[Federal Register Volume 67, Number 191 (Wednesday, October 2, 2002)]
[Notices]
[Pages 61943-61944]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 02-25010]


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SECURITIES AND EXCHANGE COMMISSION

[Release No. 34-46561; File No. SR-OCC-2002-09]


Self-Regulatory Organizations; The Options Clearing Corporation; 
Order Granting Approval of a Proposed Rule Change Relating to Fixing 
Settlement Prices in the Event of Market Disruptions

September 26, 2002.

I. Introduction

    On May 17, 2002, The Options Clearing Corporation (``OCC'') filed 
with the Securities and Exchange Commission (``Commission'') proposed 
rule change SR-OCC-2002-09 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 August 1, 2002.\2\ No comment 
letters were received. For the reasons discussed below, the Commission 
is approving the proposed rule change.
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    \1\ 15 U.S.C. 78s(b)(1).
    \2\ Securities Exchange Act Release No. 46265 (July 25, 2002), 
67 FR 49973.
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II. Description

    The primary purpose of the proposed rule change is to ensure that 
OCC will have the ability, in case of market disruptions, to conform 
settlement prices for OCC-cleared security futures and index options, 
where appropriate, to settlement prices that are used for related 
products (such as other futures on the same security or index) traded 
in other markets and not cleared by OCC. The proposed rule change will 
primarily affect the fixing of exercise settlement amounts for expiring 
options as well as final settlement prices for maturing futures 
contracts.\3\ OCC does not anticipate any substantive change in its 
present policy with respect to fixing settlement prices for options 
that are exercised prior to expiration.\4\
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    \3\ These will include single stock futures and narrow-based 
index futures as well as broad-based index futures subject to the 
exclusive jurisdiction of the Commodity Futures Trading Commission.
    \4\ That general policy will be restated in new Interpretation 
.02 to Section 4 of Article XVII of OCC's by-laws.
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    In the event of an interruption in the markets for an underlying 
security or one or more component securities in an underlying index, 
OCC needs to have discretion to act to set final settlement values in a 
manner that avoids inconsistencies between the futures and options 
markets and among futures markets.\5\ At times, investors employ 
hedging and other trading strategies that involve holding positions in 
different contracts on the same underlying security or index. These 
strategies are based on the expectation that the values of different 
derivative contracts with the same underlying interest will have a 
predictable relationship to one another. This expectation may not be 
met when trading halts or other disruptions in markets for the 
underlying interests require the derivatives markets to fix settlement 
prices using prices or values other than those that would normally be 
used. In such cases, discrepancies in settlement prices can occur 
unless prices for derivative products traded in different markets are 
fixed using a common method. Unless such coordination occurs, investors 
with positions in options and futures that were intended to hedge one 
another may find that the positions do not produce the anticipated 
offset.
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    \5\ This rule change will affect the fixing of final settlement 
prices for futures contracts and exercise settlement amounts for 
options. However, in the case of options exercised other than at 
expiration, coordination with other markets is ordinarily not a 
significant factor because either there is no concurrent final 
settlement in related futures markets or an investor need not 
exercise the option.
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    In the spring of 2000, OCC attempted to solve the problem of a 
potential disconnect between the options and futures markets in setting 
final index contract settlement prices by conforming its rules more 
closely to the rules of the Chicago Mercantile Exchange (``CME'') as 
then in effect.\6\ OCC's rule change broadened the circumstances under 
which OCC could fix a settlement price for expiring index options to 
include situations where market disruptions affected one or more 
securities in an index (as opposed to ``securities representing a 
substantial portion of the value of an index'') and added a paragraph 
relating solely to expiring options specifically permitting OCC to fix 
settlement prices based on the next opening prices for one or more 
component stocks.\7\
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    \6\ For example, CME Rule 2003.A., which governs the method for 
determining the final settlement price for Standard & Poor's 500 
Stock Index Futures, provided (at that time) as follows:
    If the primary market for a component stock in the index does 
not open on the day scheduled for determination of the Final 
Settlement Price, then the price of that stock shall be determined, 
for the purposes of calculating the Final Settlement Price, based on 
the opening price of that stock on the next day that its primary 
market is open for trading.
    If a component stock in the index does not trade on the day 
scheduled for determination of the Final Settlement Price while the 
primary market for that stock is open for trading, the price of that 
stock shall be determined, for the purposes of calculating the Final 
Settlement Price, based on the last sale price of that stock.
    \7\ Securities Exchange Act Release No. 42769 (May 9, 2000), 65 
FR 31036 (May 15, 2000) [SR-OCC-2000-01].
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    Effective December 1, 2001, CME changed its rules governing its 
method of fixing final settlement prices for each of its index futures 
products under certain circumstances. CME's newly amended rules provide 
that if the primary market for a component stock opens for trading on 
the day scheduled for determination of a final settlement price but the 
component stock does not trade while the market is open, the price of 
the component stock for purposes of calculating the final settlement 
price will be based on the last sale price of the stock unless CME's 
president or his delegate determines that there is a reasonable 
likelihood that trading in the component stock will occur shortly. In 
that case, for purposes of determining the final settlement price, the 
price of the component stock may be based on the opening price of the 
component stock on the next day the component stock is traded on its 
primary market.\8\
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    \8\ For example, CME added the following underlined language to 
CME Rule 2003.A:
    If a component stock in the index does not trade on the day 
scheduled for determination of the Final Settlement Price while the 
primary market for that stock is open for trading, the price of that 
stock shall be determined, for the purposes of calculating the Final 
Settlement Price, based on the last sale price of that stock. 
However, if the President of the Exchange or his delegate determines 
that there is a reasonable likelihood that trading in the stock 
shall occur shortly, the President or his delegate may instruct that 
the price of stock shall be based, for the purposes of calculating 
the Final Settlement Price, on the opening price of the stock on the 
next day that it is traded on its primary market. Factors to be 
considered in determining whether trading in the stock is likely to 
occur shortly shall include the nature of the event and recent 
liquidity levels in the affected stock.
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    OCC's existing rules do not authorize OCC to fix a settlement price 
based on a stock's next opening price in situations where the stock's 
primary market is open but the stock does not trade. SR-OCC-00-01 
authorized the use of opening values only in cases where a stock's 
primary market did not open or remain open for trading at or before the 
time when the exercise settlement amount would ordinarily be 
determined. As a result, OCC is again faced with a potential disconnect 
between its rules and CME's rules.
    The most fundamental aspect of SR-OCC-00-01 was that for the first 
time OCC was allowed to fix a settlement

