[Federal Register Volume 64, Number 164 (Wednesday, August 25, 1999)]
[Notices]
[Pages 46356-46361]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 99-22013]



[[Page 46356]]

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COMMODITY FUTURES TRADING COMMISSION


Petition of the Chicago Board of Trade, the Chicago Mercantile 
Exchange, and the New York Mercantile Exchange for Exemption Pursuant 
to Section 4(c) of the Commodity Exchange Act

AGENCY: Commodity Futures Trading Commission.

ACTION: Notice of petition for exemption and request for comment.

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SUMMARY: The Chicago Board of Trade, the Chicago Mercantile Exchange, 
and the New York Mercantile Exchange have submitted a joint petition 
dated June 25, 1999, to the Commodity Futures Trading Commission 
requesting an exemption, pursuant to Section 4(c) of the Commodity 
Exchange Act, for all boards of trade that have been designed by the 
Commission as contract markets from certain statutory requirements 
concerning the contract market designation process for new contract 
submissions and the contract market rule review process. The Commission 
believes that publication of the petition for comment in the public 
interest, will assist the Commission in considering the views of 
interested persons, and is consistent with the purposes of the 
Commodity Exchange Act and the Commission's regulations. The full text 
of the petition is reproduced at the end of this Notice.

DATES: Comments must be received on or before October 12, 1999.

ADDRESSES: Comments should be submitted to Jean A. Webb, Secretary, 
Commodity Futures Trading Commission, Three Lafayette Centre, 1155 21st 
Street, NW, Washington, DC 20581. Comments also may be sent by 
facsimile to (202) 418-5521 or by electronic mail to 
[email protected]. Reference should be made to the ``Petition of the 
Chicago Board of Trade, the Chicago Mercantile Exchange, and the New 
York Mercantile Exchange for Exemption Pursuant to Section 4(c) of the 
Commodity Exchange Act.''.

FOR FURTHER INFORMATION CONTACT: Rebecca L. Creed, Attorney, Division 
of Trading and Markets, Commodity Futures Trading Commission, Three 
Lafayette Centre, 1155 21st Street, NW, Washington, DC 20581. Telephone 
number (202) 418-5430; electronic mail [email protected].

SUPPLEMENTARY INFORMATION: 

