsequent products may be listed for

trading by self-certification under § 5.1 of this

chapter.

(b) Acceptable Practices.

Guideline No. 1, 17 CFR Part 5, Appendix

A may be used as guidance in meeting this

core principle.

77990 Federal Register / Vol. 65, No. 240 / Wednesday, December 13, 2000 / Rules and Regulations

Core Principle 3: Position monitoring and

reporting: Monitor markets on a routine and

nonroutine basis as necessary to prevent

manipulation, price distortion, and

disruptions of the delivery or cash settlement

process.

(a) Application Guidance. [Reserved]

(b) Acceptable Practices.

(1) An acceptable program for monitoring

markets will generally involve the collection

of various market data, including information

on traders’ market activity. Those data

should be evaluated on an ongoing basis in

order to make an appropriate regulatory

response to potential market disruptions or

abusive practices.

(2) The recognized futures exchange

should collect data in order to assess whether

the market price is responding to the forces

of supply and demand. Appropriate data

usually include various fundamental data

about the underlying commodity, its supply,

its demand, and its movement through

marketing channels. Especially important are

data related to the size and ownership of

deliverable supplies—the existing supply

and the future or potential supply, and to the

pricing of the deliverable commodity relative

to the futures price and relative to similar,

but nondeliverable, kinds of the commodity.

For cash-settled markets, it is more

appropriate to pay attention to the

availability and pricing of the commodity

making up the index to which the market

will be settled, as well as monitoring the

continued suitability of the methodology for

deriving the index.

(3) To assess traders’ activity and potential

power in a market, at a minimum, every

exchange should have routine access to the

positions and trading done by the members

of its clearing facility. Although clearing

member data may be sufficient for some

exchanges, an effective surveillance program

for exchanges with substantial numbers of

customers trading through intermediaries

should employ a much more comprehensive

large-trader reporting system (LTRS). The

Commission operates an industry-wide

LTRS. As an alternative to having its own

LTRS or contracting out for such a system,

exchanges may find it more efficient to use

information available from the Commission’s

LTRS data for position monitoring.

Core Principle 4: Position Limits. Adopt

position limits on trading where necessary

and appropriate to lessen the threat of

market manipulation or congestion during

delivery months.

(a) Application Guidance. [Reserved]

(b) Acceptable Practices.

(1) In order to diminish potential problems

arising from excessively large speculative

positions, the Commission sets limits on

traders’ positions for certain commodities.

These position limits specifically exempt

bona fide hedging, permit other exemptions,

and set limits differently by markets, by

futures or delivery months, or by time

periods. For purposes of evaluating an

exchange speculative-limit program, the

Commission considers the specified limit

levels, aggregation policies, types of

exemptions allowed, methods for monitoring

compliance with the specified levels, and

procedures for enforcement to deal with

violations.

(2) In general, position limits are not

necessary for markets where the threat of

excessive speculation or manipulation is very

low. Thus, exchanges do not need to set

position-limit levels for futures markets in

major foreign currencies and in certain

financial futures having very liquid and deep

underlying cash markets. Where speculative

limits are appropriate, acceptable

speculative-limit levels typically are set in

terms of a trader’s combined position in the

futures contract plus its position in the

option contract (on a delta-adjusted basis).

(3) Spot-month levels for physical-delivery

markets should be based upon an analysis of

deliverable supplies and the history of spotmonth liquidations. Spot-month limits for

physical-delivery markets are appropriately

set at no more than 25 percent of the

estimated deliverable supply. For cashsettled markets, spot-month position limits

may be necessary if the underlying cash

market is small or illiquid such that traders

can disrupt the cash market or otherwise

influence the cash-settlement price to profit

on a futures position. In these cases, the limit

should be set at a level that minimizes the

potential for manipulation or distortion of

the futures contract’s or the underlying

commodity’s price. Markets may elect not to

provide all-months-combined and non-spot

month limits.

(4) An exchange may provide for position

accountability provisions in lieu of position

limits for contracts on financial instruments,

intangible commodities, or certain tangible

commodities. Markets appropriate for

position accountability rules include those

with large open-interest, high daily trading

volumes and liquid cash markets.