[[Page 61944]]

value based on prices that occurred after an expiration and to treat 
options that were in the money based upon that subsequently determined 
price as having been exercised on the expiration date. This rule change 
makes more explicit the broad scope of OCC's discretion to invoke that 
authority and the broad discretion that OCC or an adjustment panel (in 
the case of options) has in fixing final settlement prices and exercise 
settlement amounts.\9\ The rule change also will make clear that OCC 
may follow the procedures in CME's current rule and may use either the 
latest closing prices for individual stocks that fail to trade or use 
opening prices for the next day on which the stock trades.
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    \9\ A supplement to the Options Disclosure Document that 
describes the substance of the by-law changes proposed herein has 
been filed with the Commission.
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    The authority to fix final settlement prices for futures and 
exercise settlement amounts for options in unusual market conditions 
should be sufficiently broad to ensure that the authority will exist to 
conform such settlement values to the settlement values established for 
related products traded in other markets whenever that result is 
deemed, on balance, to be in the best interest of investors. Experience 
has shown that this authority must be stated broadly so that if CME or 
other related markets in the future amend the circumstances in which 
they can fix settlement values or the means that they use to fix those 
values, OCC will not need to amend its rules further to conform. 
Because CME and other markets often do not coordinate with OCC when 
they change their rules governing the fixing of settlement values, OCC 
may not be able to conform its rules to amendments made by other 
markets quickly enough to avoid a disconnect between the futures and 
options markets. The rule change provides broad discretion both as to 
the circumstances in which authority would exist to fix a settlement 
value and the method by which the settlement value would be fixed.
    The primary purpose of the rule change is to give OCC broad 
discretionary authority to adjust settlement values for OCC-cleared 
index options and futures whenever, and in whatever manner, OCC deems 
appropriate to avoid a disconnect between the futures and options 
markets or among the futures markets. It is equally important to note, 
however, that such coordination is primarily of importance only when 
OCC-cleared options are exercised on expiration dates or when OCC-
cleared futures have maturity dates that coincide with the expiration, 
maturity, or delivery dates of related contracts traded in other 
markets. Accordingly, exercises of index options prior to the 
expiration date would not necessarily be adjusted to conform to 
activity in other markets. Finally, even in the case of final 
settlement values that would ordinarily correspond with final 
settlement values in other markets, the coordination of such settlement 
values is not the only factor that OCC (or an adjustment panel) will 
consider in deciding whether and how to fix settlement values. 
Accordingly, there could be circumstances where settlement values for 
OCC-cleared products would not be conformed to prices used in other 
markets even though the authority would exist to do so.

III. 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 the requirements of the 
Act and the rules and regulations thereunder applicable to such 
organization. Section 17A(b)(3)(F) of the Act requires that the rules 
of a clearing agency be designed to protect investors and the public 
interest.\10\ By being able in times of market disruptions to conform 
settlement prices for security futures and index options to settlement 
prices that are used for related products traded in other markets, OCC 
will be able to fix exercise prices to better meet investors' 
expectations in establishing hedged positions that the values of 
different derivatives contracts with the same underlying interest will 
have a predictable relationship to one another. As a result, investors 
will be better protected from losses resulting from market disruptions. 
Therefore, OCC's proposed rule change meets the requirements of section 
17A(b)(3)(F).
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    \10\ 15 U.S.C. 78q-1(b)(3)(F).
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IV. 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 with the requirements of section 17A of the Act and the 
rules and regulations thereunder applicable.
    It is therefore ordered, pursuant to section 19(b)(2) of the Act, 
that the proposed rule change (File No. SR-OCC-2002-09) be, and hereby 
is, approved.

    For the Commission by the Division of Market Regulation, 
pursuant to delegated authority.\11\
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    \11\ 17 CFR 200.30-3(a)(12).

Margaret H. McFarland,
Deputy Secretary.
[FR Doc. 02-25010 Filed 10-1-02; 8:45 am]
BILLING CODE 8010-01-P