[Federal Register Volume 67, Number 196 (Wednesday, October 9, 2002)]
[Notices]
[Pages 63006-63009]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 02-25674]


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SECURITIES AND EXCHANGE COMMISSION

[Release No. 34-46593; File No. SR-OCC-2002-23]


Self-Regulatory Organizations; The Options Clearing Corporation; 
Notice of Filing of a Proposed Rule Change Relating to Physically-
Settled Futures on Narrow-Based Stock Indexes

October 2, 2002.
    Pursuant to section 19(b)(1) of the Securities Exchange Act of 1934 
(``Act''),\1\ notice is hereby given that on September 30, 2002, The 
Options Clearing Corporation (``OCC'') filed with the Securities and 
Exchange Commission (``Commission'') the proposed rule change as 
described in Items I, II, and III below, which items have been prepared 
primarily by OCC. The Commission is publishing this notice to solicit 
comments on the proposed rule change from interested persons.
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    \1\ 15 U.S.C. 78s(b)(1).
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I. Self-Regulatory Organization's Statement of the Terms of Substance 
of the Proposed Rule Change

    The proposed rule change would amend OCC's by-laws and rules to 
provide for the clearance and settlement of transactions in physically-
settled futures on narrow-based stock indexes.

[[Page 63007]]

II. Self-Regulatory Organization's Statement of the Purpose of, and 
Statutory Basis for, the Proposed Rule Change

    In its filing with the Commission, OCC included statements 
concerning the purpose of and basis for the proposed rule change and 
discussed any comments it received on the proposed rule change. The 
text of these statements may be examined at the places specified in 
Item IV below. OCC has prepared summaries, set forth in sections (A), 
(B), and (C) below, of the most significant aspects of such 
statements.\2\
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    \2\ The Commission has modified parts of these statements.
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(A) Self-Regulatory Organization's Statement of the Purpose of, and 
Statutory Basis for, the Proposed Rule Change

Introduction
    The proposed amendments would provide for the clearance and 
settlement of physically-settled futures on narrow-based stock indexes 
under the same basic rules and procedures recently approved by the 
Commission for the clearance and settlement of other security futures 
contracts.\3\ Delivery of the constituent securities of an underlying 
narrow-based index would be effected pursuant to the same rules and 
procedures currently applicable to the clearance and settlement of 
stock options and physically-settled stock futures.
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    \3\ E.g., Securities Exchange Act Releases No. 44434 (June 15, 
2001), 66 FR 33283 [File No. SR-OCC-2001-05 and 44727 (August 20, 
2001), 66 FR 45351 [File No. SR-OCC-2001-07].
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Background and Brief Product Description
    As amended by the Commodity Futures Modernization Act of 2000 
(``CFMA''), section 3(a)(55) of the Act defines the term ``security 
future'' to include ``a contract of sale for future delivery of * * * a 
narrow-based security index, including any interest therein or based on 
the value thereof.'' CFMA does not specify or restrict the means by 
which a narrow-based security index future can be settled. OneChicago 
LLC (``ONE'') has proposed to include physically-settled index futures 
among the contracts listed for trading through its facilities and has 
asked OCC to provide clearing and settlement services for those 
contracts. OCC's existing rules for clearing security futures 
contracts, which were approved by the Commission in 2001, provide for 
the clearance of cash-settled stock futures and index futures and for 
the clearance of physically-settled stock futures. They do not, 
however, provide for physically-settled index futures.\4\ The purpose 
of the present rule change is to amend those rules as necessary to 
provide for clearance and settlement of this additional type of 
security future.
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    \4\ Id.
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    ONE proposes to trade physically-settled narrow-based index futures 
that would allow a participant to take a position in defined economic 
sectors such as airlines, computers, investment banking, and 
semiconductors. These futures contracts will require the seller at 
maturity of the contract to deliver to the buyer a specified number of 
shares (to be set initially at 100 shares or multiples thereof, subject 
to adjustments to reflect certain corporate events such as stock 
splits) of each of the constituent securities in the index. The number 
of deliverable shares of each security will essentially define the 
index.
    ONE intends that the constituent stocks will be represented in an 
index under an approximate equal-dollar weighting formula. OneChicago 
will rebalance the index periodically to account for relative price 
changes of the constituent securities. ONE may also change constituent 
securities from time to time so that the index better reflects the 
particular industry sector. New classes of contracts will be opened 
after each rebalancing or change in the composition of the index. 
Existing contracts will be unaffected by these rebalancing changes and 
will continue trading until expiration.
Overview of OCC's Proposed Rule Changes
    OCC has determined that physically-settled index futures may be 
readily settled in a manner similar to physically-settled stock 
futures. As is the case with stock futures and stock options, delivery 
of the underlying would ordinarily be made through the National 
Securities Clearing Corporation (``NSCC'') with OCC's broker-to-broker 
settlement procedures as a fallback in the event that a deliverable 
security is ineligible to be settled through NSCC. ONE has determined 
to set the final settlement price against which delivery will be made 
based on the price of the future rather than using the cash prices of 
the constituent stocks. The prices that OCC would provide to NSCC with 
respect to each underlying constituent security would be determined by 
allocating the final futures settlement price to each constituent 
security in proportion to its weighting in the index. This would be 
essentially the same way that OCC currently handles the settlement of 
equity options that have multiple deliverables as a result of corporate 
events.
    The following discussion describes revisions to particular by-laws 
or rules that are of particular significance or appear to require 
explanation. Where special provisions for physically-settled narrow-
based index futures are needed, they are proposed to be added primarily 
in either the basic rules in Articles VI of the By-Laws, Clearance of 
Exchange Transactions, or to the rules governing security futures 
generally, which are in Article XII of the By-Laws, Futures and Futures 
Options, and Chapter XIII of the Rules, Futures and Futures Options. 
Chapter IX of the Rules, Delivery of Underlying Securities and 
Payments, governing settlement of delivery obligations with respect to 
underlying stocks also would be amended slightly. Many other proposed 
changes are not discussed individually because they are merely 
conforming changes, constitute minor, nonsubstantive changes to 
existing by-laws and rules, or are otherwise self-explanatory.
New and Amended Definitions
    OCC proposes to define several additional terms applicable to 
physically-settled narrow-based index futures and to include those 
terms in Article I of the By-Laws, Definitions, because they are used 
throughout the by-laws and rules. The new definitions are mostly self-
explanatory, but a few terms that are of particular significance are 
described below.
    The term ``aggregate purchase price'' would be amended to identify 
the total price against which all of the deliverable securities would 
be delivered at maturity of a physically-settled narrow-based index 
future. For purposes of settlement, that aggregate purchase price will 
then be apportioned among the constituent securities of the underlying 
index (as described in ``Amendments to Chapter IX of the Rules'' 
below).
    The amendment to the definition of ``final settlement price'' would 
provide that the final settlement price of a futures contract could be 
determined by reference to the value of the underlying or, as ONE 
proposes in the case of physically-settled narrow-based index futures, 
by reference to the final settlement price of the futures contract 
itself.
    The term ``class'' would be amended to clarify that only 
physically-settled narrow-based index futures that have identical 
constituent securities and identical weightings of such securities in 
the index underlying such future belong to the same ``class.'' This 
amendment reflects OCC's intention to

