[Federal Register Volume 66, Number 120 (Thursday, June 21, 2001)]
[Notices]
[Pages 33283-33286]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 01-15624]


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SECURITIES AND EXCHANGE COMMISSION

[Release No. 34-44434; File No. SR-OCC-2001-05]


Self-Regulatory Organizations; The Options Clearing Corporation; 
Order Granting Approval of a Proposed Rule Change Relating to Clearing 
Security Futures

June 15, 2001.
    On March 21, 2001, The Options Clearing Corporation (``OCC'') filed 
with the Securities and Exchange Commission (``Commission'') and on 
April 16, 2001, amended a proposed rule change (File No. SR-OCC-2001-
05) pursuant to Section 19(b)(1) of the Securities Exchange Act of 1934 
(``Act'').\1\ Notice of the proposal was published in the Federal 
Register on April 30, 2001.\2\ Three comment letters were received.\3\ 
For the reasons discussed below, the Commission is granting approval of 
the proposed rule change.
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    \1\ 15 U.S.C. 78s(b)(1).
    \2\ Securities Exchange Act Release No. 44212, (April 23, 2001), 
66 FR 21425.
    \3\ Letters to Jonathan Katz, Secretary, SEC, from Chris 
Concannon, Vice President, The Island ECN, Inc. (May 21, 2001) 
(``Island letter''); William H. Navin, Executive Vice President and 
General Counsel, OCC (June 1, 2001) (``OCC letter''); and Fulbright 
& Jaworski, L.L.P., on behalf of The Philadelphia Stock Exchange, 
(June 7, 2001) (``PHLX letter'').
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I. Description

    The Commodity Futures Modernization Act (``CFMA''), which became 
law on December 21, 2000, eliminated the preexisting ban on trading in 
futures contracts on individual securities and narrow-based stock 
indices. Such ``security futures'' will be permitted to be traded on a 
principal to principal basis between ``eligible contract participants'' 
on August 21, 2001, and by other classes of customers on December 21, 
2001. The purpose of OCC's proposed rule change is to make an initial 
identification of the kinds of markets for whom OCC will clear 
transactions in security futures.
    OCC proposed to amend its By-Laws to provide that OCC may clear 
transactions in security futures effected on any national securities 
exchange or association registered under Section 6(a) or 15A(a) of the 
Act, as amended, or any ``designated contract market'' (as that term is 
used in the Commodity Exchange Act (``CEA'')) that is registered as a 
national securities exchange under Section 6(g) of the Act.
    OCC anticipates that some or all of OCC's five participant 
exchanges will trade security futures, either on the participant 
exchange itself or on an affiliated futures exchange. OCC expects that 
it will therefore enter into the business of clearing security futures. 
However, the types of entities that can provide a marketplace for 
security futures include markets in addition to the options exchanges 
that are OCC's participant exchanges. These include other national 
securities exchanges and national securities associations as well as 
any ``board of trade'' that has been designated as a ``contract 
market'' under the CEA. An SEC-regulated market that wishes to trade 
security futures is required to obtain a limited-purpose registration 
as a designated contract market in security futures products under the 
CEA through a notice filing with the Commodity Futures Trading 
Commission (``CFTC''). A CFTC-regulated market trading security futures 
is required to obtain a limited-purpose registration with the 
Commission as a national securities exchange under a similar procedure. 
Each market will be regulated primarily by the agency (i.e., the 
Commission or the CFTC) with which it is fully registered.
    OCC believes that it is well-positioned to clear security futures 
for any of these types of markets. OCC's role as the common 
clearinghouse for equity options offers opportunities for margin 
offsets and other efficiencies that would not be as readily available 
if positions in security futures were carried with other 
clearinghouses. OCC's settlement interface with the National Securities 
Clearing Corporation gives OCC the

[[Page 33284]]