I. Introduction

    By letter dated June, 1999, and received June 28, 1999, the Chicago 
Board of Trade, the Chicago Mercantile Exchange, and the New York 
Mercantile Exchange (collectively referred to as the ``Exchanges'') 
submitted a joint petition to the Commodity Futures Trading Commission 
(``Commission'' or ``CFTC''), pursuant to Section 4(c) of the Commodity 
Exchange Act (``Act''),\1\ requesting an exemption for all boards of 
trade that have been designated by the Commission as contract markets 
from certain statutory requirements. Specifically, the petition 
requests an exemption from the Act's requirements in three areas: (1) 
the contract market designation process for new contract submissions, 
set forth in Sections 5 and 6 of the Act and any related statutory 
provisions, including Section 2(a)(8)(B)(ii) of the Act; (2) the 
contract market rule review process, set forth in Section 5a(a)(12) of 
the Act; and (3) pertinent provisions of the Act that would otherwise 
prevent the immediate adoption and implementation of trading rules an 
procedures that are comparable to those of a competing foreign 
exchange.
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    \1\ Section 4(c) of the Act states in relevant part:
    Unless exempted by the Commission pursuant to subsection (c), it 
shall be unlawful for any person to offer to enter into, to enter 
into, to execute, to confirm the execution of, or to conduct any 
office or business anywhere in the United States, its territories or 
possessions, for the purpose of soliciting, or accepting any order 
for, or otherwise dealing in, any transaction in, or in connection 
with, a contract for the purchase or sale of a commodity for future 
delivery (other than a contract which is made on or subject to the 
rules of a board of trade, exchange, or market located outside the 
United States, its territories or possessions) unless--
    (1) such transaction is conducted on or subject to the rules of 
a board of trade which has been designated by the Commission as a 
`contract market' for such commodity;
    (2) such contract is executed or consummated by or through a 
member of such contract market; and
    (3) such contract is evidenced by a record in writing which 
shows the date, the parties to such contract and their addresses, 
the property covered and its price, and the terms of delivery * * *.
    Section 4(c) of the Act provides the Commission with the 
authority ``by rule, regulation, or order'' after notice and 
opportunity for hearing to exempt ``any agreement, contract, or 
transaction (or class thereof)'' from the requirements of Section 
4(a) or from any other provision of the Act, with the exception of 
the Shad-Johnson Accord provisions of Section 2(a)(1)(B) (stock 
index futures).
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    The Exchanges' petition was filed in response to the Commission's 
Order dated June 2, 1999. That Order withdrew the Commission's proposed 
rules governing the use of automated trading systems in the United 
States (``U.S.'') which provide access to foreign electronic boards of 
trade.\2\ The Order also directed Commission staff ``to begin 
immediately processing no-action requests from foreign boards of trade 
seeking to place trading terminals in the United States, and to issue 
responses where appropriate, pursuant to the general guidelines 
included in the Eurex (DTB) no-action process, or other guidelines 
established by the Commission, to be reviewed and applied as 
appropriate on a case-by-case basis.'' \3\ Finally, by the same Order, 
the Commission determined to ``commit to simultaneously initiate 
processes to address the comparative regulatory levels between U.S. and 
foreign electronic trading systems so as not to provide one with a 
competitive advantage.''
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    \2\ See 64 FR 14159 (March 24, 1999) (proposed rules); 64 FR 
32829 (June 18, 1999) (announcement of withdrawal of proposed 
rules).
    \3\ In February 1996, the Commission's Division of Trading and 
Markets (``Division'') issued a no-action letter to the Deutsche 
Terminborse (``DTB''), an automated international futures and 
options exchange headquartered in Frankfurt, Germany. DTB has 
subsequently changed its name to Eurex Deutschland (``Eurex''). In 
this no-action letter, the Division agreed, subject to certain 
conditions, not to recommend enforcement action to the Commission if 
Eurex placed computer terminals in the U.S. offices of its members 
for principal trading and, where the Eurex member is also a futures 
commission merchant (``FCM'') registered with the Commission under 
the Act, for trading on behalf of U.S. customers as well, without 
Eurex being designated as a U.S. contract market. See CFTC 
Interpretative Letter No. 96-28 [1994-1996 Transfer Binder] Comm. 
Fut. L. Rep. (CCH) para.26,669 (Feb. 29, 1996).
    Subsequent to receiving the Exchanges' petition for exemptive 
relief, on July 23, 1999, the Division granted a no-action request 
submitted by LIFFE Administration and Management (which operates The 
London International Financial Futures and Options Exchange) to make 
its electronic trading and order matching system available to its 
members in the U.S. Similarly, on August 10, 1999, the Division 
granted the no-action requests submitted on behalf of Eurex, the 
Sydney Futures Exchange Limited, the New Zealand Futures and Options 
Exchange Limited, and the ParisBourse SBF SA with respect 
to the placement of their respective electronic trading and order 
matching systems in the U.S.
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    The Exchanges state that their petition for exemptive relief should 
be in order to avoid unfair competition from foreign exchanges that 
have been or will be permitted to place their electronic trading 
systems in the U.S. pursuant to no-action letters issued by Commission 
staff.\4\ Since these foreign exchanges will not be required to obtain 
Commission designation as contract markets in order to operate in the 
U.S., the Exchanges state that they will not be

[[Page 46357]]

subject to the same statutory and regulatory requirements as existing 
U.S. contract markets. The Exchanges state that this no-action process 
severely hampers their ability to compete with such foreign exchanges.
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    \4\ Currently, U.S. customers can access the products offered by 
foreign exchanges by: (1) communicating through a U.S. registered 
FCM or introducing broker (``IB'') (where the FCM or IB would relay 
the cutomer's order for execution to a foreign member of the foreign 
exchange by telephone, facsimile transmission, or other means); (2) 
communicating with a foreign firm that has received an exemption 
from registration under Part 30 of the Commission's regulations; or 
(3) utilizing cross-exchange access programs or other trading links 
between U.S. contract markets and foreign exchanges (see e.g., the 
trading of Marche a Terme International de France products through 
Chicago Mercantile Exchange Globex terminals located in the U.S.).
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    The Commission wishes to emphasize that it has not made any prior 
judgment with respect to any element of the Exchanges' petition for 
exemptive relief and that it will give serious consideration to all of 
the issues raised by, and the comments received on, the petition. The 
Commission urges members of the interested public, including U.S. 
contract markets, market participants, Commission registrants and end-
users, as well as other federal government regulators to comment on all 
aspects of the petition.

