[Federal Register Volume 84, Number 188 (Friday, September 27, 2019)]
[Rules and Regulations]
[Pages 51005-51023]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 2019-20476]
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Rules and Regulations
Federal Register
________________________________________________________________________
This section of the FEDERAL REGISTER contains regulatory documents
having general applicability and legal effect, most of which are keyed
to and codified in the Code of Federal Regulations, which is published
under 50 titles pursuant to 44 U.S.C. 1510.
The Code of Federal Regulations is sold by the Superintendent of Documents.
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Federal Register / Vol. 84, No. 188 / Friday, September 27, 2019 /
Rules and Regulations
[[Page 51005]]
COMMODITY FUTURES TRADING COMMISSION
17 CFR Part 41
RIN 3038-AE61
Position Limits and Position Accountability for Security Futures
Products
AGENCY: Commodity Futures Trading Commission.
ACTION: Final rule.
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SUMMARY: The Commodity Futures Trading Commission (``CFTC'' or
``Commission'') is issuing a final rule to amend the position limit
rules applicable to security futures products (``SFP'') by increasing
the default maximum level of equity SFP position limits that designated
contract markets (``DCMs'') may set; modifying the criteria for setting
a higher position limit and position accountability level by relying
primarily on estimated deliverable supply; and adjusting the time
during which position limits or position accountability must be in
effect. In addition, the final rule will provide DCMs discretion to
apply limits to either a person's net position or a person's position
on the same side of the market. The rule also includes position limit
requirements and related guidance and acceptable practices for DCMs to
apply in adopting position limits for SFPs based on products other than
an equity security.
DATES: Effective November 26, 2019.
FOR FURTHER INFORMATION CONTACT: Thomas Leahy, Associate Director,
Division of Market Oversight (``DMO'') at 202-418-5278 or
[email protected] or Aaron Brodsky, Senior Special Counsel, DMO at 202-
418-5349 or [email protected]; Commodity Futures Trading Commission,
Three Lafayette Center, 1155 21st Street NW, Washington, DC 20581.
SUPPLEMENTARY INFORMATION:
I. Background
On December 21, 2000, the Commodity Futures Modernization Act
(``CFMA'') became law and amended the Commodity Exchange Act (``CEA'')
and the Securities Exchange Act of 1934 (``Exchange Act'').\1\ The CFMA
removed a long-standing ban on trading futures on single securities and
narrow-based security indexes \2\ in the United States.\3\ Under the
CEA as amended by the CFMA, in order for a DCM to list an SFP,\4\ the
SFP and the securities underlying the SFP must meet a number of
criteria.\5\ One of the criteria requires that trading in the SFP is
not readily susceptible to manipulation of the price of the SFP, nor to
causing or being used in the manipulation of the price of any
underlying security, option on such a security, or option on a group or
index including such securities.\6\
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\1\ See Commodity Futures Modernization Act of 2000, Public Law
106-554, 114 Stat. 2763 (Dec. 21, 2000). The CFMA created a joint
jurisdictional framework under which the CFTC is the primary
regulator for DCMs that list SFPs, and the Securities and Exchange
Commission (``SEC'') is the primary regulator for national security
exchanges (``NSE''), national securities associations, and
alternative trading systems that list SFPs. The other regulator is
the secondary regulator. A DCM that elects to list SFPs must first
notice register with the SEC (see section 252(a) of the CFMA), and
an NSE that elects to list SFPs must first notice register with the
CFTC (see section 202(a) of the CFMA). See also Designated Contract
Markets in Security Futures Products: Notice-Designation
Requirements, Continuing Obligations, Applications for Exemptive
Orders, and Exempt Provisions, 66 FR 44960 (Aug. 27, 2001). In that
final rule, the Commission adopted new regulations that provide
notice registration procedures for a NSE, a national securities
association, or an alternative trading system to become a DCM in
SFPs. By registering with the Commission, a national securities
exchange, a national securities association, or an alternative
trading system is, by definition, a DCM for purposes of trading
SFPs. SFPs may be listed for trading only on DCMs that are notice-
registered as NSEs, including NSEs that are notice-registered with
the Commission as DCMs. Security-based swaps are equivalent
contracts under the exclusive jurisdiction of the SEC that may be
traded over-the-counter or on SEC-regulated security-based swap
execution facilities.
