[Federal Register Volume 59, Number 190 (Monday, October 3, 1994)]
[Unknown Section]
[Page 0]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 94-24304]
[[Page Unknown]]
[Federal Register: October 3, 1994]
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SECURITIES AND EXCHANGE COMMISSION
[Release No. 34-34712; International Series Release No. 717; File No.
SR-PHLX-93-13]
Self-Regulatory Organizations; Order Approving Proposed Rule
Change and Notice of Filing and Order Granting Accelerated Approval of
Amendment No. 3 to the Proposed Rule Change by the Philadelphia Stock
Exchange, Inc., Relating to Modifications of the Position and Exercise
Limits for Foreign Currency Options
September 23, 1994.
On March 29, 1993, the Philadelphia Stock Exchange, Inc. (``PHLX''
or ``Exchange'') filed with the Securities and Exchange Commission
(``SEC'' or ``Commission''), pursuant to Section 19(b)(1) of the
Securities Exchange Act of 1934 (``Act''),\1\ and Rule 19b-4
thereunder,\2\ a proposal to amend PHLX Rules 1001, ``Position
Limits'', and 1002,'' ``Exercise Limits,''\3\ to increase the position
and exercise limits for foreign currency options (``FCOs'') from
100,000 contracts to 150,000 contracts for FCOs with annual trading
volume of at least 3,500,000 contracts, based on the previous year's
trading volume.\4\
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\1\15 U.S.C. Sec. 78s(b)(1) (1988).
\2\17 CFR 240.19b-4 (1993).
\3\Position limits impose a ceiling on the number of option
contracts in each class on the same side of the market (i.e.,
aggregating long calls and short puts or long puts and short calls)
that can be held or written by an investor or group of investors
acting in concert. Exercise limits prohibit an investor or group of
investors acting in concert from exercising more than a specified
number of puts or calls in a particular class within five
consecutive business days. Throughout this approval order, the terms
``position limits'' or ``limits'' will be used to refer to both
position and exercise limits.
\4\On July 19, 1994, the PHLX amended its proposal to establish
an FCO position limit of 150,000 contracts for FCOs with annual
trading volume of at least 4,000,000 contracts. See Letter from
Gerald D. O'Connell, First Vice President, Regulation and Trading
Operations, PHLX, to Michael Walinskas, Branch Chief, Options
Regulation, Division of Market Regulation (``Division''),
Commission, dated July 19, 1994 (``Amendment No. 1''). In addition,
the PHLX submitted information concerning the implementation and
effective date of the proposal. See Letter from Edith Hallahan,
Attorney, Market Surveillance, PHLX, to Richard Zack, Branch Chief,
Options Branch, Division, Commission, dated July 27, 1993 (``July 27
Letter''). On July 26, 1994, the PHLX amended the proposal to
provide that FCOs with annual trading volume of 3,500,000 contracts
would be eligible for a position limit of 150,000 contracts and to
indicate that the PHLX plans a one-time immediate review to
implement the higher position limit for FCOs which meet the annual
trading volume requirement. See Letter from Gerald D. O'Connell,
First Vice President, Regulation and Trading Operations, PHLX, to
Michael Walinskas, Branch Chief, Options Regulation, Division,
Commission, dated July 26, 1994 (``Amendment No. 2''). On September
22, 1994, the PHLX amended its proposal to revise the effective date
of a change to a lower FCO position limit. Specifically, if the
PHLX's beginning-of-the-year review of FCO trading volume indicates
that the position limit for an FCO must be lowered from 150,000 to
100,000 contracts, the PHLX will promptly advise FCO participants
that all series in that FCO will be subject to the lower limit
effective the Monday following the mid-month June expiration. See
Letter from Gerald D. O'Connell, First Vice President, Regulation
and Trading Operations, PHLX, to Michael Walinskas, Branch Chief,
Options Regulation, Division, Commission, dated September 22, 1994
(``Amendment No. 3'').
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Notice of the proposal appeared in the Federal Register on August
18, 1994.\5\ No comments were received on the proposal.
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\5\See Securities Exchange Act Release No. 34525 (August 11,
1994), 59 FR 42620 (August 18, 1994).