II. The Exchanges' Petition for Exemption

A. Contract Market Designation Process for New Contract Submissions

    Through their petition, the Exchanges are requesting that all 
boards of trade designated by the Commission as contract markets be 
exempt from complying with the contract market designation process for 
new contract submissions set forth in Sections 5 and 6 of the Act as 
well as any related statutory provisions, including Section 
2(a)(8)(B)(ii) of the Act. The Exchanges state that they need the 
ability to list new contracts without being subject to the Act's review 
and approval process in order to remain competitive with foreign 
exchanges that have been or will be allowed to place electronic trading 
systems in the U.S. without being designated as contract markets by the 
Commission.

B. Review of New Rules or Rule Amendments

    Through their petition, the Exchanges request that all boards of 
trade designated by the Commission as contract markets be exempt from 
complying with the contract market rule review process set forth in 
Section 5a(a)(12) of the Act.\5\ Instead, the Exchanges are proposing 
that U.S. contract markets be required to provide notice of new rules 
or rule amendments to the Commission ten days in advance of the 
effective date. New rules and rule amendments submitted pursuant to 
this exemptive procedure would not be stayed or delayed unless the 
Commission determined that the rule was likely to cause fraud, render 
trading readily susceptible to manipulation, or threaten the financial 
integrity of the market.
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    \5\ In their petition, the Exchanges indicate they are not 
requesting relief from those provisions of Section 5a(a)(12) of the 
Act which related to emergency rules. The Commission presumes that 
the Exchanges are not seeking an exemption from the contract market 
rule disapproval provisions of Section 5a(a)(12).
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C. Immediate Adoption and Implementation of Contract Market Trading 
Rules and Procedures That Are Comparable to Those of Competing Foreign 
Exchanges

    Finally, the Exchanges are requesting that all boards of trade 
designated by the Commission as contract markets be exempt from 
pertinent provisions of the Act that would otherwise prevent such 
contract markets from responding immediately to competition from a 
foreign exchange authorized to operate trading terminals in the U.S. 
Specifically, under the exemptive relief requested by the Exchanges in 
their petition, any designated contract market would be able to 
implement trading rules and procedures comparable to those of the 
competing foreign exchange, provided that such rules and procedures 
would only apply to contracts listed by the U.S. contract market that 
are subject to direct competition from a contract listed by such 
foreign exchange. Under this procedure, designated contract markets 
would be able to adopt and implement such trading rules and procedures 
immediately upon submission to the Commission of the following 
materials: (1) the text of the rules and procedures being adopted; and 
(2) a certification that a foreign exchange employs comparable rules 
and procedures for a contract that directly competes with a contract 
listed by the U.S. contract market.

III. Request for Comment

    The Commission requests comment on all aspects of the Exchanges' 
petition for exemption, including the issues identified below.
    (1) The no-action process by which foreign exchanges are allowed to 
place their electronic trading terminals in the U.S. permits these 
exchanges to have limited access to the U.S. markets. For example, when 
the Division recently granted a no-action request submitted on behalf 
of LIFFE to make its electronic trading system available in the U.S., 
the Division imposed certain conditions that, among other things, 
require LIFFE to adhere to periodic reporting requirements apprising 
the Commission of the level of its business activity in the U.S. 
Moreover, if LIFFE wishes to make new contracts or products available 
in the U.S. through its electronic trading system, LIFFE must request 
and obtain supplementary no-action relief from the Division. To the 
extent that LIFFE substantially increases the quantity or modifies the 
nature of its business activity within the U.S., the Division has the 
discretion to re-examine the relief granted to LIFFE and, if 
appropriate, the Commission could require it to become designated as a 
contract market under Section 5 of the Act. Do the limitations on the 
degree of access that foreign exchanges will have to the U.S. markets 
pursuant to no-action positions alter the need for any of the exemptive 
relief sought by the Exchanges in their petition?
    (2) In their petition, the Exchanges specifically request that all 
boards of trade designated by the Commission as contract markets be 
exempt from complying with the contract market designation process for 
new contract submissions set forth in Sections 5 and 6 of the Act as 
well as any related statutory provisions, including Section 
2(a)(8(B)(ii) of the Act. The Commission recently proposed a two-year 
pilot program to permit the immediate listing of certain new contracts 
for trading for a specified period of time prior to obtaining 
Commission approval.\6\ Please discuss whether the Commission's 
proposed rulemaking addresses the Exchange's stated need for relief in 
this area.
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    \6\ See 64 FR 40528 (July 27, 1999).
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    (3) In their petition, the Exchanges specifically request that all 
boards of trade designated by the Commission as contract markets be 
exempt from complying with the contract market rule review process set 
forth in Section 5a(a)(12) of the Act. Alternatively, the Exchanges 
propose that contract markets be required to provide notice of new 
rules or rule amendments to the Commission ten days in advance of the 
effective date and that the review of such proposals not be stayed or 
delayed unless the Commission determined that the rule was ``likely to 
cause fraud, render trading readily susceptible to manipulation, or 
threaten the financial integrity of the market.''
    (a) Is this standard sufficient for the Commission to carry out its 
statutory obligations?
    (b) In additional to fraud, manipulation, and financial integrity 
issues, are there any other issues which the Commission should address 
when determining whether to stay or delay the immediate implementation 
of proposed contract market rules or rule amendments?
    (4) Please discuss the impact of any legal uncertainty on contract 
markets and market users if the Commission were to undertake 
disapproval of

