[Federal Register Volume 60, Number 234 (Wednesday, December 6, 1995)]
[Rules and Regulations]
[Pages 62323-62326]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 95-29618]



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SECURITIES AND EXCHANGE COMMISSION

17 CFR Part 240

[Release No. 34-36530, International Series Release No. 893, File No. 
S7-26-95]
RIN 3235-AG65


Exemption of the Securities of the United Mexican States Under 
the Securities Exchange Act of 1934 for Purposes of Trading Futures 
Contracts on Those Securities

AGENCY: Securities and Exchange Commission.

ACTION: Final rule.

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SUMMARY: The Securities and Exchange Commission (``SEC'' or 
``Commission'') is adopting an amendment to Rule 3a12-8 under the 
Securities Exchange Act of 1934 that would designate debt obligations 
issued by the United Mexican States (``Mexico'') as ``exempted 
securities'' for the purpose of marketing and trading futures contracts 
on those securities in the United States. The purpose of this amendment 
is solely to permit futures on Mexican Government debt to be traded in 
the United States. This change is not intended to have any substantive 
effect on the operation of the Rule.

EFFECTIVE DATE: December 6, 1995.

FOR FURTHER INFORMATION CONTACT: James T. McHale, Attorney, Office of 
Market Supervision, Division of Market Regulation, Securities and 
Exchange Commission (Mail Stop 5-1), 450 Fifth Street, N.W., 
Washington, D.C. 20549, at 202/942-0190.

SUPPLEMENTARY INFORMATION:

I. Introduction

    Under the Commodity Exchange Act (``CEA''), it is unlawful to trade 
a futures contract on any individual security, unless the security in 
question is an exempted security (other than a municipal security) for 
the purposes of the Securities Act of 1933 (``Securities Act'') or the 
Securities Exchange Act of 1934 (``Exchange Act'').1 Debt 
obligations of foreign governments are not exempted securities under 
either of these statutes. The Commission, however, has adopted Rule 
3a12-8 under the Exchange Act (``Rule'')2 to designate debt 
obligations issued by certain foreign governments as exempted 
securities under the Exchange Act solely for the purpose of marketing 
and trading futures contracts on those securities in the United States. 
The foreign governments currently designated in the Rule are Great 
Britain, Canada, Japan, Australia, France, New Zealand, Austria, 
Denmark, Finland, the Netherlands, Switzerland, Germany, the Republic 
of Ireland, Italy, and the Kingdom of Spain (the ``Designated Foreign 
Governments''). As a result of being included in the Rule, futures 
contracts on the debt obligations of these countries may be sold in the 
United States, as long as the other terms of the Rule are satisfied.

    \1\The term ``exempted security'' is defined in Section 3 of the 
Securities Act, 15 U.S.C. 77c, and Section 3(a)(12) of the Exchange 
Act, 15 U.S.C. 78c(a)(12).
    \2\17 CFR 240.3a12-8.
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    On September 11, 1995, the Commission issued a release proposing to 
amend Rule 3a12-8 to designate the debt obligations of Mexico as 
exempted securities, solely for the purpose of futures trading.3 
Four commentators, the 

[[Page 62324]]
Chicago Mercantile Exchange (``CME''), Euro Brokers Investment 
Corporation (``Euro Brokers''), Sakura Dellsher, Inc. (``SDI''), and 
Centre Financial Products Limited (``Centre Financial''), submitted 
letters supporting the proposal.4

    \3\See Securities Exchange Act Release No. 36213 (``Proposing 
Release'') (September 11, 1995), 60 FR 48078 (September 18, 1995).
    \4\See Letter from William J. Brodsky, President and Chief 
Executive Officer, CME to Jonathan G. Katz, Secretary, Commission, 
dated October 18, 1995; letter from Donald R.A. Marshall, President, 
Euro Brokers to Jonathan G. Katz, Secretary, Commission, dated 
October 18, 1995; letter from Leo Melamed, Chairman and Chief 
Executive Officer, SDI to Jonathan G. Katz, Secretary, Commission, 
dated October 18, 1995; and letter from Richard L. Sandor, Ph.D., 
Chairman and Chief Executive Officer, Centre Financial to Jonathan 
G. Katz, Secretary, Commission, dated October 19, 1995.
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    The Commission is adopting this amendment to the Rule, adding 
Mexico to the list of countries whose debt obligations are exempted by 
Rule 3a12-8. In order to qualify for the exemption, futures contracts 
on debt obligations of Mexico would have to meet all the other 
requirements of the Rule.