\2\ See 7 U.S.C. 1a(35) for the definition of ``narrow-based
security index.''
\3\ See Section 251(a) of the CFMA. This trading previously was
prohibited by 7 U.S.C. 2(a)(1)(B)(v).
\4\ The term ``security futures product'' is defined in section
1a(45) of the CEA, 7 U.S.C. 1a(45), and section 3(a)(56) of the
Exchange Act, 15 U.S.C. 78c(a)(56), to mean a security future or any
put, call, straddle, option, or privilege on any security future.
The term ``security future'' is defined in section 1a(44) of the
CEA, 7 U.S.C. 1a(44), and section 3(a)(55)(A) of the Exchange Act,
15 U.S.C. 78c(a)(55)(A), to include futures contracts on individual
securities and on narrow-based security indexes. The term ``narrow-
based security index'' is defined in section 1a(35) of the CEA, 7
U.S.C. 1a(35), and section 3(a)(55)(B) of the Exchange Act, 15
U.S.C. 78c(a)(55)(B).
\5\ 7 U.S.C. 2(a)(1)(D)(i).
\6\ See 7 U.S.C. 2(a)(1)(D)(i)(VII).
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As the Commission noted when it proposed to adopt criteria for
trading of SFPs:
It is important that the listing standards and conditions in the
CEA and the Exchange Act be easily understood and applied by [DCMs].
The rules proposed today address issues related to these standards
and establish uniform requirements related to position limits, as
well as provisions to minimize the potential for manipulation and
disruption to the futures markets and underlying securities
markets.\7\
\7\ See Listing Standards and Conditions for Trading Security
Futures Products, proposed rules, 66 FR 37932, 37933 (Jul. 20, 2001)
(``2001 Proposed SFP Rules''). The Commission further noted, ``The
speculative position limit level adopted by a [DCM] should be
consistent with the obligation in section 2(a)(1)(D)(i)(VII) of the
CEA that the [DCM] maintain procedures to prevent manipulation of
the price of the [SFP] and the underlying security or securities.''
Id. at 37935.
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Among those provisions is current Commission regulation
41.25(a)(3), which requires a DCM that lists SFPs to establish position
limits or position accountability standards.\8\ The Commission's
existing SFP position limits were set at levels that, when adopted,
were generally comparable, but not identical, to the limits that
applied to options on individual securities at that time.\9\ The CFMA
sought comparable regulation of security options and SFPs.
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\8\ 17 CFR 41.25(a)(3).
\9\ See Listing Standards and Conditions for Trading Security
Futures Products, 66 FR 55078, 55082 (Nov. 1, 2001) (``2001 Final
SFP Rules'').
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Under existing Sec. 41.25(a)(3), a DCM is required to establish
for each SFP a position limit, applicable to positions held during the
last five trading days of an expiring contract month, of no greater
than 13,500 (100-share) contracts, except under specific
conditions.\10\ If a security underlying an SFP has either: (i) An
average daily trading volume that exceeds 20 million shares; or (ii) an
average daily trading volume that exceeds 15 million shares and more
than 40 million shares outstanding, then the DCM may establish a
position limit for the SFP of no more than 22,500 contracts.\11\
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\10\ 17 CFR 41.25(a)(3)(i).
\11\ 17 CFR 41.25(a)(3)(i)(A).
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As an alternative to an applicable position limit requirement,
existing
[[Page 51006]]
rules permit a DCM to adopt a position accountability rule for an SFP
on a security that has: (i) An average daily trading volume that
exceeds 20 million shares; and (ii) more than 40 million shares
outstanding.\12\ Under any position accountability regime, upon a
request from a DCM, traders holding a position of greater than 22,500
contracts, or such lower threshold as specified by the DCM, must
provide information to the exchange regarding the nature of the
position.\13\ Under position accountability, traders must also consent
to halt increases in the size of their positions upon the direction of
the DCM.\14\
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\12\ 17 CFR 41.25(a)(3)(i)(B).
