[Federal Register Volume 60, Number 229 (Wednesday, November 29, 1995)]
[Notices]
[Pages 61277-61280]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 95-29152]



-----------------------------------------------------------------------

SECURITIES AND EXCHANGE COMMISSION
[Release No. 34-36505; International Series Release No. 889; File No. 
SR-Phlx-95-42]


Self-Regulatory Organizations; Order Approving a Proposed Rule 
Change and Notice of Filing and Order Granting Accelerated Approval of 
Amendment No. 2 to the Proposed Rule Change by the Philadelphia Stock 
Exchange, Inc., to List and Trade 3D Foreign Currency Options on the 
Japanese Yen

November 22, 1995.

I. Introduction

    On June 14, 1995, the Philadelphia Stock Exchange, Inc. (``Phlx'' 
or ``Exchange'') filed a proposed rule change 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\ to list and trade Dollar Denominated Delivery 
(``3D'') foreign currency options (``FCOs'') on the Japanese yen. The 
Exchange filed Amendment No. 1 to the proposal on July 7, 1995.\3\ The 
Exchange filed Amendment No. 2 on November 8, 1995.\4\

    \1\15 U.S.C. 78s(b)(1).
    \2\17 CFR 240.19b-4.
    \3\The Phlx submitted Amendment No. 1 to the Commission to make 
certain technical corrections to the proposal. See Letter from 
Michele Wiesbaum, Associate General Counsel, Phlx. to John Ayanian, 
Attorney, Office of Market Supervision (``OMS''), Division of Market 
Regulation (``Market Regulation''), Commission, dated July 7, 1995.
    \4\The Phlx submitted Amendment No. 2 to the Commission to 
explain its proposed provisions for calculating and disseminating 
the settlement value for the 3D Japanese yen options. See Letter 
from Michele Weisbaum, Associate General Counsel, Phlx, to John 
Ayanian, Attorney, OMS, Market Regulation, Commission, dated 
November 8, 1995 (``Amendment No. 2'').
---------------------------------------------------------------------------

    Notice of the proposal, and Amendment No. 1, was published for 
comment and appeared in the Federal Register on August 11, 1995.\5\ No 
comment letters were received on the proposed rule change. This order 
approves the Exchange's proposal, as amended.

    \5\See Securities Exchange Act Release No. 36062 (August 4, 
1995), 60 FR 41140.
---------------------------------------------------------------------------

II. Background

    In March 1994, the Commission approved the listing and trading of 
3D FCOs on the German mark.\6\ 3D FCOs are cash-settled, European-style 
options issued by The Options Clearing Corporation (``OCC'') that allow 
holders to receive U.S. dollars representing the difference between the 
current foreign exchange spot price\7\ and the exercise price of the 
option. Specifically, upon exercise of an in-the-money 3D FCO 
structured as a call, the holder will receive, from OCC, U.S. dollars 
representing the difference between the exercise strike price and the 
closing settlement value of the 3D FCO contract multiplied by the 
number of units of currency covered by the contract. For a 3D FCO 
structured as a put, the holder will receive U.S. dollars representing 
the excess of the exercise price over the closing settlement value of 
the 3D FCO contract multiplied by the number of units of foreign 
currency covered by the contract.

    \6\See Securities Exchange Act Release No. 33732 (March 8, 
1995), 59 FR 12023 (March 15, 1994).
    \7\The ``spot price'' with respect to an option contract on a 
foreign currency option contract means the price for the sale of one 
foreign currency for another, quoted by various commercial banks in 
the interbank foreign exchange market for the sale of a single unit 
of such foreign currency for immediate delivery (which generally 
means delivery within two business days following the date on which 
the terms of such sale are agreed upon). See Phlx Rule 1000(b)(16).
---------------------------------------------------------------------------

    Unlike other Phlx-traded FCOs, 3D FCOs which are in-the-money by 
any amount on the expiration date will be exercised automatically by 
OCC. 3D FCOs which are out-of-the-money at expiration will expire 
worthless.
    German 3D FCOs were originally listed with one-week and two-week 
expirations to provide a hedging vehicle to sophisticated retail 
customers, portfolio managers and multi-national corporations which 
needed to hedge their short term foreign currency exposure and also to 
banks which needed to hedge the risks associated with trading in the 
forward and cash markets. The Commission recently approved the Phlx's 
proposal to list German 3D FCO contracts with longer term expirations 
up to twelve months.\8\

    \8\See Securities Exchange Act Release No. 35756 (May 24, 1995), 
60 FR 28638 (June 1, 1995).
---------------------------------------------------------------------------