(5) Exchanges must have aggregation rules

that apply to those accounts under common

control, those with common ownership, i.e.,

where there is a 10 percent or greater

financial interest, and those traded according

to an expressed or implied agreement.

Exchanges will be permitted to set more

stringent aggregation policies. For example,

one major exchange adopted a policy of

automatically aggregating members of the

same household, unless they were granted a

specific waiver. Exchanges may grant

exemptions to their position limits for bona

fide hedging (as defined in Commission Rule

1.3(z)) and may grant exemptions for reduced

risk positions, such as spreads, straddles and

arbitrage positions.

(6) Exchanges must establish a program for

effective monitoring and enforcement of

these limits. One acceptable enforcement

mechanism is a program whereby traders

apply for these exemptions by the exchange

and are granted a position level higher than

the applicable speculative limit. The position

levels granted under hedge exemptions are

based upon the trader’s commercial activity

in related markets. Exchanges may allow a

brief grace period where a qualifying trader

may exceed speculative limits or an existing

exemption level pending the submission and

approval of appropriate justification. An

exchange should consider whether it wants

to restrict exemptions during the last several

days of trading in a delivery month.

Acceptable procedures for obtaining and

granting exemptions include a requirement

that the exchange approve a specific

maximum higher level.

(7) Exchanges with many markets with

large numbers of traders should have an

automated means of detecting traders’

violations of speculative limits or

exemptions. Exchanges should monitor the

continuing appropriateness of approved

exemptions by periodically reviewing each

trader’s basis for exemption or requiring a

reapplication.

(8) Finally, an acceptable speculative limit

program must have specific policies for

taking regulatory action once a violation of a

position limit or exemption is detected. The

exchange policy will need to consider

appropriate actions where the violation is by

a non-member and should address traders

carrying accounts through more than one

intermediary.

(9) A violation of exchange position limits

that have been approved by the Commission

is also a violation of section 4a(e) of the Act.

Core Principle 5: Emergency Authority:

Exercise authority to intervene to maintain

fair and orderly trading, including, where

applicable, authority to liquidate or transfer

open positions, to require the suspension or

curtailment of trading, and to require the

posting of additional margin.

(a) Application Guidance.

A recognized futures exchange should have

clear procedures and guidelines for exchange

decision-making regarding emergency

intervention in the market, including

procedures and guidelines to carry out such

decision-making without a conflict of

interests. An exchange should also have the

authority to intervene as necessary to

maintain markets with fair and orderly

trading as well as procedures for carrying out

the intervention. The Commission believes

that a recognized futures exchange should

also have procedures and guidelines for the

notification of the Commission of the

exercise of regulatory emergency authority,

as well as procedures and guidelines to

prevent conflicts of interest, for the

documentation of the exchange’s decisionmaking process and for the reasons for use

of its emergency action authority.

(b) Acceptable Practices.

As is necessary to address perceived

market threats, the exchange, among other

things, should be able to impose position

limits in particular in the delivery month,

impose or modify price limits, modify circuit

breakers, call for additional margin either

from customers or clearing members, order

the liquidation or transfer of open positions,

order the fixing of a settlement price, order

the reduction in positions, extend or shorten

the expiration date or the trading hours,

suspend or curtail trading on the market,

order the transfer of customer contracts and

the margin for such contracts from one

member of the exchange to another or alter

the delivery terms or conditions.

Core Principle 6: Public Information: Make

information concerning the contract terms

and conditions and the trading mechanism,

as well as other relevant information, readily

available to market authorities, users and the

public.

(a) Application Guidance.

A recognized futures exchange should have

arrangements and resources for the

Federal Register / Vol. 65, No. 240 / Wednesday, December 13, 2000 / Rules and Regulations 77991

disclosure of contract terms and conditions

and trading mechanisms to the Commission,

users and the public. Procedures should also

include the provision of information on

listing new products, rule amendments or

other changes to previously disclosed

information to the Commission, users and the

public.