ready ability to effect delivery of underlying stocks with respect to 
physically settled security futures. Because of OCC's experience and 
expertise in adjusting equity option contracts to compensate for 
various corporate actions, OCC is prepared to perform the same 
necessary function for security futures. Finally, OCC, as a securities 
clearing agency, is legally able to clear security futures transactions 
originating on any type of market whereas a futures clearinghouse 
cannot clear security futures transactions originating on national 
securities exchanges that are registered with the Commission pursuant 
to Section 6(a) of the Act without registering as a securities clearing 
agency.\4\
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    \4\ 15 U.S.C. 78q-1(b)(1).
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    Clearing members have conveyed to OCC their desire to consolidate 
clearance, settlement, and collateralization of similar or hedgeable 
products. This need grows in urgency with the scale of the collateral 
necessary to support the growing security derivatives markets.
    OCC believes that by clearing security futures, it will minimize 
the scale and cost of collateral, maximize the efficiency of clearance 
and settlement, reduce systemic risk, provide the best possible service 
to clearing members at the lowest possible price, and ultimately will 
reduce costs to investors. Therefore, as an initial step in providing 
clearing services for security derivatives markets, OCC wishes to begin 
clearing stock futures transactions for any national securities 
exchange or association registered under Section 6(a) or 15A(a) of the 
Act or any ``designated contract market'' (as that term is used in the 
CEA) that is registered as a national securities exchange under Section 
6(g) of the Act.
    Because these products and the systems and other infrastructure 
needed to clear them are still being designed and developed, OCC has 
not yet filed a complete set of rules for clearing security futures. 
These rules, including a proposed form of clearing agreement for 
security futures, will be filed subsequently under Rule 19b-4. However, 
OCC filed the present rule filing to identify for which markets OCC 
will initially clear so those markets and OCC can begin preparing for 
the start of security futures trading, which can begin on August 21, 
2001.
    Accordingly, the proposed amendment to Article I of OCC's By-Laws 
defines a separate category of market--a ``security futures market''--
for whom OCC would clear transactions in security futures. The 
definition of ``security futures market'' includes certain marketplaces 
for security futures under the provisions of the CFMA other than 
participant exchanges.\5\ A security futures market would not be 
defined as an ``exchange'' under OCC's By-Laws, and OCC would be simply 
a provider of clearing services to such markets.\6\ For convenience, 
however, the terms ``exchange transaction,'' ``exchange rules,'' and 
``exchange member'' would be redefined to include transactions on, and 
the rules and members of, as the case may be, a security futures 
market.\7\
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    \5\ At the present, OCC does not define the term ``security 
futures market'' to include an ``alternative trading system'' or a 
``derivatives transaction execution facility'' even though such 
markets may also trade security futures under provisions of the 
CFMA.
    \6\ A security futures market would not be defined as an 
exchange under OCC's By-Laws because such market would not be 
required to purchase OCC stock, would not have representation on the 
OCC board, and would not be required to execute a participant 
agreement under Article VII of OCC's By-Laws.
    \7\ The term ``security futures market'' is included in the 
above-named terms in OCC's rules so that OCC will be able to clear 
security futures for such a market.
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    OCC anticipates that it will clear security futures transactions on 
the same terms and subject to the same clearing fees for any market for 
which it clears. However, OCC proposes to distinguish in limited ways 
between participant exchanges and security futures markets that are 
affiliated with a participant exchange, on the one hand, and non-
affiliated security futures markets on the other hand.
    For example, OCC proposes that markets other than participant 
exchanges and their affiliates be required to make some form of 
``investment'' in OCC analogous to the redeemable equity investments 
required of participant exchanges. However, OCC does not propose that 
such markets be offered common stock. Instead, OCC proposes that non-
affiliated security futures markets be required to make a ``good 
faith'' deposit with OCC of $250,000 to support the clearing of 
transactions for security futures.\8\ That deposit will be refunded to 
the security futures market in whole or in part if it ceases clearing 
security futures through OCC. OCC is considering formula that would fix 
the amount of the refund at the lesser of either the full amount of the 
original deposit or 50% of the amount of clearing fees received by OCC 
from clearing members as a result of transactions on that market (i.e., 
a kind of ``earn out'' provision).\9\
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    \8\ This is similar to the requirement that participant 
exchanges make an investment in OCC of common stock but is 
considerably less than the $1 million fee associated with making 
such an investment.
    \9\ Such completed formula will be subject to a future rule 
filing by OCC either as a statement of fees or as part of the 
clearing agreement for security futures.
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    OCC would not be obligated to undertake security futures clearing 
for any non-affiliated security futures market if it determined that to 
do so would tax OCC's resources in a way that would jeopardize OCC's 
ability to fully perform its other contractual and statutory 
responsibilities. Any OCC determination to refuse to undertake security 
futures clearing for a non-affiliated security futures market will be 
done on a fair and non-discriminatory basis.
    The proposed By-Law provision would also require an exchange or 
security futures market that wishes OCC to clear its transactions in 
security futures to enter into a clearing agreement with OCC that would 
define the business relationship between OCC and such market with 
respect to security futures. Additionally, as described below, OCC 
proposes covering security futures udner separate clearing agreements 
between it and the markets desiring to clear security futures 
transactions through OCC rather than to incorporate such agreements 
concerning security futures in the Restated Participant Exchange 
Agreement (``RPEA''). OCC anticipates that there will be separate but 
uniform (except for provisions relating to the good faith deposit 
required of non-affiliated security futures markets) clearing 
agreements with each exchange and security futures market that clears 
security futures through OCC. These agreements would cover some of the 
same matters covered in the RPEA but would omit inapplicable provisions 
relating to the registration statement on which OCC registers options, 
registration under state securities laws, and the options disclosure 
document. The clearing agreement would also contain appropriate 
indemnification of OCC and its officers and directors. The clearing 
agreement would terminate if the exchange or security futures market is 
no longer eligible to list security futures, no longer lists security 
futures despite being eligible to do so, or is in material breach of 
the clearing agreement.

