[Federal Register Volume 72, Number 92 (Monday, May 14, 2007)]
[Notices]
[Pages 27091-27093]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: E7-9212]


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COMMODITY FUTURES TRADING COMMISSION


Proposal To Exempt the Trading and Clearing of Certain Credit 
Default Products Traded on the Chicago Board Options Exchange and 
Cleared Through the Options Clearing Corporation Pursuant to the 
Exemptive Authority in Sec.  4(c) of the Commodity Exchange Act

AGENCY: Commodity Futures Trading Commission.

ACTION: Notice of proposed order and request for comment.

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SUMMARY: The Commodity Futures Trading Commission (``CFTC'' or the 
``Commission'') is proposing to exempt the trading and clearing of 
certain credit default products that are proposed to be traded on the 
Chicago Board Options Exchange (``CBOE'') and cleared through the 
Options Clearing Corporation (``OCC'') from any applicable provisions 
of the Commodity Exchange Act (``CEA'').\1\ Authority for this 
exemption is found in Section 4(c) of the CEA.\2\
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    \1\ 7 U.S.C. 1 et seq.
    \2\ 7 U.S.C. 6(c).

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DATES: Comments must be received on or before May 29, 2007.

ADDRESSES: Comments may be submitted by any of the following methods:
     Federal eRulemaking Portal: http://www.regulations.gov/http://frwebgate.access.gpo/cgi-bin/leaving. Follow the instructions 
for submitting comments.
     E-mail: [email protected]. Include ``OCC Clearing Credit 
Default Options'' in the subject line of the message.
     Fax: 202-418-5521.
     Mail: Send to Eileen A. Donovan, Acting Secretary, 
Commodity Futures Trading Commission, Three Lafayette Centre, 1155 21st 
Street, NW., Washington, DC 20581.
     Courier: Same as mail above.
    All comments received will be posted without change to http://www.CFTC.gov/.

FOR FURTHER INFORMATION CONTACT: John C. Lawton, Deputy Director and 
Chief Counsel, 202-418-5480, [email protected], and Robert B. Wasserman, 
Associate Director, 202-418-5092, [email protected], Division of 
Clearing and Intermediary Oversight, Commodity Futures Trading 
Commission, Three Lafayette Centre, 1151 21st Street, NW., Washington, 
DC 20581.

SUPPLEMENTARY INFORMATION:

I. Introduction

    The OCC is both a Derivatives Clearing Organization (``DCO'') 
registered pursuant to Section 5b of the CEA, 7 U.S.C. 7a-1, and a 
securities clearing agency registered pursuant to Section 17A of the 
Securities Exchange Act of 1934 (``1934 Act'').\3\ The CBOE is a 
national securities exchange registered as such under Section 6 of the 
1934 Act.\4\
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    \3\ 15 U.S.C. 78q-l.
    \4\ 15 U.S.C. 78f.
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    CBOE has filed with the Securities and Exchange Commission 
(``SEC'') proposed rule changes to provide for the listing and trading 
on CBOE of cash-settled, binary call options based on credit events in 
one or more debt securities.\5\ These options are referred to as Credit 
Default Options (``CDOs''), and would pay the holder a specified amount 
upon the occurrence, as determined by CBOE, of a ``Credit Event,'' 
defined to mean an ``Event of Default'' on any debt security issued or 
guaranteed by a specified ``Reference Entity.''
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    \5\ See Release No. 34-55251, 72 FR 7091 (Feb. 14, 2007).
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    CBOE has also filed with the SEC proposed rule changes to provide 
for the listing and trading on CBOE of Credit Default Basket Options 
(``CDBOs'').\6\ These are similar in concept to CDOs, except that a 
CDBO covers more than one Reference Entity, and for each Basket 
Component (that is, a single Reference Entity) a notional value (a 
fraction of the aggregate Notional Face Value of the basket) and a 
recovery rate is specified. Upon the occurrence of a Credit Event 
involving a particular Reference Entity, the payout to the holder is 
equal to the product of (a) The Notional Face Value of that Basket 
Component multiplied by (b) one minus the recovery rate specified in 
advance for that Basket Component. CDBOs may be of the multiple-payout 
variety, or of the single-payout variety, where a payout occurs only 
the first time a Credit Event is confirmed with respect to a Reference 
Entity prior to expiration.
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    \6\ See SR-CBOE-2007-026.
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    OCC has filed with the CFTC, pursuant to Section 5c(c) of the CEA 
and Commission Regulations 39.4(a) and 40.5 thereunder,\7\ requests for 
approval of rules and rule amendments that would enable OCC to clear 
and settle these CDOs and CDBOs in its capacity as a registered 
securities clearing agency (and not in its capacity

[[Page 27092]]

as a DCO).\8\ Section 5c(c)(3) provides that the CFTC must approve any 
such rules and rule amendments submitted for approval unless it finds 
that the rules or rule amendments would violate the CEA.
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    \7\ 7 U.S.C. 7a-2(c), 17 CFR 39.4(a), 40.5.
    \8\ See SR-OCC-2007-01 A-1; SR-OCC-2007-06. OCC has filed 
identical proposed rule changes with the SEC.
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    The request for approval concerning the CDO product was filed 
effective March 8, 2007. On April 23, 2007, the review period was 
extended pursuant to Regulation 40.5(c) until June 6, 2007, on the 
ground that the CDOs ``raise novel or complex issues, including the 
nature of the contract, that require additional time for review.'' The 
request for approval concerning the CDBO product was filed effective 
April 23, 2007, and absent an extension the review period is scheduled 
to run until June 7, 2007.