(b) Acceptable Practices. [Reserved]

Core Principle 7: Transparency: Provide

market participants on a fair, equitable and

timely basis information regarding, as

appropriate to the market, prices, bids and

offers, and other appropriate information,

and make available to the public information

regarding daily opening and closing prices,

price ranges, trading volume, open interest

and other related market information.

(a) Application Guidance. [Reserved].

(b) Acceptable Practices. [Reserved]

Core Principle 8: Trading System: Provide

a competitive, open and efficient market.

(a) Application Guidance.

(1) Appropriate objective testing and

review of any automated systems should

occur initially and periodically to ensure

proper system functioning, adequate capacity

and security. A recognized futures

exchange’s analysis of its automated system

should address appropriate principles for the

oversight of automated systems, ensuring

proper system function, adequate capacity

and security. The Commission believes that

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’’), subsequently adopted by

the Commission on November 21, 1990 (55

FR 48670), are appropriate guidelines for a

recognized futures exchange to apply to

electronic trading systems. Any program of

objective testing and review of the system

should be performed by a qualified

independent professional. The Commission

believes that information gathered by

analysis, oversight or any program of

objective testing and review of any

automated systems regarding system

functioning, capacity and security should be

made available to the Commission and the

public.

(2) A recognized futures exchange that

determines to allow block trading should

have rules which:

(i) Define the block based upon the

customary size of large positions in the cash

and derivatives market,

(ii) Restrict access to block trading to

eligible participants,

(iii) Provide a mechanism for ensuring that

the block’s price will be fair and reasonable,

and

(iv) provide for transparency of the trade

by requiring that it be reported for clearing

within a reasonable period of time and that

it be identified separately in the price

reporting system.

(b) Acceptable Practices.

A professional that is a certified member of

the Informational Systems Audit and Control

Association experienced in the industry

would be an example of an acceptable party

to carry out such testing and review.

Core Principle 9: Audit Trail: Have

procedures to ensure the recording of full

data entry and trade details sufficient to

reconstruct trading, the quality of the data

captured, and the safe storage of such

information, and have systems to enable

information to be used in assisting in

detecting and deterring customer and market

abuse.

(a) Application Guidance.

A recognized futures exchange should have

arrangements and resources for recording of

full data entry and trade details sufficient to

reconstruct trading and the safe storage of

audit trail data systems enabling information

to be used in combating customer and market

abuse.

(b) Acceptable Practices.

(1) The goal of an audit trail is to detect

and deter customer and market abuse. An

effective exchange audit trail should capture

and retain sufficient trade-related

information to permit exchange staff to detect

trading abuses and to reconstruct all

transactions. An audit trail should include

specialized electronic surveillance programs

that would identify potentially abusive trades

and trade patterns, including for instance,

withholding or disclosing customer orders,

trading ahead, and preferential allocation. An

acceptable audit trail must be able to track a

customer order from time of receipt through

fill allocation. The exchange must create and

maintain an electronic transaction history

database that contains information with

respect to transactions affected on the

recognized futures exchange.

(2) An acceptable audit trail, therefore,

should include the following: original source

documents, transaction history, electronic

analysis capability, and safe storage

capability. A registered futures exchange

whose audit trail satisfies the following

acceptable practices would satisfy Core

Principle 9.

(i) Original Source Documents. Original

source documents include unalterable,

sequentially identified records on which

trade execution information is originally

recorded, whether recorded manually or

electronically. For each customer order, such

records reflect the terms of the order, an

account identifier that relates back to the

account(s) owner(s), and the time of order

entry. For floor-based exchanges, the time of

report of execution of the order should also

be captured.

(ii) Transaction History. A transaction

history which consists of an electronic

history of each transaction, including:

(A) All data that are input into the trade

entry or matching system for the transaction

to match and clear;

(B) Whether the trade was for a customer

or proprietary account;

(C) Timing and sequencing data adequate

to reconstruct trading; and

(D) The identification of each account to

which fills are allocated.

(iii) Eectronic Analysis Capability. An

electronic analysis capability that permits

sorting and presenting data included in the

transaction history so as to reconstruct

trading and to identify possible trading

violations with respect to both customer and

market abuse.