\13\ Id.
\14\ Id.
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Since adoption of the 2001 Final SFP Rules, the Commission's SFP
position limit regulations have not been substantively amended to
account for SFPs on securities other than common stock, although CEA
section 2(a)(1)(D)(i) authorizes DCMs to list for trading SFPs based
upon common stock and such other equity securities as the Commission
and the Securities and Exchange Commission jointly determine
appropriate.\15\ The CFMA further authorized the Commission and the SEC
(collectively ``Commissions'') to allow SFPs to be ``based on
securities other than equity securities.'' \16\ The Commissions used
their authority to allow SFPs on Depositary Receipts; \17\ Exchange
Traded Funds, Trust Issued Receipts, and Closed End Funds; \18\ and
debt securities.\19\ Since the Commission's initial adoption of SFP
position limits, the SEC has granted approval to increase position
limits for equity options listed on NSEs, but the Commission has not
amended its SFP regulations to reflect those changes, or to take into
account the characteristics of other types of SFPs, such as an SFP on
one or more debt securities.
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\15\ 7 U.S.C. 2(a)(1)(D)(i)(III).
\16\ 7 U.S.C. 2(a)(1)(D)(v)(I).
\17\ See Joint Order Granting the Modification of Listing
Standards Requirements under Section 6(h) of the Securities Exchange
Act of 1934 and the Criteria under Section 2(a)(1) of the Commodity
Exchange Act, (Aug. 20, 2001), https://www.sec.gov/rules/other/34-44725.htm.
\18\ See Joint Order Granting the Modification of Listing
Standards Requirements Under Section 6(h) of the Securities Exchange
Act of 1934 and the Criteria Under Section 2(a)(1) of the Commodity
Exchange Act, 67 FR 42760 (Jun. 25, 2002).
\19\ See 17 CFR 41.21(a)(2)(iii) (providing that the underlying
security of an SFP may include ``a note, bond, debenture, or
evidence of indebtedness''); see also Joint Final Rules: Application
of the Definition of Narrow-Based Security Index to Debt Securities
Indexes and Security Futures on Debt Securities, 71 FR 39534 (Jul.
13, 2006) (describing debt securities to include ``notes, bonds,
debentures, or evidences of indebtedness'').
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II. The Proposal
On July 31, 2018, the Commission published a Notice of Proposed
Rulemaking to amend Commission regulation 41.25 to update the position
limit rules for SFPs to provide regulatory comparability with equity
options, foster innovation by providing a framework for position limits
on SFPs that are not covered under the existing rules, and provide
flexibility to DCMs in setting position limits for such products
(``Proposal'').\20\
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\20\ See Position Limits and Position Accountability for
Security Futures Products, 83 FR 36799 (Jul. 31, 2018)
(``Proposal'').
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Notably, the Commission proposed changes to the default position
limit level and the criteria for DCMs adopting position limits and
accountability levels for SFPs, relying primarily on estimated
deliverable supply, as defined in the rule. For equity SFPs, the
Proposal would increase the default position limit level from 13,500
(100-share) contracts to 25,000 (100-share) contracts and would permit
a DCM to establish a position limit level higher than 25,000 (100-
share) contracts based on the estimated deliverable supply of the
underlying security.\21\ The Proposal provided guidance on estimating
delivery supply, and in connection with this change, would require a
DCM to estimate deliverable supply at least semi-annually, rather than
calculating the six-month average daily trading volume at least
monthly.\22\
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\21\ Proposal at 36803-05.
\22\ Proposal at 36806-07.
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Also for equity SFPs, the Proposal would change the criteria that
permit a DCM to adopt an exchange rule for position accountability in
lieu of position limits. Under the Proposal, for a DCM to adopt an
exchange rule for position accountability in lieu of position limits,
the underlying security must have an estimated deliverable supply of
more than 40 million shares and a total trading volume of more than 2.5
billion shares over a six-month period.\23\
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\23\ Proposal at 36805.