[[Page 46358]]

contract market rules after their implementation.
    (5) In their petition, the Exchanges specifically request that all 
boards of trade designated by the Commission as contract markets be 
exempt from pertinent provisions of the Act that would otherwise 
prevent such contract markets from responding immediately to 
competition from those foreign exchanges authorized to operate trading 
terminals in the U.S. Specifically, under this area of requested 
exemptive relief, contract markets would be able to adopt and implement 
trading rules and procedures comparable to those of competing foreign 
exchanges immediately upon their submission to the Commission along 
with certain accompanying certifications when the foreign exchanges are 
offering contracts in direct competition with those of a U.S. exchange.
    (a) Under the proposal, it might be possible for a single U.S. 
contract to be subject to rules drawn from a number of different 
competing foreign exchanges. It also might be possible for different 
contracts trading side-by-side at a particular U.S. contract market to 
be subject to different sets of rules based upon the rules of competing 
foreign exchanges. Please discuss the implications of these 
possibilities, including their impact, if any, upon the ability of the 
Commission, the contract markets, or Commission registrants to 
discharge their regulatory responsibilities.
    (b) The Exchanges preface their specific requests for exemptive 
relief with the general request that the ``Commission exercise its 
authority under Section 4(c) of the Act and grant certain exemptions 
from provisions of the Act except for . . . the provisions that 
prohibit manipulation.'' If the Commission were to grant the exemptive 
relief requested, could the Commission and the contract markets ensure 
that such comparable trading rules and procedures were not inconsistent 
with the Act's prohibitions against fraud and manipulation?
    (c) Implicit in the Exchanges' petition is the notion that rules 
established for electronic trading on foreign exchanges could be 
applied to open outcry markets. Are there any public interest issues 
raised by applying rules designed for electronic trading systems to 
open outcry markets?
    (6) The Commission's public comment process provides an opportunity 
to interested parties, both private and governmental, to comment on any 
issues related to proposed contracts and significant contract market 
rule changes (e.g., electronic trading systems, alternative execution 
procedures). Under the Exchanges' petition, proposals in each of the 
three areas of requested relief would not be subject to a public 
comment period. Please discuss whether the lack of a public comment 
process would have any impact on the ability of the Commission to 
discharge its regulatory responsibilities in these areas.
    (7) In their petition, the Exchanges indicate that U.S. contract 
markets may be disadvantaged by the ability of foreign exchanges to pay 
for order flow and/or provide inducements for market makers or 
customers to trade their products. What are the differences between 
foreign exchange rules related to order flow and liquidity programs and 
the U.S. contract market rules that the Commission has approved in 
these areas? \7\
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    \7\ See, e.g., Coffee Sugar & Cocoa Exchange Registered Market 
Maker Program (approved by the Commission on April 30, 1991); 
Chicago Board of Trade Modified Market Maker Program for the 
Wilshire Small Cap Index Futures Contract (allowed into effect 
without prior Commission approval on June 18, 1993); Chicago 
Mercantile Exchange Principal Market Maker Program (approved by the 
Commission on April 20, 1995); New York Mercantile Exchange 
Specialist Market Maker Program (approved by the Commission on July 
8, 1998).
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    (8) In their petition, the Exchanges state that, in contrast to 
foreign exchanges, U.S. contract markets are unable to adopt certain 
trading methodologies that provide guaranteed price and/or execution 
quantity. In June 1999, the Commission issued an Advisory on 
Alternative Execution, or Block Trading, Procedures for the Futures 
Industry,\8\ in which it announced its intention to consider contract 
market proposals to adopt similar alternative execution methodologies. 
Please discuss whether there are any modifications that could be made 
to the Commission's Advisory that would further address the Exchanges' 
concerns in this regard. Please also discuss the extent to which such 
changes would be consistent with the Commission's responsibilities for 
ensuring the integrity and economic utility of futures markets and 
protecting market participants against manipulation, abusive trade 
practices, and fraud.
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    \8\ See FR 31195 (June 10, 1999); 64 FR 34851 (June 29, 1999) 
(corrections).
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    (9) In their petition, the Exchange states that U.S. contract 
markets are not permitted to delay the reporting of transaction 
information in order to accommodate market participants who desire to 
withhold relevant information about their transactions until they have 
been able to act in another market or execute additional transactions. 
The Exchanges believe that the ability of foreign exchanges to delay 
the reporting of certain types of transactions, such as block trades, 
to the general marketplace will enable them to capture market share 
from U.S. contract markets. Please discuss whether there are any 
modifications that could be made to the Commission's Block Trading 
Advisory that would further address the Exchanges' concerns in this 
regard. Please also discuss the extent to which such change would be 
consistent with the Commission's responsibilities as described in 
question 8 above.
    (10) In their petition, the Exchanges state that the Commission, in 
its review of U.S. contract markets' electronic trading systems, 
requires account identification information to be entered into trading 
terminals prior to the execution of customer orders. The Exchanges 
believe that U.S. contract markets may lose market share to competing 
foreign exchanges that are not subject to such a requirement. The 
Commission has allowed bunched orders for certain eligible customers to 
be placed on a contract market without specific customer account 
identification, either at the time of order placement or at the time of 
reporting order execution.\9\ Please discuss whether there are 
modifications that could be made to the approach taken by the 
Commission in this regard that would be responsive to the Exchanges' 
concerns. Please also discuss the extent to which such changes would be 
consistent with the Commission's responsibilities as described in 
question 8 above.
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    \9\ See 63 FR 45699 (August 27, 1998).
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    (11) In their petition, the Exchanges state that U.S. contract 
markets may not launch new products on their electronic trading systems 
pending the Commission's review and approval of system performance, 
capacity and security tests. The Exchanges further state that their 
foreign competitors will not be subject to the same review and approval 
process. The Commission notes that its review of newly created 
electronic trading systems has been, and continues to be, based on 
principles developed by the international regulatory community--
specifically the International Organization of Securities Commissions 
(``IOSCO'').\10\ Should the Commission's review of electronic trading 
systems be based on standards