(iv) Safe Storage Capability. Safe storage

capability provides for a method of storing

the data included in the transaction history

in a manner that protects the data from

unauthorized alteration, as well as from

accidental erasure or other loss. Data should

be retained in accordance with the

recordkeeping standards of Core Principle 14.

Core Principle 10: Financial Standards:

Have, monitor, and enforce rules regarding

the financial integrity of the transactions that

have been executed on the exchange and,

where intermediaries are permitted, rules

addressing the financial integrity of the

intermediary and the protection of customer

funds, as appropriate, and a program to

enforce those requirements.

(a) Application Guidance.

Clearing of transactions executed on a

recognized futures exchange should be

provided through a Commission-recognized

clearing facility. In addition, a recognized

futures exchange should maintain the

financial integrity of its transactions by

maintaining minimum financial standards for

its members and having default rules and

procedures. The minimum financial

standards should be monitored for

compliance purposes. The Commission

believes that in order to monitor for

minimum financial requirements, a

recognized futures exchange should routinely

receive and promptly review financial and

related information. Rules concerning the

protection of customer funds should address

the segregation of customer and proprietary

funds, the custody of customer funds, the

investment standards for customer funds,

and related recordkeeping.

(b) Acceptable Practices. [Reserved]

Core Principle 11: Customer Protection:

Have, monitor and enforce rules for customer

protection.

(a) Application Guidance.

A recognized futures exchange should have

rules prohibiting conduct by intermediaries

that is fraudulent, noncompetitive, unfair, or

an abusive practice in connection with the

execution of trades and a program to detect

and discipline such behavior. Intermediated

markets are not required to have, monitor or

enforce rules requiring intermediaries to

provide risk disclosure or to comply with

other sales practices.

(b) Acceptable Practices. [Reserved]

Core Principle 12: Dispute Resolution:

Provide for alternative dispute resolution

mechanisms appropriate to the nature of the

market.

(a) Application Guidance.

A recognized futures exchange should

provide customer dispute resolution

procedures that are fair and equitable and

that are made available to the customer on a

voluntary basis, either directly or through

another self-regulatory organization.

(b) Acceptable Practices.

(1) Core Principle 12 requires a recognized

futures exchange to provide for dispute

resolution mechanisms that are appropriate

to the nature of the market.

(2) In order to satisfy acceptable standards,

a recognized futures exchange should

provide a customer dispute resolution

mechanism that is fundamentally fair and is

equitable. The procedure should provide:

(i) The customer with an opportunity to

have his or her claim decided by a decisionmaker that is objective and impartial,

77992 Federal Register / Vol. 65, No. 240 / Wednesday, December 13, 2000 / Rules and Regulations

(ii) Each party with the right to be

represented by counsel, at the party’s own

expense,

(iii) Each party with adequate notice of

claims presented against him or her, an

opportunity to be heard on all claims,

defenses and permitted counterclaims, and

an opportunity for a prompt hearing,

(iv) For prompt written final settlement

awards that are not subject to appeal within

the exchange, and

(v) Notice to the parties of the fees and

costs which may be assessed.

(3) The procedure employed also must be

voluntary and may permit counter claims, as

provided in § 166.5 of this chapter.

(4) If the recognized futures exchange also

provides a procedure for the resolution of

disputes which do not involve customers

(i.e., member-to-member disputes), the

procedure for the resolution of such disputes

must be independent of and shall not

interfere with or delay the resolution of

customers’ claims or grievances.

(5) A recognized futures exchange may

delegate to another self-regulatory

organization or to a registered futures

association its responsibility to provide for

customer dispute resolution mechanisms,

Provided, however, that, if the recognized

futures exchange does so delegate that

responsibility, the exchange shall in all

respects treat any decision issued by such

other organization or association as if the

decision were its own including providing

for the appropriate enforcement of any award

issued against a delinquent member.

Core Principle 13: Governance: Have

fitness standards for members, owners or

operators with greater than 10 percent

interest or an affiliate of such an owner,

members of the governing board, and those

who make disciplinary determinations. The

recognized futures exchange must have a

means to address conflicts of interest in

making decisions and access to, and use of,

material non-public information by the

foregoing persons and by exchange

employees. For mutually owned futures

exchanges, the composition of the governing

board must reflect market participants.