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The Proposal also provided that the DCM could have the discretion
to adopt limits and accountability levels on either a net basis or
gross basis (``on the same side of the market'') and included specific
position limit requirements and guidance for a physically-delivered
basket of equities SFP, a cash-settled equity index SFP, and an SFP on
one or more debt securities.\24\ The Proposal further included
requirements for recalculating position limits and accountability
levels based on updated estimated deliverable supply and trading volume
calculations, and it provided guidance to DCMs on granting SFP position
limit exemptions.\25\
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\24\ The SFP definition permits the listing of SFPs on debt
securities (other than exempted securities). 17 CFR
41.21(a)(2)(iii). While an SFP may not be listed on a debt security
that is an exempted security, futures contracts may be listed on an
exempted security. 7 U.S.C. 2(a)(1)(C)(iv).
\25\ Proposal at 36806-07, 08, and 13-14.
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When adopted, the Commission's existing SFP position limits were
set at levels that were generally comparable, but not identical, to the
limits that applied to options on individual securities at that
time.\26\ However, over time, a competitive disparity emerged between
the Commission's SFP position limits and security options limits
despite both serving economically similar functions.\27\ Position
limits for security options have increased to higher levels while the
Commission's SFP position limits have remained unchanged. To address
this disparity, the Commission drafted the Proposal with the goal of
providing a level regulatory playing field.
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\26\ Section 2(a)(1)(D)(i) of the CEA lists eleven criteria that
a DCM must meet to list SFPs. 7 U.S.C. 2(a)(1)(D)(i). The Exchange
Act lists twelve listing standards and conditions for trading that
an NSE must meet to list SFPs, eleven of which are common to those
in the CEA. Among the common criteria that make reference directly
or indirectly to security options are: (i) Coordinated surveillance
across security, security futures, and security option markets; (ii)
coordinated trading halts across security, security futures, and
security option markets; and (iii) margin levels for security
futures and security options. The Exchange Act requires that listing
standards filed by an NSE ``be no less restrictive than comparable
listing standards for options traded on a national securities
exchange.'' 15 U.S.C. 78f(h)(3)(C). Notably, the CEA lacks such a
criterion.
\27\ For example, the price of a long call option with a strike
price well below the prevailing market price of the underlying
security is expected to move almost in lock step with the price of a
long SFP on the same underlying security. Similarly, the price of a
long put option with a strike price well above the prevailing market
price of the underlying security is expected to move almost in lock
step with the price of a short SFP on the same underlying security.
Such deep-in-the-money call or put options behave this way, with a
delta at or near one, because there is a high probability that such
options will expire in-the-money.
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Noting the differences in the position limit rules applicable to
SFPs and security options,\28\ the Commission determined certain
approaches were necessary to effectively oversee the markets,
consistent with the obligation
[[Page 51007]]
of a DCM to prevent manipulation of the price of an SFP and its
underlying security or securities.\29\ In light of its experience since
the first adoption of a position limits regime for SFPs in 2001,\30\
the Commission believes it is appropriate to update Commission
regulation 41.25 to permit DCMs to set position limits above a default
level in appropriate circumstances based on an estimate of deliverable
supply.\31\
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\28\ Specifically, these differences were: (1) The specification
that position limits for SFPs are on a net, rather than a gross
basis; (2) the numerical limits on SFPs differ from those on
security options; and (3) the position limits for SFPs are
applicable only during the last five trading days prior to
expiration, rather than at any time in the lifespan of a security
option contract. See 2001 Final SFP Rules at 55081.
\29\ In 2001, the Commission noted:
The differences mainly reflect certain provisions adopted for
commodity futures contracts that reflect the special characteristics
of those markets. In this regard, the proposed position limit
requirements for security futures differ from individual security
option position limit rules in that the limits would apply only to
net positions in an expiring security futures contract during its
five last trading days. The Commission believes that this provision
is appropriate since, consistent with its experience in conducting
surveillance of other futures markets, it is during the time period
near contract expiration that the potential for manipulation based
on an extraordinarily large net futures position would most likely
occur.