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Currently, PHLX Rule 1001 establishes a position limit of 100,000
contracts for FCOs traded on the PHLX. The PHLX proposes to amend
Exchange Rules 1001 and 1002 to increase the position and exercise
limits for FCOs, including cross-rate FCOs.\6\ Specifically, under
proposed Commentary .05(b) to PHLX rule 1001, the PHLX proposes to
establish a position limit of 150,000 contracts for FCOs with annual
trading volume of at least 3,500,000 contracts, based upon the previous
year's volume. At the beginning of each calendar year, the PHLX will
review FCO volume information from the previous year to determine which
limit will apply; a higher limit will be effective on the date set by
the Exchange, and a lower limit will take effect on the Monday
following the mid-month June expiration. If the PHLX's beginning-of-
the-year FCO trading volume review indicates that the position limit
for an FCO must be lowered from 150,000 contracts to 100,000 contracts,
the PHLX will promptly notify FCO participants that the lower limit
will be effective for all series in that option on the Monday following
the mid-month June expiration, and FCO participants will be required to
comply with the lower limit.\7\ In addition, the PHLX's Market
Surveillance Department plans to monitor trading volume on a monthly
basis, so that FCOs will be eligible immediately for a higher position
limit when annual trading volume, as measured from the beginning of the
calendar year, exceeds the levels established in the proposal.
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\6\Currently, the PHLX trades two cross-rate FCOs, the British
pound/Deutsche mark and the Deutsche mark/Japanese yen.
\7\See Amendment No. 3, supra note 4.
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In order to implement the proposal prior to the end of 1994, the
PHLX plans to conduct a one-time review of FCO volume, calculating
volume for the 12-month period immediately preceding approval of the
proposal, so that FCOs with annual trading volume during that period of
at least 3,500,000 contracts will be eligible for the 150,000-contract
limit immediately after approval of the proposal.\8\ The PHLX states
that for the 12-month period from September 1993-August 1994, the
Deutsche mark and the French franc would qualify for the higher
limit.\9\
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\8\See Amendment No. 2, supra note 4.
\9\See Amendment No. 3, supra note 4.
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The PHLX notes that the Exchange's exercise limits are established
by reference to position limits, so that any increase in position
limits will also increase exercise limits. Accordingly, the PHLX
proposes to amend Exchange Rule 1002 to reflect the proposed amendment
to Exchange Rule 1001.
The Exchange views the current FCO position and exercise limits as
too low in light of increased levels of trading activity in the
underlying currency markets and the resultant growth in liquidity of
PHLX FCOs in recent years. The PHLX's proposal is designed to identify
and accommodate those active currencies where heavier trading and open
interest warrant higher limits. The PHLX understands that if it were to
begin trading a new currency, measurement of the new currency's trading
volume for purposes of establishing its eligibility for the 150,000-
contract limit would be calculated from the beginning of the ``calendar
year.''
When FCOs began trading on the PHLX in 1982, FCO position limits
were set at 10,000 contracts.\10\ Since that time the position limits
have been changed three times, including an increase to the current
level of 100,000 contracts in 1986.\11\ Since 1986, the PHLX has added
several new products for which position limits are aggregated with
other trading in the same underlying foreign currency.\12\ As a result,
many traders have begun to regularly accumulate positions near existing
limits, especially in certain more active currencies. In those active
currencies, the PHLX believes that trading interest could migrate to
the over-the-counter (``OTC'') market, hampering PHLX liquidity if
large traders continue to be restricted by the current position limits.
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\10\See Securities Exchange Act Release No. 19313 (December 8,
1982) 47 FR 56591 (order approving File No. SR-PHLX-81-04).
\11\See Securities Exchange Act Release No. 27310, supra note 2.
See also Securities Exchange Act Release Nos. 21676 (January 18,
1985) 50 FR 3859 (order approving File No. SR-PHLX-84-18)
(increasing position limits from 10,000 to 25,000 contracts); and
22479 (September 27, 1985), 50 FR 41276 (order approving File No.
SR-PHLX-85-22) (increasing position limits to 50,000 contracts).
\12\See e.g. Securities Exchange Act Release Nos. 24859 (August
27, 1987) 52 FR 33493 (order approving File No. SR-PHLX-87-24)
(aggregating European-style contracts); 30945 (July 21, 1992) 57 FR
33381 ((order approving File No. SR-PHLX-92-13) (aggregating month-
end options); and 33732 (May 8, 1994), 59 FR 12023 (order approving
File No. SR-PHLX-93-10) (aggregating cash-spot FCOs).
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The PHLX notes that since the time of the most recent increase in
position limits, the size of the underlying currency market has grown
exponentially.\13\ Since 1986, average daily trading volume in PHLX
FCOs has grown from 30,880 to 48,246 contracts in 1992.\14\ As of
February 1993, average daily volume was 61,062 contracts. Monthly
volume and open interest have also increased dramatically since 1986,
especially in certain FCOs. Further, the highest monthly open interest
in FCOs reached 995,941 in 1986; 1,188,570 contracts in 1987; 1,190,389
contracts in 1992; and 1,338,458 in 1993. Total annual volume has
increased from 7,905,239 contracts in 1986 to 12,158,069 contracts in
1992 to 13,101,365 contracts in 1993. Total FCO trading volume as of
July 1994 was 5,755,939 contracts.