II. Discussion

    Section 19(b)(2)(B) of the Act directs the Commission to approve a 
proposed rule change of a self-regulatory organization if it finds that 
such proposed rule change is consistent with

[[Page 33285]]

the requirements of the Act and the rules and regulations thereunder 
applicable to such organization. For the reasons set forth below, the 
Commission believes that OCC's proposed rule change is consistent with 
OCC's obligations under the Act. Specifically, the proposal rule change 
is consistent with Section 17A(b)(3)(A) of the Act which requies that a 
clearing agency be organized and have the capacity to be able to 
facilitate the prompt and accurate clearance and settlement of 
securities transactions and with Section 17A(b)(3)(F) which requires 
that the rules of a clearing agency be designed to promote the prompt 
and accurate clearance and settlement of securities transactions and to 
assure the safeguarding of securities and funds which are in the 
custody or control of the clearing agency or for which it is 
responsible.\10\ For the reasons set forth below, the Commission also 
finds that the proposed rule change is consistent with Section 
17A(b)(3)(I) of the Act which requires that the rules of a clearing 
agency not impose any burden on competition not necessary or 
appropriate in furtherance of the purposes of the Act.\11\
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    \10\ 15 U.S.C. 78q-1(b)(3)(A), (F).
    \11\ 15 U.S.C. 78q-I(b)(3)(I).
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A. Prompt and Accurate Clearance and Settlement of Securities 
Transactions

    Among other things, the CFMA amended the Act to include ``security 
future'' within the definition of ``security.'' \12\ Under Section 17A 
of the Act, registered clearing agencies are authorized to clear 
securities. OCC's proposed rule change amends its By-Laws to allow it 
to clear and settle security futures effected on any national 
securities exchange or association registered under Section 6(a) or 
15A(a) of the Act or on any ``designated contract market'' that is 
registered as a national securities exchange under Section 6(g) of the 
Act. OCC's proposed rule change is consistent with Sections 
17A(b)(3)(A) and (F) of the Act in that it should facilitate the prompt 
and accurate clearance and settlement of transactions in security 
futures by providing an efficient and reliable clearing facility for 
these instruments.
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    \12\ 15 U.S.C. 78c(a)(10).
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B. Clearing Agency Rules and the Burden on Competition