See 2001 Final SFP Rules at 55082. The approach NSEs may use to
set an equity option's position limit is not consistent with
existing Commission policy and may, in the Commission's opinion, as
noted below, render position limits ineffective.
\30\ The Commission observed the experience of NSEs over several
years with higher position limit levels on security options. Absent
apparent significant issues, the Commission believes that it is
reasonable to establish default SFP position limits that closely
resemble existing contract limits for equity options at NSEs.
\31\ To allow DCMs to adapt as NSE position limits change, the
proposal was designed to provide a formula for a DCM to set a level
above a default in cases where estimated deliverable supply exceeds
a certain threshold, rather than setting a default that does not
change as deliverable supply changes.
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In addition to requesting comments on the Proposal, the Commission
solicited comments on, among other things, the impact of the Proposal
on small entities, the Commission's cost-benefit considerations, and
any anti-competitive effects of the Proposal. The comment period for
the Proposal closed on October 1, 2018. The Commission received one
substantive comment letter on the Proposal, from OneChicago, LLC
(``OneChicago'' or the ``Exchange'').\32\ OneChicago, a DCM that is
notice registered with the SEC, is the only domestic exchange listing
SFPs.\33\ The Commission addresses OneChicago's comments on the
Proposal within the discussion of each section of the final rule.
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\32\ OneChicago Comment Letter No. 61824 (``OneChicago
Letter''), dated Oct. 1, 2018, available at https://comments.cftc.gov/PublicComments/CommentList.aspx?id=2899. The
Commission also received another comment letter, which was not
substantive and appears to have been posted in error.
\33\ OneChicago Letter at 1.
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III. Final Rule
The Commission has considered the comments received in response to
the Proposal and is adopting it as proposed but with a few
modifications.
A. General Comments
OneChicago challenged what it viewed as the Commission's assumption
that SFPs and security options are economically equivalent.\34\
Focusing its comment letter on single stock futures (``SSFs''), a
subset of SFPs, the Exchange stated that the Commission should not
treat SSFs the same as security options, because the market views them
differently.\35\ The Exchange opined that options are exercised for two
reasons: (i) To harvest dividends; and (ii) to invest the proceeds from
selling stock through exercise of deep in-the-money puts.\36\ The
Exchange contrasted these reasons with the use of SSFs to transfer
securities through the clearing process at the Options Clearing
Corporation (``OCC'') and National Securities Clearing Corporation.\37\
OneChicago believes that while the price of a deep in-the-money put
would, in theory, move in tandem with the price of a short SFP, in
practice deep in-the-money puts are exercised early by their holders to
collect and invest proceeds from the sale of the stock and to get the
benefit of re-investment.\38\
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\34\ OneChicago Letter at 3.
\35\ OneChicago Letter at 5-6.
\36\ Id.
\37\ Id.
\38\ OneChicago Letter at 4.
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OneChicago commented that SSF contracts do not contain any
optionality and, accordingly, have a delta of one, where delta means
the rate of change in the price of a derivative relative to the rate of
change in price of the underlying instrument.\39\ The Exchange noted
such an instrument is called a Delta One derivative and that exchange-
traded SSFs and OTC Total Return Swaps, such as Master Securities
Lending Agreements (``MSLA'') and Master Securities Repurchase
Agreements (``MSRP''), are all Delta One derivatives.\40\ The Exchange
noted further that the OCC clears securities lending agreements in the
same risk pools as OneChicago's contracts, and that those securities
lending agreements have no position limits and receive risk-based
margining treatment.\41\
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\39\ OneChicago Letter at 2.
\40\ Id.
\41\ OneChicago Letter at 5.
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According to OneChicago, because only a Delta One derivative can
avoid a tax event (from the transfer of a security), no other
derivative is equivalent to a Delta One derivative.\42\ The Exchange
noted that no option, or combination of options, can be used without
triggering a tax event.\43\
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\42\ OneChicago Letter at 3.
\43\ Id.