II. Background

    Rule 3a12-8 was adopted in 19845 pursuant to the exemptive 
authority in Section 3(a)(12) of the Exchange Act in order to provide 
limited relief from the CEA's prohibition on the trading of futures 
overlying individual securities.6 As originally adopted, the Rule 
provided that debt obligations of the United Kingdom and Canada would 
be deemed to be exempted securities, solely for the purpose of 
permitting the offer, sale, and confirmation of ``qualifying foreign 
futures contracts'' on such securities, so long as the securities in 
question were neither registered under the Securities Act nor the 
subject of any American depositary receipt so registered. A futures 
contract on such a debt obligation is deemed under the Rule to be a 
``qualifying foreign futures contract'' if delivery under the contract 
is settled outside the United States and is traded on a board of 
trade.7

    \5\Securities Exchange Act Release Nos. 20708 (``Original 
Adopting Release'') (March 2, 1984), 49 FR 8595 (March 8, 1984) and 
19811 (``Original Proposing Release'') (May 25, 1983), 48 FR 24725 
(June 2, 1983).
    \6\In enacting the Futures Trading Act of 1982, Congress 
expressed its understanding that neither the SEC nor the Commodity 
Futures Trading Commission (``CFTC'') had intended to bar the sale 
of futures contracts on debt obligations of the United Kingdom of 
Great Britain and Northern Ireland (``United Kingdom'') to U.S. 
persons, and its expectation that administrative action would be 
taken to allow the sale of such futures contracts in the United 
States. See Original Proposing Release, supra note 5, 48 FR at 24725 
[citing 128 Cong. Rec. H7492 (daily ed. September 23, 1982) 
(statements of Representatives Daschle and Wirth)].
    \7\As originally adopted, the Rule required that the board of 
trade be located in the country that issued the underlying 
securities. This requirement was eliminated in 1987. See Securities 
Exchange Act Release No. 24209 (March 12, 1987), 52 FR 8875 (March 
20, 1987).
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    The conditions imposed by the Rule were intended to facilitate the 
trading of futures contracts on foreign government securities in the 
United States while requiring offerings of foreign government 
securities to comply with the federal securities laws. Accordingly, the 
conditions set forth in the Rule were designed to ensure that, absent 
registration, a domestic market in foreign government securities would 
not develop, and that markets for futures on these instruments would 
not be used to avoid the securities law registration requirements.
    Subsequently, the Commission amended the Rule to include the debt 
securities issued by Japan, Australia, France, New Zealand, Austria, 
Denmark, Finland, the Netherlands, Switzerland, Germany, Ireland, 
Italy, and Spain.8