(a) Application Guidance.

(1) A recognized futures exchange should

have appropriate eligibility criteria for the

categories of persons set forth in the Core

Principle which should include standards for

fitness and for the collection and verification

of information supporting compliance with

such standards. Minimum standards of

fitness are those bases for refusal to register

a person under section 8a(2) of the Act or a

history of serious disciplinary offenses, such

as those which would be disqualifying under

§ 1.63 of this chapter. The Commission

believes that such standards should include

the provision to the Commission of

registration information for such persons,

whether registration information,

certification to the fitness of such persons, an

affidavit of such persons’ fitness by the

facility’s counsel or other information

substantiating the fitness of such persons. If

an exchange provided certification of the

fitness of such a person, the Commission

believes that such certification should be

based on verified information that the person

is fit to be in their position. The means to

address conflicts of interest in decisionmaking should include methods to ascertain

the presence of conflicts of interest and to

make decisions in the event of such a

conflict. In addressing the access to, and use

of, material non-public information, the

Commission believes that the recognized

futures exchange should provide for

limitations on exchange employee trading.

(2) A recognized futures exchange may not

limit its liability or the liability of any of its

officers, directors, employees, licensors,

contractors and/or affiliates where such

liability arises from such person’s violation

of the Act or Commission rules, fraud, or

wanton or willful misconduct.

(b) Acceptable Practices. [Reserved]

Core Principle 14: Recordkeeping: Keep full

books and records of all activities related to

its business as a recognized futures exchange

in a form and manner acceptable to the

Commission for a period of five years, during

the first two of which the books and records

are readily available, and which shall be

open to inspection by any representative of

the Commission or the U.S. Department of

Justice.

(a) Application Guidance. [Reserved]

(b) Acceptable Practices.

Commission rule 1.31 constitutes the

acceptable practice regarding the form and

manner for keeping records.

Core Principle 15: Competition: Operate in

a manner consistent with the public interest

to be protected by the antitrust laws.

(a) Application Guidance.

An entity seeking recognition as a

recognized futures exchange may request that

the Commission consider under the

provisions of section 15 of the Act any of the

entity’s rules, including trading protocols or

policies, and including both operational rules

and the terms or conditions of products listed

for trading, at the time of recognition or

thereafter. The Commission intends to apply

section 15 of the Act to its consideration of

issues under the Competition Core Principle

in a manner consistent with that previously

applied to contract markets.

(b) Acceptable Practices. [Reserved]

PART 170—REGISTERED FUTURES

ASSOCIATIONS

11. The authority citation for Part 170

continues to read as follows:

Authority: 7 U.S.C. 6p, 12a, and 21.

12. Section 170.8 is revised to read as

follows:

§ 170.8 Settlement of customer disputes

(section 17(b)(10) of the Act).

A futures association must be able to

demonstrate its capacity to promulgate

rules and to conduct proceedings which

provide a fair, equitable and expeditious

procedure, through arbitration or

otherwise, for the voluntary settlement

of a customer’s claim or grievance

brought against any member of the

association or any employee of a

member of the association. Such rules

shall conform to and be consistent with

section 17(b)(10) of the Act and be

consistent with the guidelines and

acceptable practices for dispute

resolution found within Appendix A

and Appendix B to part 38 of this

chapter.

PART 180—ARBITRATION OR OTHER

DISPUTE SETTLEMENT PROCEDURES

13. Part 180 is removed.

Issued in Washington, DC, this 21st day of

November, 2000, by the Commission.

Jean A. Webb,

Secretary of the Commission.

[This statement will not appear in the

Code of Federal Regulations]

Dissent of Commissioner Thomas J. Erickson

Regarding Final Rules for a New Regulatory

Framework for Multilateral Transaction

Execution Facilities, Intermediaries and

Clearing Organizations

I dissent from the Commission’s final rules

regarding multilateral transaction execution

facilities, or ‘‘MTEFs.’’ While I believe this is

the most dynamic element of the proposed

framework, I also fear that it will only

expand the legal uncertainty that the

industry has decried for so long in reference

to the existing swaps exemption in Part 35.