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The Exchange recommended regulating Delta One derivatives, whether
traded OTC or on an exchange, comparably.\44\ The Exchange opined that
different regulation of Delta One derivatives creates an uneven playing
field, and disagreed with trying to achieve regulatory parity between
Delta One derivatives and security options, which are non-Delta One
derivatives.\45\ The Exchange noted Delta One derivatives are used
primarily in financing transactions, where a financing counterparty
provides a customer with synthetic (long) exposure to a notional amount
of a security and pre-hedges that exposure by accumulating an identical
notional value in the underlying shares.\46\ Furthermore, the Exchange
noted that securities lending rebate rates are decided in the OTC
market and have a direct effect on listed equity derivatives.\47\ The
Exchange believes that entities who determine the rebate rate do so in
relative secrecy and may front run the equity derivatives market prior
to disclosure of a change in the rebate rate.\48\ OneChicago requested
that the Commission and the SEC update the Risk Disclosure Documents
for options and SFPs to discuss this risk.\49\
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\44\ Id.
\45\ Id.
\46\ OneChicago Letter at 2.
\47\ OneChicago Letter at 4.
\48\ Id.
\49\ OneChicago's request regarding Risk Disclosure Documents
for options and SFPs is beyond the scope this rule and is not
addressed here.
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OneChicago noted that, in its experience, its market participants
hedge a short SFP position with a long stock position and hedge a long
SFP position with a short sale of stock (with a stock borrow).\50\
According to the Exchange, when such parties extend financing, they do
so in order to take the position through expiration.\51\ They use the
stock held to satisfy the short SFP obligation, without the need for
another transaction to unwind the positions, as the best way to
extinguish a hedged position.\52\ The Exchange noted that in the last
four years (since 2015), at least 53 percent of open interest, as of
the first of the month, goes through delivery.\53\ The Exchange
contrasted this percentage with Options Industry
[[Page 51008]]
Council data that shows only 7 percent of options get exercised.\54\
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\50\ OneChicago Letter at 5.
\51\ Id.
\52\ Id.
\53\ Id.
\54\ Id.
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The Commission's regulations distinguish between cash market
transactions, such as securities lending agreements, and derivative
market transactions. Delta One derivatives, as defined by the Exchange,
include certain cash market forward transactions. The Commission notes
that it does not directly regulate cash market transactions but has
certain anti-fraud and anti-manipulation authority over cash
markets.\55\
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\55\ The CEA includes various prohibitions against the
manipulation of the price of commodities, including in cash market
transactions. 7 U.S.C. 9(1), 9(3) and 13(a)(2).
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The CFMA lifted the ban on security futures and sought to ensure
comparable regulation of SFPs and security options on NSEs. The
Commission appreciates that SFPs may not be identical to equity
options. The Commission also notes that use of SFPs as lending
transactions is not the only way in which SFPs may be used. As such,
the Commission's approach reflects the concept of economic equivalence
of SFPs and security options contained in the CFMA.\56\
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\56\ The concept of economic equivalence of SFPs and security
options evident in the CFMA includes among the listing standards for
SFPs in the Exchange Act (but not the CEA) the requirement that
listing standards for SFPs ``be no less restrictive than comparable
listing standards for options traded on a national securities
exchange or national securities association. . . .'' 15 U.S.C.
78f(h)(3)(C). If a security is not eligible to underlie an option,
then it may not underlie an SFP. This is consistent with the view
that SFPs and security options have some degree of economic
equivalence.
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B. Definitions--Commission Regulation 41.25(a) 57
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\57\ The insertion of new paragraph (a) necessitates re-
designating existing paragraph (a) as (b), existing paragraph (b) as
(c), existing paragraph (c) as (d), and existing paragraph (d) as
(e). With the exception of the amended re-designated paragraph
(b)(3), the Commission is not amending these paragraphs except for
the cross references contained in the text of these paragraphs.
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To facilitate implementation of its proposed changes to its SFP
rules, the Commission proposed definitions for two new terms:
``estimated deliverable supply'' and ``same side of the market.'' The
Commission also proposed guidance on estimating deliverable supply.