[[Page 46359]]

other than or different from those contained in the IOSCO principles?
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    \10\ See IOSCO, Report of the Technical Committee, Screen-Based 
Trading Systems for Derivative Products (June 1990).
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IV. Conclusion

    As noted above, the full text of the Exchanges' petition is 
reproduced below.

    Issued in Washington, DC, on August 19, 1999 by the Commission.
Catherine D. Dixon,
Assistant Secretary of the Commission.

Chicago Mercantile Exchange

June 25, 1999.
Ms. Jean A. Webb,
Office of the Secretariat, Commodity Futures Trading Commission, 
1155 21st Street, N.W., Washington, D.C. 20581

Re: Petition for Exemption Pursuant to Section 4(c).

Dear Ms. Webb:
    On behalf of the Chicago Board of Trade, Chicago Mercantile 
Exchange and New York Mercantile Exchange, I am submitting the 
enclosed petition to the Commission pursuant to Section 4(c) of the 
Commodity Exchange Act.

        Very truly yours,
Carl A. Royal.
    Enclosure.

Petition for Exemption Pursuant to Section 4(c) of the Commodity 
Exchange Act

June 25, 1999
    Pursuant to Section 4(c) of the Commodity Exchange Act 
(``Act''), the Chicago Board of Trade (``CBOT''), Chicago Mercantile 
Exchange (``CME'') and New York Mercantile Exchange (``NYMEX''), 
designated contract markets with their principal places of business 
in the United States (the ``Exchanges''), respectfully petition the 
Commodity Futures Trading Commission (``Commission'' or ``CFTC'') 
for exemptive relief. This petition seeks exemptions necessary to 
promote responsible innovation and fair competition. This request is 
made in response to the Commission Order dated June 2, 1999, 
instructing CFTC staff ``to begin immediately processing no-action 
requests from foreign boards of trade seeking to place trading 
terminals in the United States. . . .''
    Granting this petition is essential to permit the Exchanges to 
avoid unfair competition in the United States from foreign exchanges 
that have been and will be permitted to establish trading facilities 
in this country pursuant to no-action letters issued by CFTC staff. 
Those foreign exchanges have not sought designation to operate as 
contract markets in the United States and therefore will not be 
required to comply with the Commodity Exchange Act.
    The Exchanges requested that this petition be processed and 
approved in an expedited fashion to comply with the terms of the 
Commission's Order of June 2, 1999, and with Senator Richard Lugar's 
letter to the Commission dated May 6, 1999. It is essential that the 
relief afforded to U.S. exchanges be timed so that foreign exchanges 
are not afforded any unfair competitive advantage. Some of those 
foreign exchanges are subject to far less regulation than U.S. 
exchanges and employ trading rules and procedures that are 
prohibited by the Act. If foreign exchanges receive no-action relief 
before this petition is granted, the Exchanges will be placed at a 
severe competitive disadvantage.