    \8\As originally adopted, the Rule applied only to British and 
Canadian government debt securities. See Original Adopting Release, 
supra note 5. In 1986, the Rule was amended to include Japanese 
government debt securities. See Securities Exchange Act Release No. 
23423 (July 11, 1986), 51 FR 25996 (July 18, 1986). In 1987, the 
Rule was amended to include debt securities issued by Australia, 
France and New Zealand. See Securities Exchange Act Release No. 
25072 (October 29, 1987), 52 FR 42277 (November 4, 1987). In 1988, 
the Rule was amended to include debt securities issued by Austria, 
Denmark, Finland, the Netherlands, Switzerland, and West Germany. 
See Securities Exchange Act Release No. 26217 (October 26, 1988), 53 
FR 43860 (October 31, 1988). In 1992 the Rule was again amended to 
(1) include debt securities offered by the Republic of Ireland and 
Italy, (2) change the country designation of ``West Germany'' to the 
``Federal Republic of Germany,'' and (3) replace all references to 
the informal names of the countries listed in the Rule with 
references to their official names. See Securities Exchange Act 
Release No. 30166 (January 6, 1992), 57 FR 1375 (January 14, 1992). 
Finally, the Rule was amended to include debt securities issued by 
the Kingdom of Spain. See Securities Exchange Act Release No. 34908 
(October 27, 1994), 59 FR 54812 (November 2, 1994).
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    The CME has informed the Commission that U.S. citizens may be 
interested in futures products based on the debt obligations of Mexico, 
and has requested that Rule 3a12-8 be amended to facilitate such 
trading.9 The CME has represented that it intends to develop a 
contract market in Mexican Certificados de la Tesoreria de la 
Federacion (``Cetes''), which are short-term Mexican government 
securities, and in Mexican Brady bonds, a class of longer term 
sovereign Mexican debt issues.10 Mexican Brady bonds were issued 
pursuant to the Brady plan, which allows developing countries to 
restructure their commercial bank debt by issuing long-term dollar 
denominated bonds.11 The Commission understands that Mexican Brady 
bonds are currently traded primarily in the over-the-counter market in 
the United States.

    \9\See Letter from William J. Brodsky, President and Chief 
Executive Officer, CME, to Arthur Levitt, Jr., Chairman, Commission, 
dated May 3, 1995.
    \10\The marketing and trading of foreign futures contracts is 
subject to regulation by the CFTC. In particular, Section 4b of the 
CEA authorizes the CFTC to regulate the offer and sale of foreign 
futures contracts to U.S. residents, and Rule 9 (17 CFR 30.9), 
promulgated under Section 2(a)(1)(A) of the CEA, is intended to 
prohibit fraud in connection with the offer and sale to U.S. persons 
of futures contracts executed on foreign exchanges. Additional rules 
promulgated under 2(a)(1)(A) of the CEA govern the domestic offer 
and sale of futures and options contracts traded on foreign boards 
of trade. These rules require, among other things, that the domestic 
offer and sale of foreign futures be effected through the CFTC 
registrants or through entities subject to a foreign regulatory 
framework comparable to that governing domestic futures trading. See 
17 CFR 30.3, 30.4, and 30.5 (1991).
    \11\There are several types of Brady bonds, but ``Par Bradys'' 
and ``Discount Bradys'' represent the great majority of issues in 
the Brady bond market. In general, both Par Bradys and Discount 
Bradys are secured as to principal at maturity by U.S. Treasury 
zero-coupon bonds. Additionally, usually 12 to 18 months of interest 
payments are also secured in the form of a cash collateral account, 
which is maintained to pay interest in the event that the sovereign 
debtor misses an interest payment.
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    The Commission is amending Rule 3a12-8 to add Mexico to the list of 
countries whose debt obligations are deemed to be ``exempted 
securities'' under the terms of the Rule. Under this amendment, the 
existing conditions set forth in the Rule (i.e., that the underlying 
securities not be registered in the United States,12 that the 
futures contracts require delivery outside the United States,13 
and that the contracts be traded on a board of trade) would continue to 
apply.

    \12\The Commission notes that neither Mexican Cetes nor Mexican 
Brady bonds are currently registered in the United States. The 
Commission is aware, however, that certain Mexican sovereign debt is 
registered in the United States and that the trading of futures on 
these debt issues would not be exempted under Rule 3a12-8 from the 
CEA's prohibition on the trading of futures overlying individual 
securities that are not exempted securities.
    \13\The CME's proposed futures contracts will be cash-settled 
(i.e., settlement of the futures contracts will not entail delivery 
of the underlying securities). The Commission has recognized that a 
cash-settled futures contract is consistent with the requirement of 
the Rule that delivery must be made outside the United States. See 
Securities Exchange Act Release No. 25072 (October 29, 1987), 52 FR 
42277 (November 4, 1987).
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III. Discussion