1. ``Estimated Deliverable Supply''
The Commission proposed to define ``estimated deliverable supply''
as the quantity of the security underlying a SFP that reasonably can be
expected to be readily available to short traders and salable by long
traders at its market value in normal cash marketing channels during
the specified delivery period.
The Proposal also included guidance for estimating deliverable
supply in proposed appendix A to Commission regulation 41.25.\58\
Specifically, the proposed guidance provided that deliverable supply
for an equity security should be no greater than the free float of the
security, while deliverable supply should not include securities that
are committed for long-term agreements (e.g., closed-end investment
companies, structured products, or similar securities).\59\ Free float
of the security would generally mean issued and outstanding shares less
restricted shares. Restricted shares would include restricted and
control securities, which are not registered with the SEC to sell in a
public marketplace. The Commission suggested that the estimate of
deliverable supply in an exchange traded fund (``ETF'') should be equal
to the existing shares of the ETF.\60\ The Commission requested comment
on whether there are any other adjustments that should be made in
estimating deliverable supply for equities and whether an estimate of
deliverable supply for an ETF should include an allowance for the
creation of ETF shares.\61\
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\58\ Proposal at 36807 and 13.
\59\ Further guidance on estimating deliverable supply,
including consideration of whether the underlying security is
readily available, is found in appendix C to part 38 of this
chapter. See appendix C to part 38 of the Commission's regulations.
17 CFR part 38.
\60\ See Proposal at 36807.
\61\ Id.
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OneChicago opined that the Commission's proposed guidance for
estimating deliverable supply is inadequate. In this respect,
OneChicago noted that cash market participants going through settlement
are more likely to borrow shares rather than purchase shares.\62\ The
Exchange noted that to find out how much of the float of shares is
available for lending, one would need to inquire with the ``Securities
Lending world'' [sic]. The Exchange is not concerned with this issue
because it believes that ``Broker-Dealers . . . are well positioned to
determine supply, and will not allow themselves to be put into a
position where they cannot deliver.'' \63\
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\62\ OneChicago Letter at 8.
\63\ Id.
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The Commission is adopting the definition of ``estimated
deliverable supply,'' and the associated guidance for calculating it,
as proposed. The Commission notes that the deliverable supply of equity
securities in the cash market may be estimated in many ways. A maximum
estimate of deliverable supply could be the total number of shares that
could be authorized by a corporation. However, there may be a
significant time lag before a corporation actually issues additional
shares. Accordingly, a more conservative estimate of deliverable supply
is based on the number of shares issued and outstanding. The Commission
proposed to estimate deliverable supply based on free float, that is,
shares issued and outstanding, excluding shares that either: (i) Are
restricted from transfer (e.g., restricted stock units) or (ii) have
been repurchased by the issuing corporation (i.e., treasury shares).
Such free float shares should be more readily available for delivery
than shares that are: (i) Authorized but not issued; (ii) issued but
held in treasury; or (iii) subject to transfer restriction.
The Commission notes that a short position holder in an SFP may
obtain shares for delivery either through purchase of shares or through
a securities lending or securities repurchase agreement. The Commission
further notes that, at a particular point in time, there can be no more
shares available for lending than there are shares outstanding. The
Commission acknowledges that, when certain shares are on loan, the
borrower of such shares may enter a subsequent transaction to lend such
security. However, subsequent lending transactions (resulting in
repetitive re-lending of the same shares) should not be used as a basis
to increase an estimate of deliverable supply. Once shares are obtained
by a market participant, either to deliver on a short SFP position, or
in an attempt to corner the readily available supply of such security,
then such shares presumably would not be made available for lending
during the SFP delivery period. Further, at the termination of a
securities lending agreement, the borrower must return securities to
the lender. A borrower who has re-sold securities would need to
purchase shares (or borrow such shares again) to close out the
securities lending agreement.
By way of example, when estimating the deliverable supply of wheat,
the Commission does not count both the wheat in a warehouse and a
warehouse receipt representing ownership of that same wheat; a
warehouse receipt is simply the ownership of the commodity, and is not
an increase in the amount of the commodity. Likewise, a forward
purchase of wheat would not increase the estimated deliverable supply.