I. Relief Sought

    The Exchanges seek permission to respond, without delay, to any 
new contract, contract amendment, advantageous trading practice, or 
less costly regulatory device offered or likely to be offered by 
foreign exchanges on U.S. based trading terminals. This principle 
means that the Exchanges must to be able to list new contracts and 
amend existing contracts without being delayed by a lengthy CFTC 
approval process. The Exchanges must be free to offer any trading 
methodology, including prearranged trades, cross trades, block 
trades, etc., offered any trading methodology, including prearranged 
trades, cross trades, block trades, etc., offered by a foreign 
exchange, and such trades must be accompanied by the same reporting 
requirements that might make the foreign exchange a more attractive 
venue. The Exchanges must be free to offer the same order entry 
procedures employed by such foreign exchanges if those order entry 
and customer identification procedures make it more attractive to 
trade on the foreign exchange. The Exchanges must be free to operate 
and modify their trading systems with no more governmental 
interference than is imposed on the foreign exchanges.
    In order to promote responsible innovation and fair competition, 
the Exchanges hereby respectfully requests that the Commission 
exercise its authority under Section 4(c) of the Act and grant 
certain exemptions from provisions of the Act except for Sections 
4(a), 2(a)(1)(B), and the provisions that prohibit manipulation. The 
Exchanges request that the exemption be granted in the following 
form:
    Pursuant to its powers under Section 4(c)(1) of the Commodity 
Exchange Act, the Commission hereby determines, consistent with the 
public interest and in order to promote responsible economic or 
financial innovation and fair competition, that notwithstanding any 
other provision of law, rule, regulation or order of the Commission:
    Boards of trade that have been designated as contract markets:
    1. Shall be exempted, to the extent of the Commission's power 
under Section 4(c)(1), from complying with the contract market 
designation process for new contract submissions under sections 5 
and 6 of the Act as well as any related regulations or statutory 
provisions, including section 2(a)(8)(B)(ii) of the Act.
    2. Shall be exempted, to the extent of the Commission's power 
under Section 4(c)(1), from the rule approval provisions of section 
5a(a)(12) of the Act and related regulations, except the provisions 
relating to emergency rules, if the contract market provides notice 
of new rules or rule changes to the Commission 10 days in advance of 
the effective date. Rules submitted pursuant to this exemption shall 
not be stayed or delayed unless the Commission finds that the rule 
is likely to cause fraud, render trading readily susceptible to 
manipulation or threaten the financial integrity of the market. The 
Commission's power to alter or supplement any rule change 
implemented pursuant to this exemption shall not be diminished.
    3. Shall be exempted, to the extent of the Commission's power 
under section 4(c)(1), to permit such contract market to respond to 
competition from any foreign exchange authorized to locate trading 
terminals in the U.S. Any designated contract market may implement 
trading rules and procedures comparable to those of the competing 
foreign exchange, provided that such rules and procedures shall 
apply only to contracts listed by the contract market that are 
subject to direct competition from contract listed by such foreign 
exchange. The contract market may adopt and implement such rules and 
procedures immediately upon its submission to the Commission of (i) 
the text of the rules and procedures being adopted and (ii) its 
certification that the foreign exchange employs comparable rules and 
procedures for trading a contract that competes directly with the 
contract listed by the contract market.