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\13\In 1989, total gross global foreign exchange turnover was
estimated to be $932 billion per day and net global turnover was
estimated to be $640 billion per day. See Bank for International
Settlements (``BIS'') Survey of Foreign Exchange Market Activity,
April 1989. In 1992, total gross global foreign exchange turnover
was estimated to be $1,354 billion per day, a 35% increase since
April 1989. After allowing for the elimination of local and cross-
border double-counting and estimated gaps in reporting (e.g.,
exchange-traded options and futures and countries not providing
counterparty information for over-the-counter transactions), global
``net-net'' exchange market turnover in spot, forward and derivative
contracts may be estimated at $880 billion per day during April
1992. See BIS Central Bank Survey of Foreign Exchange Market
Activity in April 1992, March 1993.
\14\Average daily volume in foreign currency options was 14,829
contracts in 1985 and 30,880 contracts in 1986.
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In light of these market changes, the PHLX believes that increased
position and exercise limits are necessary to add depth and liquidity
to the market. Because of the large size of the underlying market in
foreign currencies, the PHLX does not believe that higher position and
exercise limits will increase manipulative concerns. Moreover, the
Exchange believes that these increases are particularly appropriate
because the FCO market attracts a large number of institutional and
corporate investors who have substantial hedging needs and execute
block-sized\15\ transactions in FCOs.
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\15\For the purposes of this proposal, the PHLX defines ``block-
sized orders'' as orders of 100 contracts or more. See July 27
Letter, supra note 4.
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Although the Exchange may grant position limit exemptions in the
interest of fair and orderly markets, the Exchange believes that it is
more direct and logical to establish more appropriate position limits
for all investors.
The PHLX believes that the proposed rule change is consistent with
Section 6 of the Act, in general, and, in particular, with Section
6(b)(5), in that it is designed to promote just and equitable
principles of trade as well as to protect investors and the public
interest. The PHLX believes that the increased depth and liquidity of
the FCO market should promote just and equitable principles of trade.
In addition, the PHLX believes that the proposed approach to FCO
position limits should ensure that the applicable limit is reasonably
related to trading volume. The PHLX believes that this, in turn, should
result in position limit levels that serve the purposes of protecting
investors and the public interest as well as preventing unfair acts and
practices, such as manipulation.
The Commission finds that the proposed rule change is consistent
with the requirements of the Act and the rules and regulations
thereunder applicable to a national securities exchange and, in
particular, the requirements of Section 6(b)(5).\16\ Specifically, the
Commission believes that the proposal to raise the position limit for
only those FCOs with annual trading volume of at least 3,500,000
contracts should help to accommodate the needs of investors and market
participants while ensuring that the increased limits are only
available for those currencies with extremely large and liquid markets.
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\16\15 U.S.C. Sec. 78f(b)(5) (1982).
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In this regard, the Commission believes, as it has stated in the
past, that although position and exercise limits for FCOs must be
sufficient to protect the options and related markets from disruptions
by manipulation, the limits must not be established at levels that are
so low as to discourage participation in the options market by
institutions and other investors with substantial hedging needs or to
prevent market makers from adequately meeting their obligations to
maintain a fair and orderly market.\17\ In its proposal, the PHLX
states that the FCO market attracts a large number of institutional and
corporate investors who have substantial needs and who execute block-
sized transactions in FCOs. In addition, the PHLX believes that trading
in active currencies could migrate to the OTC market if traders
continue to be restricted by the PHLX's current FCO position limits. In
light of the size of the FCO market and the needs of FCO investors and
market makers, the Commission believes that the PHLX's proposal is a
reasonable effort to accommodate the needs of market participants and
to help the Exchange remain competitive with the OTC market for FCOs.
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\17\See Securities Exchange Act Release No. 22479, supra note
11.
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At the same time, the Commission does not believe that the proposal
significantly increases concerns regarding intermarket manipulations or
disruptions of the markets for FCOs or the underlying currencies. The
Commission notes that the interbank foreign currency spot market is an
extremely large, diverse market comprised of banks and other financial
institutions worldwide.\18\ That market is supplemented by equally deep
and liquid markets for standardized options and futures on foreign
currencies and options on those futures. An active OTC market also
exists in FCOs. Given the probable expense of attempting to affect the
cash market for the currencies underlying the FCOs, the Commission
believes that it would be difficult for a market participant to
manipulate the underlying cash market to benefit a previously
established FCO position.
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\18\See Securities Exchange Act Release No. 31627 (December 21,
1992), 57 FR 62399 (December 30, 1992) (order approving File No. SR-
Amex-92-36).