[[Page 63008]]

treat a class of physically-settled narrow-based index futures 
contracts that has been rebalanced as a separate class of futures 
contracts.
    The new term ``deliverable security'' would be defined broadly to 
include any security that might be deliverable with respect to any 
physically-settled cleared contract. This term would be created 
primarily to avoid possible confusion from use of the term ``underlying 
security'' to mean a particular constituent security in an underlying 
index. Similarly, the term ``deliverable amount'' is used to refer to 
the number of shares or other units of a particular constituent 
security that is deliverable with respect to a single contract.
    The term ``physically-settled narrow-based index future'' would be 
added to distinguish these products from cash-settled narrow-based 
index futures. The definition of ``narrow-based index future'' would be 
amended to encompass both cash- and physically-settled narrow-based 
index futures, and the definition of ``security future'' would be 
amended to include a specific reference to stock futures and narrow-
based index futures.
Amendments to Article VI of the By-Laws
    Article VI, Clearance of Exchange Transactions, sets out the basic 
terms of option contracts and the general rules for the clearance of 
exchange transactions. These basic rules apply to stock options, and 
except where they are replaced or modified by the by-laws in later 
articles specifically applicable to other products, they apply to those 
other OCC cleared products. An amendment to section 10(d) would be 
added to clarify the mechanism for determination of the deliverable 
amount with respect to each constituent security in a series of 
physically-settled narrow-based index futures. Section 19 previously 
addressed shortages of ``underlying'' securities. The title would be 
modified to refer to the new term ``deliverable securities.'' Section 
19 would be modified generally to provide for contracts, including but 
not limited to physically-settled narrow-based index futures, which may 
call for delivery of multiple securities. This could also be the case, 
for example, where a stock option or stock future has been adjusted as 
the result of a special distribution or other corporate event. As 
proposed, section 19 would provide for the partial settlement of 
contracts that may have multiple deliverable securities, not all of 
which are affected by the shortage. Various conforming changes would be 
made in the remainder of the section and in the interpretations and 
policies following the section. Subparagraphs (2)-(4) of section 19(a), 
which are substantively identical but dealt with different types of 
contracts, would be consolidated into new subparagraph (2). Section 
19(c) would be redrafted for clarity and would not effect substantive 
changes to the treatment of contracts previously addressed by that 
section. Item 7 under Interpretation and Policy .02 to section 19 would 
no longer be necessary and would be deleted in its entirety.
Amendments to Article XII of the By-Laws
    Article XII, Futures and Futures Options, sets out the basic 
provisions for futures and futures options. Section 2(a), which sets 
forth the general rights and obligations of buyers and sellers of 
futures and futures options, would be amended to set out the general 
rights and obligations of buyers and sellers of physically-settled 
narrow-based index futures. A new sentence would be added to section 
3(a) clarifying that determinations of adjustments required to reflect 
certain events with respect to the constituent securities of the index 
underlying a physically-settled narrow-based index futures contact 
would be made by the exchange or security futures market on which such 
futures are traded. It is anticipated that the exchange or security 
futures market on which such futures are traded would determine the 
deliverable amount for each constituent security in the index, and that 
this would effectively define the index. Accordingly, OCC believes that 
adjustments should be made by the market (as the source of the index) 
rather than by OCC.
Amendments to Chapter IX of the Rules
    As noted above, the Rules in Chapter IX, Delivery of Underlying 
Securities and Payment relating to delivery of and payment for 
underlying securities would be modified to apply to the constituent 
securities in an index underlying a physically-settled narrow-based 
security future. The proposed changes have been drafted more generally, 
however, to cover other situations where there may be multiple 