II. Statutory Background

    On October 28, 1992, the Futures Trading Practices Act of 1992 
(the ``1992 Act') was signed into law. The 1992 Act added new 
Section 4(c)(1) to the Act and authorized the Commission, by rule, 
regulation or order, to exempt any agreement, contract or 
transaction, or class thereof, from the exchange-trading 
requirements of Section 4(a) or any other requirement of the Act 
other than Section 2(a)(1)(B) of the Act. In granting exemptive 
authority to the CFTC under Section 4(c), the Conferees states: 
``The Conferees intend that the Commission, in considering fair 
competition, will implement this provision in a fair and even-handed 
manner to products and systems sponsored by exchanges and non-
exchanges alike.''\1\
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    \1\ House Conference Report No. 102-978 to H.R. 707. p. 78.
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III. Standards for Exemptive Relief

    Section 4(c)(1) of the Act provides that the Commission may 
exempt any agreement, transaction or contract from any provisions of 
the Act (except Section 2(a)(1)(B)) if the Commission determines 
that the exemption would be consistent with the public interest. In 
this regard, the Conferees stated that the ``public interest'' under 
Section 4(c) includes the ``national public interests noted in the 
Act, the prevention of fraud and the preservation of the financial 
integrity of the markets, as well as the promotion of responsible 
economic or financial innovation and fair competition.'' The 
Conference Report noted that the reference to the purposes of the 
Act was intended ``to underscored [the] expectation that the 
Commission will assess the impact of a proposed exemption on the 
maintenance of the integrity and soundness of markets and market 
participants.''\2\
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    \2\ Id.
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    The Commission was granted authority to:
``exempt any agreement, contract, or transaction (or class thereof) 
that is otherwise subject to subsection 9a) of this section [the

[[Page 46360]]

exchange trading requirement] (including any person or class of 
persons offering, entering into, rendering advice or rendering other 
services with respect to, the agreement, contract, or transaction), 
either unconditionally or on stated terms or conditions or for 
states periods and either retroactively or prospectively, or both, 
from any of the requirements of subsection (a) of this section, or 
from any other provision of this chapter (except section 2a of this 
title), if the Commission determines that the exemption would be 
consistent with the public interest.''
    In plain language, the Commission was authorized to grant a 
designated contact market an exemption from any provision of the 
CEA, other than the exchange trading requirements and the Shad/
Johnson Accord, if the Commission determined that the ``exemption 
would be consistent with the public interest.'' The exchange trading 
requirements set forth in Section 4(a) are:
    1. such transaction is conducted on or subject to the rules of a 
board of trade which has been designated by the Commission as a 
``contact market'' for such commodity;
    2. such contract is executed or consummated by or through a 
member of such contract market; and
    3. such contract is evidenced by a record which shows the date, 
the parties to such contract and their addresses, the property 
covered and its price, and the terms of delivery: Provided, That 
each contract market member shall keep such record for a period of 
three years from the date thereof, or for a longer period if the 
Commission shall so direct, which record shall at all times be open 
to the inspection of any representative of the Commissioner or the 
Department of Justice.
    Finally, Section 15 of the Act provides, in pertinent part, that 
the CFTC must consider the public interest to be protected by the 
antitrust laws and endeavor to take the least anticompetitive means 
of achieving the objectives, policies, and purposes of the Act in 
adopting any exemption under Section 4(c) of the Act. As set forth 
below, approval of the petition is in accordance with the standards 
enumerated in the Act, while denial of this petition would clearly 
violate the strictures of Section 15.