I am thus simultaneously interested in the

potential this proposal represents and

disappointed in the lost opportunity for

clarification.

At its core, my concern is this: The

framework will, for the first time, inject legal

uncertainty into regulated exchange markets

by conferring ‘‘recognition’’ upon derivatives

transaction facilities, or DTFs, without any

determination that the transactions are

within the CFTC’s jurisdiction. I believe that

if an agency of the United States Government

tells market participants, other branches of

the government, and counterpart foreign

regulators that a market is regulated, then it

should be, in fact, regulated.

At the DTF level, it seems clear that some

markets will not be subject to Commission

oversight because the Commission’s

jurisdiction—over transactions for future

delivery and commodity options—will not

attach to markets for certain products traded

on DTFs. The nature of the Commission’s

mixed jurisdiction was not lost on

commenters to the proposed framework;

while some saw this as a flaw in the

Federal Register / Vol. 65, No. 240 / Wednesday, December 13, 2000 / Rules and Regulations 77993

1See Mercatus letter, Aug. 21, 2000, p. 4 (‘‘While

it may be appropriate for the CFTC to avoid such

a determination in granting an exemption from

regulation, it is not clear that the CFTC can exercise

its antifraud authority in relation to a particular

transaction without determining that the CFTC is

authorized to exercise jurisdiction in the first

instance.’’) The drafters of the Mercatus letter

further note that the ‘‘broad definition of MTEF’’ in

the proposed rules could even be read ‘‘to cover

auction markets such as eBay and all other forms

of B2B trading facilities, whether electronic or not.’’

Id. at 5. The Commission attempts to deflect this

criticism in the final rules, stating that ‘‘so long as

a facility auctions instruments outside of the

Commission’s regulatory jurisdiction under the Act,

[the] exemptions therefrom and this framework

would have no application to its business.’’ See

Final Rules for a New Regulatory Framework for

Multilateral Transaction Execution Facilities,

Intermediaries and Clearing Organizations, pp. 13–

14. The Commission’s response misses the

rudimentary point that it will be anyone’s guess

whether some instruments possibly traded on DTFs

are within or outside the Commission’s jurisdiction.

2See Lehman Brothers letter, Sept. 5, 2000, p. 2

(‘‘[T]he Commission’s jurisdiction extends solely to

futures and commodity options, such that reserving

anti-fraud and anti-manipulation authority over

futures and commodity options merely restates the

current state of law. Such a reservation of authority

cannot, legally, extend to transactions other than

futures and commodity options and repeating the

nature of the agency’s statutory jurisdiction carries

no legal baggage.’’)

3The only apparent penalty for refusing to

comply with Commission rules is the market’s loss

of recognition as a DTF. I am not comfortable with

this after-the-fallout remedy, and I cannot imagine

potential market participants or domestic or

international regulators being any more pleased.

4See A New Regulatory Framework for

Multilateral Transaction Execution Facilities,

Intermediaries and Clearing Organizations, p. 11,

citing H.R. Rep. No. 978, 102d Cong., 2d Sess. 82–

83 (1992).

5See Department of Treasury letter, Aug. 16,

2000, p. 4.

proposal,1 others took comfort in it.2 Despite

this ‘‘don’t ask, don’t tell’’ approach, DTFs all

will be ‘‘recognized’’ by the Commission as

regulated markets.3 In turn, these DTF

markets will hold themselves out to the

public as markets regulated by the CFTC.

The Commission and certain commenters

within the industry find the possible mix of

futures and non-futures products on DTFs

acceptable. They rely on Congressional report

language from the 1992 legislation that, in

effect, allows the Commission to exempt

transactions without first determining that

they are in the agency’s jurisdiction.4

In the context of bilateral, privately

negotiated transactions—such as those swaps

the Commission was directed by Congress to

‘‘promptly exempt—such an exemption

makes a certain amount of sense. The

consequence of any performance failure or

fraud is borne solely by the parties to the

transaction.

However, today the Commission extends

this rationale to entities that are, in fact,

exchange markets. Global participants and

international regulators rely on our

representations that these markets are

regulated. I will not be comfortable making

such representations with regard to DTFs

where the Commission’s jurisdiction is so

questionable.