A. Comment Letters

    As noted above, the Commission received four comment letters, all 
in support of the proposal.14 The CME additionally recommended 
that the Commission eliminate its practice of granting exemptions under 
the Rule on 

[[Page 62325]]
a country-by-country basis.15 In support of adding Mexico to the 
list of Designated Foreign Governments in the Rule, the CME restated 
its belief that futures on Mexican sovereign debt would serve a 
valuable economic purpose and would benefit both U.S. investors and the 
Mexican economy. The CME asserted that Mexican Brady bonds are actively 
traded in the over-the-counter market in the United States, and that 
dealers and investors in Mexican Brady bonds could use the CME's 
proposed futures contracts to hedge the price risk in holding the 
underlying bonds.

    \14\See supra note 4.
    \15\Instead of the current country-by-country analysis, the CME 
suggested that the Commission's approach should be to permit futures 
trading on any country's sovereign debt, provided that the futures 
contracts do not allow delivery of unregistered foreign government 
securities in the United States. See CME comment letter, supra note 
4. This approach would require an amendment to Rule 3a12-8 that has 
not been proposed at this time.
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    Euro Brokers noted that while the underlying cash market for 
emerging market debt securities, including Mexico, has experienced 
considerable growth, there does not exist a proper hedging vehicle for 
positions in emerging market debt. According to Euro Brokers, this lack 
of an effective hedging tool limits the growth, liquidity, and 
stability of the market. If the CME is permitted to market and trade 
futures contracts on Mexican sovereign debt, Euro Brokers asserted, 
traders and investors will have the ability to hedge their exposure, 
thus generating depth, liquidity, and stability for the emerging 
markets as a whole both in the cash and futures markets.
    SDI additionally suggested that the Commission be ``flexible'' in 
allowing the debt obligations of additional foreign governments to 
qualify for such exempt status.
    Finally, according to Centre Financial, the fact that Mexico's debt 
is not rated in one of the two highest rating categories by at least 
two Nationally Recognized Statistical Rating Organizations (``NRSROs'') 
is immaterial when considering the obligations as the basis of a 
futures or options contract. Moreover, Centre Financial suggested that 
the Commission consider an exemption for all sovereign debt, thereby 
allowing individual exchanges to determine whether a futures or options 
contract on a country's debt is appropriate.
    It should be noted that in the Proposing Release, the Commission 
sought comment on: the appropriateness of designating Mexican sovereign 
debt as exempted securities even though its long-term debt is not rated 
in one of the two highest rating categories by at least two NRSROs (a 
factor the Commission has traditionally looked to as an indication of 
the liquidity of the underlying market); whether debt ratings should 
continue to be used in evaluating proposals to add countries to the 
Rule, and what alternative criteria, such as volume and depth of 
trading or amount of outstanding debt, could be used; whether the 
proposed amendment is appropriate in light of the fact that Mexico 
would be the first emerging market country to be included as a 
Designated Foreign Government; whether the CME's proposal to develop a 
contract market in Mexican Brady bonds raises any unique issues; and 
the general application and operation of the Rule given the increased 
globalization of the securities markets since the Rule was adopted. The 
commenters did not address all of these issues, but instead focused on 
the economic benefits of including Mexico as a Designated Foreign 
Government and adopting a liberal approach for further amendments to 
the Rule to include the sovereign debt of other countries.