II. Section 4(c) of the Commodity Exchange Act

    Section 4(c)(1) of the CEA empowers the CFTC to ``promote 
responsible economic or financial innovation and fair competition'' by 
exempting any transaction or class of transactions from any of the 
provisions of the CEA (subject to exceptions not relevant here) where 
the Commission determines that the exemption would be consistent with 
the public interest.\9\ The Commission may grant such an exemption by 
rule, regulation or order, after notice and opportunity for hearing, 
and may do so on application of any person or on its own initiative.
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    \9\ Section 4(c)(1) of the CEA, 7 U.S.C. 6(c)(1), provides that:
    In order to promote responsible economic or financial innovation 
and fair competition, the Commission by rule, regulation, or order, 
after notice and opportunity for hearing, may (on its own initiative 
or on application of any person, including any board of trade 
designated or registered as a contract market or derivatives 
transaction execution facility for transactions for future delivery 
in any commodity under section 7 of this title) exempt any 
agreement, contract, or transaction (or class thereof) that is 
otherwise subject to subsection (a) of this section (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 stated 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 subparagraphs (c)(ii) and (D) of section 2(a)(1) of this 
title, except that the Commission and the Securities and Exchange 
Commission may by rule, regulation, or order jointly exclude any 
agreement, contract, or transaction from section 2(a)(1)(D) of this 
title), if the Commission determines that the exemption would be 
consistent with the public interest.
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    In enacting Section 4(c), Congress noted that the goal of the 
provision ``is to give the Commission a means of providing certainty 
and stability to existing and emerging markets so that financial 
innovation and market development can proceed in an effective and 
competitive manner.'' \10\ Permitting the CDOs and CDBOs to trade on 
CBOE and be cleared on OCC as discussed above may foster both financial 
innovation and competition. The CFTC believes that the venue or venues 
for trading and clearing of instruments such as CDOs and CDBOs should 
be determined by the competitive forces of the market, particularly 
where any potential venue would be subject to federal regulatory 
oversight. The CFTC is requesting comment on whether it should exempt 
CDOs and CDBOs, as described above, that are traded on CBOE and cleared 
through OCC, from any provision of the CEA that might be transgressed 
by trading and clearing those transactions as described above.
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    \10\ HOUSE CONF. REPORT NO. 102-978, 1992 U.S.C.C.A.N. 3179, 
3213 (``4(c) Conf. Report'').
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    In proposing this exemption, the CFTC need not--and does not--find 
that the CDOs and CDBOs are (or are not) subject to the CEA. During the 
legislative process leading to the enactment of Section 4(c) of the 
CEA, the House-Senate Conference Committee noted that:

    The Conferees do not intend that the exercise of exemptive 
authority by the Commission would require any determination 
beforehand that the agreement, instrument, or transaction for which 
an exemption is sought is subject to the Act. Rather, this provision 
provides flexibility for the Commission to provide legal certainty 
to novel instruments where the determination as to jurisdiction is 
not straightforward. Rather than making a finding as to whether a 
product is or is not a futures contract, the Commission in 
appropriate cases may proceed directly to issuing an exemption.\11\
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    \11\ 4(c) Conf. Report at 3214-3215.