III. Description of the Proposal

    The Exchange is now proposing to list and trade 3D FCOs on the 
Japanese yen (U.S. dollar/Japanese yen) (``3D JY Options''). The 
contract size will be 6,250,000 yen, the same as physically settled 
Japanese yen contract. Pursuant to Phlx Rule 1012(a)(ii), the contracts 
will be listed with expirations at one week and two weeks and one, two, 
three, six and nine months (twelve month options will not be listed at 
this time but will be permitted under Phlx rules). The options will be 
on the March, June, September, December cycle and no month end or long 
term expirations will be listed. The expiration date for the 
consecutive and cycle month options will be the Monday preceding the 
third Wednesday of each month. The Exchange expects that the symbols 
for these options will be as follows:

XJA  first Monday of month expiration
XJB  second Monday of month expiration
XJC  third Monday of month expiration
XJD  fourth Monday of month expiration
XJE  fifth Monday of month expiration
XJS  settlement symbol

    The 1, 2, 3, 6 and 9 month options will be listed with the symbol 
XJB or XJC depending on whether expiration will be the second or third 
Monday of that month and will carry that symbol to expiration. For 
example, a ``Sept 1995'' option which would expire on Monday September 
18, would be listed as an XJC Sept 95 call whereas the ``Nov 1995'' 
option which would expire on Monday, November 13, would be listed as an 
XJB Nov 95 call.
    Similar to the 3D German mark contracts, the Exchange proposes that 
a series of 3D JY Options will trade during normal trading hours for 
foreign currency options, specifically, 2:30 a.m. to 2:30 p.m. E.T. 
Monday through Friday. The expiring FCO contract will cease trading at 
10:30 a.m. and expire at 11:59 p.m. on its expiration Monday, unless 
such Monday is an Exchange holiday or an Exchange designated bank 
holiday, when, under Phlx Rule 1000(b)(21), ``Expiration date,'' as 
amended, the 3D FCO will expire at 11:59 p.m. on the preceding business 
date (ordinarily a Friday).
    Accordingly, on Exchange holidays and Exchange designated bank 
holidays, the expiring 3D FCOs will cease trading at 10:30 a.m. on the 
preceding business day. In addition, when Monday is an exchange 
holiday, new series will be listed on the following Tuesday at 2:30 
a.m. E.T. as opposed to the normal Monday morning listing.
    The closing settlement value, which will be disseminated through 
the Options Price Reporting Authority (``OPRA''), will be determined by 
a designated agent(s) of the Exchange under Phlx Rule 1057, ``3D 
(Dollar Denomination Delivery) Foreign Currency Option Closing 
Settlement 

[[Page 61278]]
Value.'' Pursuant to Phlx Rule 1057, at 10:30 a.m. (E.T.), on every 
expiration date for 3D FCOs, the market information vendor(s), acting 
as the Exchange's designated agent will determine the final settlement 
value. The Exchange has retained Reuters to calculate the settlement 
value which the Exchange disseminates.\9\

    \9\See Amendment No. 2, supra note 4.
---------------------------------------------------------------------------

    The market information vendor(s) will collect a bid and offer 
quotation, from 10 a.m. (E.T.) until 10:30 a.m. (E.T.), for the current 
Japanese yen spot price from the quotations submitted by 15 interbank 
foreign participants, which the designated agent will select randomly 
from a list created by the Phlx of at least 25 active interbank foreign 
exchange market participants.\10\ After discarding the five highest 
offers and five lowest bids, the designated agent will arithmetically 
average the remaining ten bids and ten offers to arrive at a closing 
settlement value. This value will be calculated and sent to the Phlx 
every 30 seconds until 10:30 a.m. when the designated agent will 
determine the final settlement value. At that time, the settlement 
value will be automatically entered into the Phlx's systems, and then 
the Phlx disseminates it to OPRA and the OCC for entry into the OCC 
clearing systems.

    \10\The Phlx will select the list of interbank market 
participants by evaluating the number of times each contributor 
supplies Japanese yen spot quotes to the market information 
vendor(s) on Monday mornings between 10 a.m. and 10:30 a.m. The pool 
of quote contributors will be reviewed monthly based on these 
criteria and substitutions will be made, if necessary. If at any 
time an interbank market participant ceases to distribute Japanese 
yen spot quotes or is no longer in the business of making Japanese 
yen markets, that entity will be replaced. Currently, there are 40 
interbank market participants on the list which show bid and offer 
quotations. Telephone conversation between Michele Weisbaum, 
Associate General Counsel, Phlx, and John Ayanian, Attorney, OMS, 
Market Regulation, Commission, on November 15, 1995.
---------------------------------------------------------------------------