IV. The Petition Satisfies the Statutory Standards for Relief

    The Commission has apparently decided to permit foreign futures 
exchanges to operate electronic trading systems in the U.S. without 
seeking designation as contract markets or an exemption from 
designation. In consequence, U.S. futures exchanges face a 
devastating, unfair challenge. U.S. exchanges will be required to 
compete in the U.S. under the burden of a heavy regulatory handicap 
that does not apply to foreign exchanges offering U.S. customers 
clone contracts on identical trading facilities.
    The pending no-action letters are sought to immunize foreign 
exchanges from the same provisions of the Commodity Exchange Act 
that constrain U.S. exchanges' ability to respond to competition. 
For example, some foreign exchanges will be able to list new 
products and change contract terms and conditions without waiting 
for approval from any regulator. Foreign exchanges could clone and 
trade the most important contracts traded on U.S. exchanges and 
capture U.S. exchange business by using competitive devices that are 
not available to U.S. exchanges. For example, some foreign exchanges 
could pay for order flow, permit pre-arranged trades, facilitate 
block trades with delayed price reporting, dispense with strict 
audit trail rules, and allow large traders to escape reporting 
requirements.
    Open systems allow customers to chose between comparable 
contracts listed by competing exchanges available for trading on the 
same terminal. Minor differences between the regulatory environments 
of the competing exchanges can have enormous impacts on order flow. 
While every exchange must accept the verdict that will be rendered 
in a fair competitive environment, no exchange should be forced to 
compete with severe constraints on its ability to offer equivalent 
trading practices.
    Therefore, the Commission should not admit foreign exchanges 
without acting to permit U.S. based exchanges to compete on the same 
regulatory terms with the foreign exchanges. The Commission should 
immediately exercise its power under Section 4(c) of the Act to 
permit the U.S. futures exchanges to operate under the same 
standards and conditions that govern such foreign exchanges admitted 
into the U.S.
    The following issues, which are illustrative of a far longer 
list, are among those that need to be addressed by exempting U.S. 
exchanges from the constraints of the Act in order to respond to 
foreign competition. Eventually, these issues should be resolved by 
statutory amendment.
    1. Pre-approval of Contracts, Contract Amendments and Rules: The 
competitive impact of permitting foreign exchanges to clone and list 
U.S. exchange contract inventions while U.S. exchanges are trapped 
in a lengthy approval process is devastating. The same is true with 
respect to rules regarding new trading methods or even changes to 
existing contracts.
    2. Payment for Order Flow: Even if a U.S. exchange has a 
tangibly better trading environment for customers, the lure of 
payment for order flow and the difficulty of demonstrating actual 
damages to customers is likely to decide a competitive battle. If 
U.S. exchanges cannot counter competitive attacks based on such 
payments, the focus of liquidity is likely to move. Once moved, it 
cannot easily be recaptured, especially if the foreign exchange has 
no constraint on its ability to respond.
    3. Inducements to Make Markets or Trade: Customer business 
ordinarily follows liquidity. A short-term program to buy liquidity, 
if it cannot be matched by the U.S. exchange for regulatory reasons, 
can change the long-term location of markets without any benefit to 
customers.
    4. Guaranteed Pricing or Execution: U.S. exchanges cannot permit 
the type of prearrangement involved in guaranteeing price or 
execution quantity. The philosophy of the Act is to discover 
accurate prices through open competition. Firms that profit more 
from arranging such trades than the commission that would be earned 
through bringing a customer to an open outcry market will divert 
business to the foreign exchange that permits such practices.
    5. Large Trade Reporting, Position Limits: Position limits are 
controlled by Section 4a of the Act. The statutory limitations do 
not apply to foreign exchanges that trade contracts that directly 
impact interstate commerce. The Commission imposed large trader 
reporting requirements by regulation on contracts traded on 
designated exchanges. See parts 16, 17 18, 19 and 21. Such limits 
will not apply to U.S. customers trading on foreign exchange 
terminals in the U.S. even if the contracts are clones of U.S. 
exchange contracts. Position limits and reporting requirements have 
been seen to impact the choice of trading venue by sophisticated 
customers. Many large sophisticated traders can be expected to 
transfer their business to foreign exchanges to avoid limits and 
disclosure.
    6. Price Reporting: Many significant customers would rather 
withhold information about their trades until they have been able to 
act in another market or execute additional transactions. The 
Commission has precluded U.S. markets from delaying price reports 
for such purposes. The Act does not require real time price reports. 
If a competing foreign exchange, operating on the same terminal as a 
U.S. exchange, offers to delay reporting of large block trades, it 
is predictable where such trades will be registered. In fact LIFFE 
permits block traders to delay price reports.
    7. Account Identification: Neither the Act nor the Regulations 
specifically require that the account identifying number be entered 
into the trading terminal prior to execution of the customer order. 
However, the CFTC staff has imposed such a requirement as a 
condition of approval of U.S. exchange electronic trading systems. 
Orders are being entered on foreign exchange trading terminals in 
the U.S. without first entering an account identifier. If the same 
contract can be traded on two exchanges, and one slows order entry 
with technical requirements, it is clear which exchange will get the 
business.
    8. System Performance, Capacity and Security: In addition to 
burdening U.S. exchanges by requiring that new contracts and trading 
rules be approved in advance, the Commission has precluded U.S. 
exchanges from launching new products on their electronic trading 
systems until it has reviewed and approved performance and capacity 
tests. Foreign competitors will not be equally constrained under the 
proposed no-action approach.

V. Conclusion

    The exemptive relief requested by this petition should be 
granted immediately. If the Commission grants the pending no-action 
requests of foreign exchanges to install trading terminals in the 
U.S. before the Exchanges achieve regulatory parity, the Exchanges 
would be placed at a severe competitive disadvantage. Granting no-
action relief to foreign exchanges while refusing to grant 
commensurate relief to the U.S.

[[Page 46361]]

Exchanges would violate both Section 4(c) and Section 15 of the Act.

[FR Doc. 99-22013 Filed 8-24-99; 8:45 am]
BILLING CODE 6351-01-M