B. Analysis

    For the reasons discussed below, the Commission finds that it is 
consistent with the public interest and the protection of investors 
that Rule 3a12-8 be amended to include the sovereign debt obligations 
of Mexico. The Commission believes that the trading of futures on 
Mexican sovereign debt could provide U.S. investors and dealers with a 
vehicle for hedging the risks involved in holding Mexican debt 
instruments and that the sovereign debt of Mexico should be subject to 
the same regulatory treatment under the Rule as that of the Designated 
Foreign Governments for purposes of trading futures contracts on such 
debt obligations by U.S. persons.
    In determining whether to amend the Rule to add new countries, the 
Commission has considered whether there is an active and liquid 
secondary trading market in the particular sovereign debt. The market 
for Mexican sovereign debt instruments appears to be active and liquid. 
As of March 31, 1995, there was approximately US$87.5 billion face 
amount Mexican government debt issued and outstanding of various 
classes and maturities.16 According to the CME petition, the cash 
market for Cetes evidences active trading. For example, between 1993 
and 1994 the monthly trading volume (in principal amount), according to 
the CME, of Cetes ranged from a low of approximately US$18.5 billion to 
a high of US$1.1 trillion. Moreover, according to a recent survey of 
members of the Emerging Markets Traders Association (``EMTA''), Mexican 
debt instruments are one of the most actively traded of all emerging 
markets instruments. According to the survey, the total annual trading 
volume for Mexican Brady bonds amounted to approximately US$282.3 
billion.17 As is the case for all sovereign issuers, there are 
less actively traded Mexican sovereign debt issues, but the Commission 
believes that as a whole the market for Mexican sovereign debt is 
sufficiently liquid and deep for purposes of Rule 3a12-8.

    \16\See Exhibit D to Form 18-K, Annual Report for Foreign 
Governments and Political Subdivisions Thereof, filed by Mexico on 
June 30, 1995.
    \17\The survey, which was responded to by 80 out of 333 members 
of the EMTA, was prepared for the EMTA by Price Waterhouse LLP. See 
1994 Debt Trading Volume Survey, Emerging Markets Traders 
Association (May 1, 1995).
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    In amending the Rule to include the debt obligations of Mexico, 
however, the Commission has considered additional factors relating to 
Mexican government debt. In connection with some of the prior 
amendments to the Rule, the Commission noted that the long-term 
sovereign debt of those countries was rated in one of the two highest 
rating categories by at least two NRSROs.18 This factor, as 
previously stated by the Commission, could be viewed as indirect 
evidence of an active and liquid secondary trading market. Mexico's 
long-term sovereign debt obligations are not rated in one of the two 
highest rating categories.19

    \18\See Securities Exchange Act Release No. 26217 (October 26, 
1988), 53 FR 43860 (October 31, 1988) (Austria, Denmark, Finland, 
the Netherlands, Switzerland, and [West] Germany); Securities 
Exchange Act Release No. 30166 (January 6, 1992), 57 FR 1375 
(Republic of Ireland and Italy); Securities Exchange Act Release No. 
34908 (October 27, 1994), 59 FR 54812 (November 2, 1994) (Kingdom of 
Spain).
    \19\As of June, 1995, Standard and Poor's Corp. (``S&P'') rated 
Mexico's long-term foreign currency debt BB and its long-term local 
currency debt BBB+. As of the same date, Mexico's Bonos de 
Desarrollo (Bondes) were rated Baa3 by Moody's Investors Service.
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    Although the Commission in 1987 proposed to incorporate a rating 
standard specifically exempting securities issued by any country with 
outstanding long-term sovereign debt rated in one of the two highest 
rating categories by at least two NRSROs,20 it ultimately declined 
to adopt such a rule.21 At the time of the 1987 Rule 

[[Page 62326]]
proposal, the Commission expressed concerns that in the absence of such 
a requirement, the Rule might be used as a subterfuge to market or 
trade unregistered sovereign foreign debt through futures trading. The 
Commission, however, indicated that it did not intend to preclude 
futures trading on foreign debt that did not meet this ratings 
requirement and indeed subsequently sought comment on the feasibility 
of other factors for consideration, such as volume and depth of trading 
in a sovereign issuer's debt.