    The Exchange represents that there are two Reuters terminals within 
the Exchange Regulatory Services area which calculate the settlement 
value and both are connected to a digital feed. If one terminal has a 
complication with any 30 second calculation, the other terminal takes 
over. If there is a communication problem between Reuters and the 
Exchange, the Exchange can telephone Reuter's New York office to have 
the value provided verbally, as it is also calculated on a terminal in 
New York. In the event of a broad based shut down of Reuters, the 
Exchange would directly contact a group of banks and ask for their 
current spot quote, and calculate the settlement value using the same 
methodology as described above. Additionally, if the Reuters program 
does not generate enough quotes during an inactive period, the Exchange 
can add quotes from the Reuters international page which shows bank 
quotes other than the predetermined set of 40 in the normal 
program.\11\

    \11\See Amendment No. 2, supra note 4.
---------------------------------------------------------------------------

    The position limits and exercise limits for the 3D JY Options will 
be the same as the position and exercise limit for the physically 
settled Japanese yen contracts pursuant to Phlx Rule 1001\12\ and Rule 
1002 and positions in the 3D JY Options will be aggregated with 
positions in the physically settled Japanese yen contracts. The Phlx 
proposes to initially list exercise strike prices for each expiration 
around the current spot price and new strikes may be added during the 
life of the option in accordance with Phlx Rule 1012 at half-cent 
intervals for the one and two weeks and 3 near term months and at one 
cent intervals for the six and nine month options.\13\

    \12\Position and exercise limits on the Japanese yen are 100,000 
contracts on either side of the market, however, the Phlx has 
recently proposed to raise this limit to 200,000 contracts. This 
proposal is currently under review at the Commission. See Securities 
Exchange Act Release No. 35688 (May 8, 1995), 60 FR 26062 (May 16, 
1995).
    \13\The Phlx represents that it has adequate systems capacity to 
process quotations and trades in the proposed 3D JY Options. See 
Letter from William H. Morgan, Vice President, Trading Systems, 
Phlx, to Michael Walinskas, Branch Chief, OMS, Market Regulation, 
Commission, dated November 17, 1995.
    The Commission notes that trading of 3D JY Options is contingent 
upon the Commission's receipt of the Options Price Reporting 
Authority's representation that it has adequate systems capacity to 
process quotations and trades in the proposed 3D JY Options. 
Telephone Conservation between Michele Weisbaum, Associate General 
Counsel, Phlx, and John Ayanian, Attorney, OMS, Market Regulation, 
Commission, on November 22, 1995.
---------------------------------------------------------------------------

    The 3D JY Options will trade in accordance with the rules governing 
all Phlx FCOs, including sales practice rules and floor trading rules. 
For example, Phlx Rule 1014, ``Obligations and Restrictions Applicable 
to Specialists and Registered Options Traders'' provides that bid/ask 
differentials for 3D FCOs shall be determined by reference to the 
underlying foreign currency. Further, 3D JY Options will not be subject 
to customized trading pursuant to Phlx Rule 1069.
    The 3D JY Options will have the same customer margin requirements 
as are provided for the existing Japanese yen FCOs pursuant to Phlx 
Rule 722, ``Margin Accounts.'' Specifically, for any put or call on 3D 
options which are issued, guaranteed or carried ``short'' in a 
customer's account, the required margin shall be 100% of the options 
premium plus 4% of the value of the underlying contract less any out-
of-the-money account, with an adjustment for out-of-the-money options 
to be not less than 100% of the options premium plus \3/4\% of the 
underlying contract margin within five days following the date on which 
a customer enters into a 3D FCO position and within two days if the 
option has two weeks or less to expiration.
    The Exchange believes that the proposed rule change is consistent 
with Section 6 of the Act, in general, and furthers the objectives of 
Section 6(b)(5), in particular, in that it is designed to promote just 
and equitable principles of trade, prevent fraudulent and manipulative 
acts and practices, as well as to protect investors and the public 
interest by providing foreign currency option users who do not 
necessarily need to exchange currency at settlement with an alternative 
cash settled foreign currency option with corresponding expirations.