deliverables as in the case of certain adjustments to options and 
futures on single stocks as referred to above. The allocation of an 
aggregate purchase price among multiple deliverables is necessary so 
that each security can be settled against its own purchase price in 
case delivery of all the deliverable securities is not simultaneous. 
The price would be allocated in proportion to recent market prices for 
the deliverable securities. This allocation would be made by OCC in 
consultation with ONE in the case of physically-settled narrow-based 
index futures traded on that market. In the adjustment situation, the 
allocation is made solely by OCC. The precise allocation among the 
deliverable securities is ordinarily not material because any 
overpayment for one deliverable will result in an underpayment for 
another.
Amendments to Chapter XIII of the Rules
    Chapter XIII of the Rules, Futures and Futures Options, governs, 
inter alia, variation payments and delivery obligations for futures and 
futures options. Variation payments for physically-settled narrow-based 
index futures would be determined under the existing rules with no 
change except to the definition of ``final settlement price'' as 
described above. Rule 1302, Delivery of Deliverable Securities, would 
be amended by adding a new subparagraph (b) to provide that at maturity 
of a physically-settled narrow-based index future, the seller and buyer 
of such a future would be obligated, respectively, to deliver and 
receive the deliverable amount of each constituent security of the 
index underlying the future.
    OCC believes that the proposed rule change is consistent with the 
purposes and requirements of Section 17A of the Act because it provides 
for the efficient clearance and settlement of physically-settled 
narrow-based index futures by adapting existing OCC rules that have 
been approved as effective in promoting the prompt and accurate 
clearance and settlement of both single stock futures and cash-settled 
narrow-based index futures.

(B) Self-Regulatory Organization's Statement on Burden on Competition

    OCC does not believe that the proposed rule change would impose any 
burden on competition.

(C) Self-Regulatory Organization's Statement on Comments on the 
Proposed Rule Change Received From Members, Participants, or Others

    Written comments were not and are not intended to be solicited with 
respect to the proposed rule change, and none have been received.

III. Date of Effectiveness of the Proposed Rule Change and Timing for 
Commission Action

    Within thirty five days of the date of publication of this notice 
in the Federal Register or within such longer period (i) as the 
Commission may designate up to ninety days of such date if it finds 
such

[[Page 63009]]

longer period to be appropriate and publishes its reasons for so 
finding or (ii) as to which the self-regulatory organization consents, 
the Commission will:
    (a) By order approve the proposed rule change or
    (b) Institute proceedings to determine whether the proposed rule 
change should be disapproved.

IV. Solicitation of Comments

    Interested persons are invited to submit written data, views, and 
arguments concerning the foregoing, including whether the proposed rule 
change is consistent with the Act. Persons making written submissions 
should file six copies thereof with the Secretary, Securities and 
Exchange Commission, 450 Fifth Street NW., Washington, DC 20549-0609. 
Copies of the submission, all subsequent amendments, all written 
statements with respect to the proposed rule change that are filed with 
the Commission, and all written communications relating to the proposed 
rule change between the Commission and any person, other than those 
that may be withheld from the public in accordance with the provisions 
of 5 U.S.C. 552, will be available for inspection and copying in the 
Commission's Public Reference Section, 450 Fifth Street NW., 
Washington, DC 20549. Copies of such filing will also be available for 
inspection and copying at the principal office of OCC. All submissions 
should refer to the File No. SR-OCC-2002-23 and should be submitted by 
October 24, 2002.

    For the Commission by the Division of Market Regulation, 
pursuant to delegated authority.\5\
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    \5\ 17 CFR 200.30-3(a)(12).
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Margaret H. McFarland,
Deputy Secretary.
[FR Doc. 02-25674 Filed 10-8-02; 8:45 am]
BILLING CODE 8010-01-P