As a secondary matter, I am concerned

with the level of oversight that will be

applied to all DTF markets. Under the new

framework, DTFs generally will not be

required to maintain or provide the

Commission with reports of futures positions

held by their customers that exceed certain

thresholds. In what appears to be a nod to the

need for these reports, known as ‘‘large trader

reports,’’ the Commission contemplates

collecting this information only in a select,

few markets. But the vast majority of markets

trading at the DTF level—generally those

without retail participants—will have no

obligation or duty to the Commission or the

public with regard to this important

information.

Large trader reports are an essential tool in

the Commission’s effort to detect and deter

market manipulations. Deterrence is

important because the effects of market

manipulations reach far beyond the market’s

participants. Consumers ultimately pay for

manipulations in commodity markets: Home

buyers pay higher interest rates; commuters

pay higher prices for gasoline; and we all pay

higher prices for heating oil and food. For

these reasons, I would require large trader

reports in all DTF markets, regardless of the

type of commodity product or participant

involved.

The Department of the Treasury identified

this issue in its comment letter, stating that

‘‘large trader reporting requirements have

worked well in the market for treasury

futures, both for the information they reveal

to regulators and their deterrent effect.’’ 5 I

could not agree more strongly with the

Treasury Department on this point. While it

appears that large trader reporting will attach

to government securities markets, I do not

understand why the Treasury’s views have

not provided just as compelling a rationale

for other markets which are not nearly as

deep or liquid.

I believe that DTF markets may prove to be

very successful, commercially. They may

well grow to be the commercial markets

where pricing and price-basing of

commodities occurs. The Commission would

be wise to retain its ability to detect and deter

manipulations at their incipience.

Dated: November 20, 2000.

Thomas J. Erickson,

Commissioner.

[FR Doc. 00–30267 Filed 12–12–00; 8:45 am]

BILLING CODE 6351–01–P

COMMODITY FUTURES TRADING

COMMISSION

17 CFR Parts 1, 3, 4, 140, 155 and 166

RIN 3038–AB56

Rules Relating to Intermediaries of

Commodity Interest Transactions

AGENCY: Commodity Futures Trading

Commission.

ACTION: Final rules.

SUMMARY: As part of a comprehensive

regulatory reform process, the

Commodity Futures Trading

Commission (CFTC or Commission) has

revised its rules relating to

intermediation of commodity futures

and commodity options (commodity

interest) transactions. These new rules

and rule amendments will provide

greater flexibility in several areas. For

example, to ease barriers to entry for

persons seeking registration as futures

commission merchants (FCMs) or

introducing brokers (IBs), the

Commission has established a

simplified registration procedure for

those persons who are regulated by

other federal financial regulatory

agencies and who limit their customer

base to institutional customers only,

regardless of the type of market

involved.

With respect to trading on recognized

derivatives transaction facilities (DTFs),

the Commission has determined to

permit non-institutional customers to

enter into transactions thereon,

provided that such non-institutional

customer business is transacted either

through a registered FCM that is a

clearing member of at least one

designated contract market or

recognized futures exchange (RFE), and

that has adjusted net capital of at least

$20 million or by a registered

commodity trading advisor (CTA) who

has discretionary authority over the

non-institutional customer’s account,

and who has assets under management

of not less than $25 million. The latter

circumstance is an expansion of the

proposal.

As proposed, the Commission is

expanding the range of instruments in

which FCMs may invest customer

funds. In response to various comments

concerning the expansion of permissible

investments, the Commission is making

certain adjustments to the proposals

relating to, among other things,

concentration limits as applied to

securities held in connection with

repurchase transactions, permissible

investments in FCMs and their affiliates

by money market mutual funds meeting

the requirements of Rule 2a–7 under the

Investment Company Act of 1940

(Investment Company Act), and

investment in foreign sovereign debt.

Separately, the Commission also is

considering proposing risk-based capital

rules for FCMs. Further, the

Commission recently adopted a revised

interpretation concerning the treatment

of customer funds on deposit with