IV. Commission Finding and Conclusions

    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) of the Act.\14\ 
Specifically, the Commission believes that the Exchange's proposal is 
designed to provide investors with an adequate means to hedge foreign 
currency portfolios and cash flows from short-term market risk, thereby 
facilitating transactions in FCOs and providing investors with greater 
flexibility to tailor foreign currency options positions to satisfy 
their investment objectives.\15\

    \14\15 U.S.C. 78f(b)(5).
    \15\Pursuant to Section 6(b)(5) of the Act the Commission must 
predicate approval of exchange trading for new products upon a 
finding that the introduction of the product is in the public 
interest. Such a finding would be difficult with respect to a 
product that served no investment hedging or other economic 
function, because any benefits that might be derived by market 
participants would likely be outweighed by the potential for 
manipulation, diminished public confidence in the integrity of the 
markets, and other valid regulatory concerns.
---------------------------------------------------------------------------

    The Commission believes that the Phlx's proposal will help to 
promote the maintenance of a fair and orderly market by extending the 
benefits of a listed currency market to an instrument designed to meet 
the investment needs of Japanese currency market participants. The 
attributes of the Exchange's markets versus the OTC market for short-
term FCOs include, but are not limited to, a regulated market 

[[Page 61279]]
center, an auction market, with posted market quotations and 
transaction reporting, standardized contract specifications, parameters 
and procedures and procedures for clearance and settlement, and the 
guarantee of the OCC.
    The trading of 3D JY Options, generally, however, raises several 
issues, including issues related to pricing and settlement value, 
customer protection, surveillance, and market impact. For the reasons 
discussed below, the Commission believes that the Phlx has adequately 
addressed these issues.

A. Pricing and Settlement Value

    The Commission believes that the methodology described above in 
Phlx Rule 1057 and Amendment No. 2 for calculating the settlement value 
of 3D JY Options is designed to provide an accurate reflection of the 
foreign currency spot price. The Commission also believes that the 
Phlx's procedures and the competitive nature of the spot market for 
foreign currencies should help to ensure that the settlement values for 
3D FCO contracts will accurately reflect the spot price for foreign 
currencies. Moreover, the Commission believes that the Phlx's 
procedures should guard against unreliable or manipulated quotes. 
Finally, as noted above, the Phlx has established adequate back-up 
mechanisms to ensure the settlement value calculation will be available 
on a timely basis.

B. Customer Protection

    The Commission believes that a regulatory system designed to 
protect public customers must be in place before the trading of 
sophisticated financial instruments, such as 3D JY Options, can 
commence on a national securities exchange. Under paragraph (b) of Phlx 
Rule 1024, members will be prohibited from accepting a customer order 
to purchase or write a 3D FCO unless such customer's account has been 
specially approved in writing by a designated Foreign Currency Options 
principal of the member for transactions in 3D FCOs. Exchange Rule 1026 
is designed to ensure that options, including 3D FCOs, will be sold 
only to customers capable of evaluating and bearing the risks 
associated with trading in the instruments. Finally, under Exchange 
Rule 1027, members will be permitted to exercise discretionary power 
with respect to trading 3D FCOs in a customer's account only if the 
member has received prior written authorization from the customer and 
the account has been accepted in writing by a designated Foreign 
Currency Options Principal. In addition, under Exchange Rule 1027, the 
Foreign Currency Options Principal or a Registered Options Principal 
must approve and initial each discretionary 3D FCO on the day the order 
is entered.
    The Commission notes that the trading of standardized exchange-
traded options occurs in an environment that is designed to ensure, 
among other things, that: (1) The special risks of options are 
disclosed to public customers; (2) only investors capable of evaluating 
and bearing the risks of options trading are engaged in such trading; 
and (3) special compliance procedures are applicable to options 
accounts. Accordingly, because the 3D JY Options will be subject to the 
same regulatory regime as the other 3D FCOs currently traded on the 
Phlx, the Commission believes that adequate safeguards are in place to 
ensure the protection of investors in 3D JY Options.

C. Surveillance

    The Commission notes that the Phlx will integrate 3D JY Options 
into existing Phlx market surveillance programs. The Commission 
believes that existing FCO surveillance procedures should enable the 
Exchange to conduct, deter, as well as detect, trading abuses involving 
the 3D JY Options market and the markets for the underlying Japanese 
yen. In light of the design of the 3D JY Options contracts and the 
developed market for foreign currencies, the Commission believes that 
the markets for the 3D JY Options will not be readily susceptible to 
manipulation.