CDOs and CDBOs are ``novel instruments'' and the ``determination as to 
[their] jurisdiction is not straightforward.'' Given their potential 
usefulness to the significant market for credit derivatives products, 
however, the Commission believes that this may be an appropriate case 
for issuing an exemption without making a finding as to the nature of 
these particular instruments.
    Section 4(c)(2) provides that the Commission may grant exemptions 
only when it determines that the requirements for which an exemption is 
being provided should not be applied to the agreements, contracts or 
transactions at issue, and the exemption is consistent with the public 
interest and the purposes of the CEA; that the agreements, contracts or 
transactions will be entered into solely between appropriate persons; 
and that the exemption will not have a material adverse effect on the 
ability of the Commission or any contract market or derivatives 
transaction execution facility to discharge its regulatory or self-
regulatory responsibilities under the CEA.\12\
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    \12\ Section 4(c)(2) of the CEA, 7 U.S.C. Sec.  6(c)(2), 
provides that:
    The Commission shall not grant any exemption under paragraph (1) 
from any of the requirements of subsection (a) of this section 
unless the Commission determines that--
    (A) The requirement should not be applied to the agreement, 
contract, or transaction for which the exemption is sought and that 
the exemption would be consistent with the public interest and the 
purposes of this Act; and
    (B) The agreement, contract, or transaction--
    (i) Will be entered into solely between appropriate persons; and
    (ii) Will not have a material adverse effect on the ability of 
the Commission or any contract market or derivatives transaction 
execution facility to discharge its regulatory or self-regulatory 
duties under this Act.
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    The purposes of the CEA include ``promot[ing] responsible 
innovation and fair competition among boards of trade, other markets 
and market participants.'' \13\ It may be consistent with these and the 
other purposes of the CEA, and with the public interest, for the mode 
of trading of these transactions--whether it is to be through CFTC-
regulated markets and clearing organizations or SEC-regulated markets 
and clearing organizations--to be determined by competitive market 
forces rather than by regulatory line-drawing. Accordingly, the CFTC is 
requesting comment as to whether an exemption from the requirements of 
the CEA should be granted in the context of these transactions.
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    \13\ CEA Sec.  3(b), 7 U.S.C. 5(b). See also CEA Sec.  4(c)(1), 
7 U.S.C. 6(c)(1) (purpose of exemptions is ``to promote responsible 
economic or financial innovation and fair competition.'')
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    Section 4(c)(3) includes within the term ``appropriate persons'' a 
number of specified categories of persons, and also in subparagraph (K) 
thereof ``such other persons that the Commission determines to be 
appropriate in light of * * * the applicability of appropriate 
regulatory protections.'' Both CBOE and OCC, as well as their members 
who will intermediate these transactions, are subject to extensive and 
detailed regulation by the SEC under the 1934 Act. The CFTC is 
requesting comment as to whether all persons trading CDOs and CDBOs 
traded on CBOE and cleared on OCC are appropriate persons.
    In light of the above, the Commission also is requesting comment as 
to whether this exemption will interfere with its ability to discharge 
its regulatory responsibilities under the CEA, including its ability to 
determine whether the listing of similar or

[[Page 27093]]

identical products on a designated contract market or derivatives 
transaction execution facility would or would not violate the CEA, or 
with the self-regulatory duties of any contract market or derivatives 
transaction execution facility.

III. Request for Comment

    The Commission requests comment on all aspects of the issues 
presented by this proposed order.

IV. Related Matters

A. Paperwork Reduction Act

    The Paperwork Reduction Act of 1995 (``PRA'') \14\ imposes certain 
requirements on federal agencies (including the Commission) in 
connection with their conducting or sponsoring any collection of 
information as defined by the PRA. The proposed exemptive order would 
not, if approved, require a new collection of information from any 
entities that would be subject to the proposed order.
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    \14\ 44 U.S.C. 3507(d).
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B. Cost-Benefit Analysis

    Section 15(a) of the CEA, as amended by Section 119 of the 
Commodity Futures Modernization Act of 2000 (``CFMA''),\15\ requires 
the Commission to consider the costs and benefits of its action before 
issuing an order under the CEA. By its terms, Section 15(a) as amended 
does not require the Commission to quantify the costs and benefits of 
an order or to determine whether the benefits of the order outweigh its 
costs. Rather, Section 15(a) simply requires the Commission to 
``consider the costs and benefits'' of its action.
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    \15\ 7 U.S.C. 19(a).
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    Section 15(a) of the CEA further specifies that costs and benefits 
shall be evaluated in light of five broad areas of market and public 
concern: Protection of market participants and the public; efficiency, 
competitiveness, and financial integrity of futures markets; price 
discovery; sound risk management practices; and other public interest 
considerations. Accordingly, the Commission could in its discretion 
give greater weight to any one of the five enumerated areas and could 
in its discretion determine that, notwithstanding its costs, a 
particular order was necessary or appropriate to protect the public 
interest or to effectuate any of the provisions or to accomplish any of 
the purposes of the CEA.
    The proposed exemptive order may facilitate market competition. The 
Commission is considering the costs and benefits of this proposed order 
in light of the specific provisions of Section 15(a) of the CEA, as 
follows:
    1. Protection of market participants and the public. CBOE, OCC and 
their members who would intermediate CDOs and CDBOs are subject to 
extensive SEC oversight.
    2. Efficiency, competition, and financial integrity. The proposed 
exemption may enhance market efficiency and competition since it could 
encourage potential trading of CDOs and CDBOs on markets other than 
designated contract markets or derivative transaction execution 
facilities. Financial integrity will not be affected since the CDOs and 
CDBOs will be cleared by OCC, a DCO and SEC-registered clearing agency, 
and intermediated by SEC-registered broker-dealers.
    3. Price discovery. Price discovery may be enhanced through market 
competition.
    4. Sound risk management practices. OCC has described appropriate 
risk-management practices that it will follow to margin CDOs and CDBOs.
    5. Other public interest considerations. The proposed exemption may 
encourage development of credit derivative products through market 
competition without unnecessary regulatory burden.
    After considering these factors, the Commission has determined to 
seek comment on the proposed order as discussed above. The Commission 
invites public comment on its application of the cost-benefit 
provision.
* * * * *

    Issued in Washington, DC, on May 9, 2007 by the Commission.
Eileen A. Donovan,
Acting Secretary of the Commission.
[FR Doc. E7-9212 Filed 5-11-07; 8:45 am]
BILLING CODE 6351-01-P