    \20\See Securities Exchange Act Release No. 24428 (May 5, 1987), 
52 FR 18237 (May 14, 1987).
    \21\See Securities Exchange Act Release No. 25072 (October 29, 
1987), 52 FR 42277 (November 4, 1987).
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    As discussed above, the Commission has independently determined 
that it is appropriate to exempt the sovereign debt of Mexico under the 
Rule because of the overall depth and liquidity of the existing cash 
market for Mexican sovereign debt. The Commission does not believe that 
either Mexico's status as an emerging market country with potentially 
more volatile debt prices, or its issuance of Brady bonds changes this 
conclusion.
    In the Proposing Release the Commission solicited comment on 
whether there are alternative approaches to the country-by-country 
designation process for adding countries to the Rule. The Commission 
intends to consider this issue further, but does not believe it should 
delay the inclusion of Mexico in the list of Designated Foreign 
Governments pending action on a more generic approach. Nevertheless, 
the Commission continues to welcome suggestions on an objective means 
of including countries within Rule 3a12-8 that are consistent with the 
Rule's overall objectives.

IV. Regulatory Flexibility Act Consideration

    Chairman Levitt has certified in connection with the Proposing 
Release that this amendment, if adopted, would not have a significant 
economic impact on a substantial number of small entities. The 
Commission received no comments on this certification.

V. Effects on Competition and Other Findings

    Section 23(a)(2) of the Exchange Act22 requires the 
Commission, in adopting rules under the Exchange Act, to consider the 
competitive effects of such rules, if any, and to balance any impact 
with the regulatory benefits gained in terms of furthering the purposes 
of the Exchange Act. The Commission has considered the amendment to the 
Rule in light of the standards cited in section 23(a)(2) and believes 
that adoption of the amendment will not impose any burden on 
competition not necessary or appropriate in furtherance of the purposes 
of the Exchange Act. As stated above, the amendment is designed to 
assure the lawful availability in this country of Mexican government 
bond futures that otherwise would not be permitted to be marketed under 
the terms of the CEA. The amendment thus serves to expand the range of 
financial products available in the United States and enhances 
competition in financial markets. Insofar as the Rule contains 
limitations, they are designed to promote the purposes of the Exchange 
Act by ensuring that futures trading on Mexican government securities 
is consistent with the goals and purposes of the Federal securities 
laws by minimizing the impact of the Rule on securities trading and 
distribution in the United States.

    \22\15 U.S.C. 78w(a)(2).
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    Because the amendment to the rule is exemptive in nature, the 
Commission has determined to make the foregoing action effective 
immediately upon publication in the Federal Register.23

    \23\15 U.S.C. 553(d).
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VI. Statutory Basis

    The amendment to rule 3a12-8 is being adopted pursuant to 15 U.S.C. 
78a et seq., particularly sections 3(a)(12) and 23(a), 15 U.S.C. 
78c(a)(12) and 78w(a).

List of Subjects in 17 CFR Part 240

    Reporting and recordkeeping requirements, Securities.

VII. Text of the Adopted Amendment

    For the reasons set forth above, the Commission is amending part 
240 of chapter II, title 17 of the Code of Federal Regulations as 
follows:

PART 240--GENERAL RULES AND REGULATIONS, SECURITIES EXCHANGE ACT OF 
1934

    1. The authority citation for part 240 continues to read in part as 
follows:

    Authority: 15 U.S.C. 77c, 77d, 77g, 77j, 77s, 77eee, 77ggg, 
77nnn, 77sss, 77ttt, 78c, 78d, 78i, 78j, 78l, 78m, 78n, 78o, 78p, 
78q, 78s, 78w, 78x, 78ll(d), 79q, 79t, 80a-20, 80a-23, 80a-29, 80a-
37, 80b-3, 80b-4 and 80b-11, unless otherwise noted.
* * * * *
    2. Sec. 240.3a12-8 is amended by removing the word ``or'' at the 
end of paragraph (a)(1)(xiv), removing the ``period'' at the end of 
paragraph (a)(1)(xv) and adding ``; or'' in its place, and adding 
paragraph (a)(1)(xvi) to read as follows:


Sec. 240.3a12-8  Exemption for designated foreign government securities 
for purposes of futures trading.

    (a) * * *
    (1) * * *
    (xvi) the United Mexican States.
* * * * *
    By the Commission.

    Dated: November 30, 1995.
Margaret H. McFarland,
Deputy Secretary.
[FR Doc. 95-29618 Filed 12-5-95; 8:45 am]
BILLING CODE 8010-01-U