D. Position and Exercise Limits and Margin Requirements

    As noted above, 3D JY Options will be aggregated with other 
existing contracts on the same underlying currency for position and 
exercise limit purposes. The Commission believes that aggregation of 3D 
FCOs with existing contracts on the same underlying currency for 
position and exercise limit purposes will reduce concerns regarding 
manipulations or disruptions of the markets for 3D FCOs, other currency 
options, and the underlying currencies, while at the same time not 
hampering the depth and liquidity of the marekt for 3D FCOs.
    The Commission believes the proposed margin levels for 3D FCO 
contracts, which are consistent with the margin levels for the Phlx's 
other FCOs, will result in adequate coverage of contract obligations 
and are designed to preclude the systemic risks arising from 
excessively low margin levels. As noted above, the margin requirement 
on any put and call 3D FCO issued, guaranteed or carried ``short'' in a 
customer's account shall be 100% of the option premium plus 4% of the 
value of the underlying contract less any out-of-the money amount, with 
an adjustment for out-of-the money options to be not less than 100% of 
the option premium plus \3/4\% of the underlying contract value. The 
Phlx plans to collect margin within five days following the date on 
which a customer enters into a 3D FCO position and within two days if 
the option has two weeks or less to expiration. The Phlx has indicated 
that the proposed margin would cover the historical volatility over the 
preceding three years of the Japanese yen over a five-day period with a 
97.50% level of confidence.\16\ Accordingly, the Commission believes 
that the Phlx's propsoed margin level will result in adequate coverage 
for 3D JY Options. Because the volatility of foreign currencies can 
change significantly, the Commission expects the Phlx to monitor the 
adequacy of margin levels for 3D JY Options to ensure that the required 
margin remains appropriate in view of the volatility of the underlying 
instrument.\17\

    \16\Telephone conversation between Michele Weisbaum, Associate 
General Counsel, Phlx, and John Ayanian, Attorney, OMS, Market 
Regulation, Commission, on November 22, 1995.
    \17\In this regard, the Commission would view coverage of less 
than 97.50% as problematic. If coverage should fall below this 
level, the Exchange will immediately notify the Commission's 
Division of Market Regulation.
---------------------------------------------------------------------------

E. Market Impact

    The Commission believes that the listing and trading of 3D JY 
Options will not adversely affect the spot or derivative foreign 
currenly markets. First, the Commission notes that the interbank 
foreign currency spot market is an extremely large, diverse market 
comprised of banks and other financial institutions worldwide. That 
market is supplemented by equally deep and liquid markets for 
standardized options and futures on foreign currencies and options on 
those futures. There is also an active OTC market for FCOs.
    Further, as noted above, the Phlx applies its existing FCO 
surveillance procedures to the 3D FCOs, which should enable the 
Exchange to conduct, deter, as well as detect, trading abuses involving 
the 3D JY Options market and the markets for the underlying Japanese 
yen.

F. Conclusion and Accelerated Approval of Amendment No. 2

    Based on the above, the Commission believes that the proposed rule 
change is consistent with the requirements of the Act and the rules and 
regulations 

[[Page 61280]]
thereunder applicable to a national securities exchange, and, in 
particular, the requirements of Section 6(b)(5) of the Act.\18\ 
Additionally, the Commission notes that implementation of this proposed 
rule change is contingent upon the Commission's receipt of OPRA's 
representation that it has adequate systems capacity to process 
quotations and trades in the proposed 3D JY Options.\19\

    \18\15 U.S.C. 78f(b)(5).
    \19\See supra note 13.
---------------------------------------------------------------------------

    The Commission finds good cause for approving Amendment No. 2 to 
the proposed rule change prior to the thirtieth day after the date of 
publication of the notice thereof in the Federal Register. In Amendment 
No. 2, the Phlx represented that the provisions for calculating and 
disseminating the settlement value for the 3D Japanese yen options will 
be exactly the same as used for the 3D German mark options. The 
Commission believes that because the provisions for calculating and 
disseminating the settlement value for the 3D Japanese yen options will 
be exactly the same as used for the 3D German mark options, and contain 
adequate back-up procedures in case of system failure or other 
problems, no new regulatory issues are raised. Accordingly, the 
Commission believes that it is consistent with Sections 6(b)(5) and 
19(b)(2) of the Act to approve Amendment No. 2 to the Phlx proposal on 
an accelerated basis.

V. Solicitation of Comments

    Interested persons are invited to submit written data, views and 
arguments concerning Phlx Amendment No. 2. 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 20549. Copies of such filing will also be available 
for inspection and copying at the principal office of the Phlx. All 
submissions should refer to SR-Phlx-95-42 and should be submitted by 
December 20, 1995.
    It is therefore ordered, pursuant to Section 19(b)(2) of the 
Act,\20\ that the proposed rule change (File No. SR-phlx-95-42), as 
amended, is approved.

    \20\15 U.S.C. 78s(b)(2).
---------------------------------------------------------------------------

    For the Commission, by the Division of Market Regulation, 
pursuant to delegated authority.\21\

    \21\17 CFR 200.30-3(a)(12).
---------------------------------------------------------------------------

Margaret H. McFarland,
Deputy Secretary.
[FR Doc. 95-29152 Filed 11-28-95; 8:45 am]
BILLING CODE 8010-01-M