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In addition, the Commission believes the proposal's requirement
that FCOs have annual trading volume of 3,500,000 contracts to be
eligible for the 150,000 contract limit further minimizes the potential
for manipulations and helps to ensure that only consistently active
currencies will be eligible for the higher position limit. In this
regard, the Commission notes that if the PHLX's annual review of FCO
trading volume indicates that an FCO is no longer eligible for the
higher position limit, then the lower limit will be effective in all
series of the FCO effective the Monday following the mid-month June
expiration.\19\
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\19\See Amendment No. 3, supra note 4.
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The Commission believes that the proposal's two-tiered approach to
FCO position limits is consistent with the three-tiered position limits
for equity and narrow-based index options traded on the PHLX, and that
tiering is consistent with the evolutionary approach that the
Commission and the options exchanges have adopted in increasing
position and exercise limits.\20\ The Commission believes that the PHLX
has had considerable experience monitoring the tiered framework in
equity options and narrow-based index options, and that differing
position limits in those options have not created programming or
monitoring problems for securities firms, or led to significant
customer confusion.\21\ Based on the PHLX's experience with the three-
tiered approach in equity and narrow-based index options, the
Commission believes the two-tiered approach for FCOs is appropriate.
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\20\See Securities Exchange Act Release No. 33288 (December 3,
1994), 58 FR 65221 (December 13, 1993) (order partially approving
File No. SR-PHLX-93-07).
\21\Id.
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Moreover, the absence of discernible manipulative problems under
the current FCO position limit leads the Commission to conclude that
the proposed increase is warranted. The Commission recognizes, as it
has stated in the past, that there are no ideal limits in the sense
that options positions of any given size can be stated conclusively to
be free of any manipulative concerns.\22\ The PHLX and the Commission,
however, have relied largely on the absence of discernible manipulation
or disruption problems under the current limit as an indicator that
additional increases can be safely considered. The Commission believes
for these reasons that the liberalization of existing FCO position and
exercise limits under the condition specified is appropriate.\23\
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\22\See Securities and Exchange Act Release No. 33288, supra
note 20.
\23\The Commission continues to believe that proposals to
increase position and exercise limits must be justified and
evaluated separately. After reviewing the proposed exercise limits,
along with the eligibility criteria for the higher tier, the
Commission has concluded that the exercise limit increase does not
raise manipulation problems or increase concerns over market
disruption in the underlying currencies.
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In addition, the Commission believes that the PHLX's surveillance
programs will be adequate to detect and deter the use of illegal
position limits by market participants as well as detect and deter
attempted manipulative activity and other trading abuses.
The Commission believes that it is reasonable for the PHLX, on a
timely basis, to review annual FCO volume during the year measured
immediately prior to approval of the proposal in order to allow the
Exchange to implement the higher position limit for eligible FCOs prior
to the end of 1994.
The Commission finds good cause for approving Amendment No. 3 to
the proposed rule change prior to the thirtieth day after the date of
publication of notice thereof in the Federal Register.
The Commission believes that Amendment No. 3 strengthens the PHLX's
proposal by requiring that lower position limits be implemented sooner
than originally proposed, i.e., six months rather than up to two years,
if an FCO's trading volume for the previous year is less than 3,500,000
contracts, thereby helping to ensure that only actively traded
currencies are eligible for the higher position limit. Accordingly, the
Commission believes it is consistent with Sections 6(b)(5) and 19(b) of
the Act to approve Amendment No. 3 to the proposed rule change on an
accelerated basis.
IV. Solicitation of Comments
Interested persons are invited to submit written data, views and
arguments concerning Amendment No. 3 to the proposed rule change.
Persons making written submissions should file six copies thereof with
the Secretary, Securities and Exchange Commission, 450 Fifth Street
NW., Washington, DC 20549. Copies of the submission, all subsequent
amendments, all written statements with respect to the proposed rule
change that are filed with the Commission, and all written
communications relating to the proposed rule change between the
Commission and any person, other than those that may be withheld from
the public in accordance with the provisions of 5 U.S.C. 552, will be
available for inspection and copying at the Commission's Public
Reference Section, 450 Fifth Street NW., Washington, DC. Copies of such
filing will also be available for inspection and copying at the
principal office of the above-mentioned self-regulatory organization.
All submissions should refer to the file number in the caption above
and should be submitted by October 24, 1994.
It is therefore ordered, Pursuant to Section 19(b)(2) of the
Act,\24\ that the proposed rule change (SR-PHLX-93-13) is approved.
\24\15 U.S.C. Sec. 78s(b)(2) (1982).
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For the Commission, by the Division of Market Regulation,
pursuant to delegated authority.\25\
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\25\17 CFR 200.30-3(a)(12) (1993).
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Margaret H. McFarland,
Deputy Secretary.
[FR Doc. 94-24304 Filed 9-30-94; 8:45 am]
BILLING CODE 8010-01-M