    In response to OCC's proposed rule change, the Commission received 
one negative comment letter, from The Island ECN, Inc. (``Island''). 
Island's main objection to the proposed rule change is that it does not 
include clearance and settlement provisions for Alternative Trading 
Systems (``ATSs''), of which Island is one. The Island letter urged the 
Commission to withhold its approval of the proposed rule change unless 
OCC opens its clearing services to all market participants that are 
allowed to trade security futures concurrent with national securities 
exchanges or associations. The Island letter asserts that because the 
CFMA allows an ATS to trade security futures, OCC must provide clearing 
services to ATSs with the current proposed rule change; otherwise, the 
Commission will be allowing OCC and its participant exchanges to 
eliminate or restrict any ATS competition that they may face.
    The Commission has carefully considered all relevant factors and 
disagrees with Island's views on the alleged anticompetitive effects of 
the proposed rule change. Section 17A(b)(3)(I) of the Act requires that 
a clearing agency's rules ``do not impose any burden on competition not 
necessary or appropriate in furtherance of the purposes of'' the 
Act.\13\ The Commission believes that OCC's proposal rule change is an 
appropriate first step in implementing the rules that will be needed to 
clear security futures for the security futures markets as they may 
develop. Indeed, OCC explicitly recognized in its proposed rule change 
that it will need to adopt additional rules governing security futures, 
such as the form of a clearing agreement, as the trading in these 
products and markets develop.
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    \13\ See also Securities Exchange Act of 1934, Section 3(f) (in 
reviewing rule of self-regulatory organization, Commission shall 
consider protection of investors, efficiency, competition, and 
capital formation) (emphasis added); See also Bradford Nat'l 
Clearing Corp. v. SEC, 191 U.S. App. D.C. 383; 590 F.2d 1085 (1978) 
(competition is one factor among others that the Commission must 
consider in connection with the approval of a clearing agency's 
rules).
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    The Commission believes that, due to the fact that this rule change 
does not foreclose OCC from clearing security futures for ATSs, 
approval of the proposed rule change will not burden competition or 
limit the ability of ATSs to trade and clear security futures. OCC's 
proposed rule change is only an initial step in its plans to undertake 
the clearance and settlement services for markets that trade security 
futures. In addition to the proposed rule change's explicit recognition 
that OCC plans to file additional proposed rule changes relating to the 
clearance and settlement of security futures, OCC staff has represented 
orally to Commission staff that at OCC's July 24, 2001, board meeting, 
OCC staff will recommend that OCC's board authorize the filing of a 
proposed rule change authorizing OCC to clear security futures for 
ATSs.\14\
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    \14\ Meeting between George Hender, Management Vice Chairman, 
William H. Navin, Executive Vice President and General Counsel, and 
Susan Milligan, First Vice President and Special Counsel, OCC, and 
staff of the Division of Market Regulation on May 24, 2001.
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    Island also asserts that if it were denied the ability to clear 
through OCC, Island would be precluded from trading security futures, 
which are required by Section 6(h)(1) of the Act to be listed on a 
national securities exchange or association, because OCC would be the 
only clearer for those security futures. Under Section 6(h)(1) of the 
Act, an ATS can trade a security future only if that security future is 
listed on a national securities exchange or association. The OCC letter 
points out that the security future traded by the ATS must have 
contract terms identical to the exchange or association-listed security 
future but that such identical contract terms do not mean that those 
security futures must be cleared by the same clearing organization.
    The Commission believes that OCC's interpretation in its letter is 
the correct one as to the clearing implications presented by Sections 
6(h)(1) and (5) of the Act. The Commission believes that the purpose of 
Section 6(h)(1) is to ensure that a regulated national securities 
exchange or national securities association establish terms for 
security futures and standards for the selection of underlying 
securities, consistent with the Act's listing standard requirements. 
Therefore, as long as the security futures satisfy these requirements 
and the coordinated surveillance and trading halt protections in 
Section 6(h)(5), they need not be cleared by OCC or any other specific 
clearing organization.
    In addition, the Commission disagrees with Island's assertion that 
OCC's proposed rule change fosters the same kind of anticompetitive 
behavior that is prohibited by the settlement accord that the options 
exchanges entered into with the Department of Justice and the 
Commission. OCC's proposed rule change does not foreclose the 
possibility of clearing for other entities, such as ATSs. Indeed, the 
proposed rule change expands the types of entities for which OCC will 
provide clearing services to include contract markets that are notice-
registered as securities exchanges with the Commission. OCC further 
represents in its proposed rule change that it expects it will clear 
security futures transactions on security futures markets on the same 
terms and subject to the same clearing fees that it will apply to 
security futures transactions originating

[[Page 33286]]

on the exchanges. Such equality of treatment is consistent with 
fostering competition.

C. Additional Provisions

    The Commission also believes that the provisions of OCC's proposed 
rule requiring (1) the deposit of $250,000 by non-affiliated security 
futures markets with OCC in return for the provision of security future 
clearing services, (2) the clearing agreement that OCC would enter into 
with an exchange or securities futures market before OCC undertakes to 
clear for either of those entities, and (3) the ability of OCC to 
refuse to undertake securities clearing for any non-affiliated security 
futures market if doing so would jeopardize OCC's ability to fully 
perform its other responsibilities, are consistent with Section 
17A(b)(3)(F) of the Act.
    The Commission believes that the $250,000 deposit to OCC in return 
for the provision of clearing services to non-affiliated security 
futures markets and the clearing arrangement are appropriate and 
consistent with Section 17A(b)(3)(F) of the Act because they will 
assist OCC and the security futures markets to set up the necessary 
arrangements whereby OCC can provide for the prompt and accurate 
clearance and settlement of securities transactions that take place on 
those markets.
    The Commission believes that allowing OCC to refuse clearing 
services to any non-affiliated security futures market if doing so 
would jeopardize OCC's ability to fully perform its other 
responsibilities is consistent with OCC's obligation under Section 
17A(b)(3)(F) of the Act to assure the safeguarding of securities and 
funds which are in OCC's custody or for which it is responsible because 
it allows OCC to avoid exposure to unnecessary financial and 
operational risks in a nondiscriminatory fashion.

III. Conclusion

    On the basis of the foregoing, the Commission finds that the 
proposed rule change is consistent with the requirements of the Act and 
in particular Section 17A of the Act and the rules and regulations 
thereunder.
    It is therefore ordered, pursuant to Section 19(b)(2) of the Act, 
that the proposed rule change (File No. SR-OCC-2001-05) be and hereby 
is approved.
    For the Commission by the Division of Market Regulation, pursuant 
to delegated authority.\15\
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    \15\ 17 CFR 200.30-3(a)(12).

Margaret H. McFarland,
Deputy Secretary.
[FR Doc. 01-15624 Filed 6-20-01; 8:45 am]
BILLING CODE 8010-01-M