Similarly, a single share of stock and a securities lending agreement
that transfers ownership of that single share
[[Page 51009]]
of stock, do not result in two shares of stock.
2. ``Same Side of the Market''
The Proposal defined ``same side of the market'' to mean long
positions in physically-delivered security futures contracts and cash-
settled security futures contracts, in the same security, and,
separately, short positions in physically-delivered security futures
contracts and cash-settled security futures contracts, in the same
security.\64\ The Commission invited comment on whether it should also
include options on security futures contracts in this definition,
although options on SFPs are not currently permitted to be listed.\65\
The Commission received no comment on its definition of ``same side of
the market'' and is adopting it as proposed.\66\
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\64\ Proposal at 36812.
\65\ 7 U.S.C. 2(a)(1)(D)(iii). Generally, under existing
industry practice, a long call and a short put, on a futures-
equivalent basis, would be aggregated with a long futures contract;
and a short call and a long put, on a futures equivalent basis,
would be aggregated with a short futures contract.
\66\ The defined terms are added to Commission regulation 41.25
in a new paragraph (a). In connection with adding the definitions
into a new paragraph (a), paragraphs (a) through (d) would be re-
designated as paragraphs (b) through (e).
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C. Position Limits or Accountability Rules Required--Commission
Regulation 41.25(b)(3)
The Commission proposed to continue to require DCMs to establish
position limits or position accountability rules in each SFP for the
expiring futures contract month. OneChicago argued that position limits
for SSFs are not significant to the market in light of margin
requirements.\67\ The Commission notes that margin levels currently
applicable to SFPs, which are generally set equivalent to margin levels
on security options, are outside the scope of this rulemaking.\68\
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\67\ OneChicago Letter at 1 (``OneChicago does not have strong
feelings one way or the other about the Commission's proposal
because it will not significantly impact our market so long as
margins remain at punitive levels.''). OneChicago previously
submitted a petition for joint rulemaking for margin relief. Id.
\68\ See Customer Margin Rules Relating to Security Futures, 84
FR 36434 (Jul. 26, 2019).
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1. Limits for Equity SFPs--Commission Regulation 41.25(b)(3)(i)
The Commission proposed in Sec. 41.25(b)(3)(i) to increase the
default level of a DCM's position limits in an equity SFP from no
greater than 13,500 100-share contracts on a net basis to no greater
than 25,000 100-share contracts (or the equivalent if the contract size
is different than 100 shares per contract), either on a net basis or on
the same side of the market.\69\ The Proposal would include, in the
requirements for limits for equity SFPs, securities such as ETFs and
other securities that represent ownership in a group of underlying
securities.\70\ The Commission invited comment on the appropriateness
of both the proposed default limit level and the inclusion of ETFs.\71\
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\69\ Proposal at 36803.
\70\ Id.
\71\ Id.
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OneChicago believes that increasing the default position limit
level to 25,000 contracts is an improvement over the status quo but
commented that the proposal did not level the playing field between
SFPs and OTC Delta One products.\72\
---------------------------------------------------------------------------
\72\ OneChicago Letter at 7.
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The Commission is adopting Commission regulation 41.25(b)(3)(i) as
proposed. The default level of 25,000 100-share contracts is equal to
2,500,000 shares. The Commission notes that 12.5 percent of 20 million
shares equals 2,500,000 shares.\73\ Thus, for an equity security with
less than 20 million shares of estimated deliverable supply, the
default position limit level for the equity SFP would be larger than
12.5 percent of estimated deliverable supply. Accordingly, for SFPs in
equity securities with less than 20 million shares of estimated
deliverable supply, the Commission would expect a DCM to assess the
liquidity of trading in the underlying security to determine whether
the DCM should set a lower position limit level, as appropriate to
ensure compliance with DCM Core Principles 3 and 5,\74\ as discussed
further below.
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\73\ As discussed below, for an SFP on a single equity security
where the estimated deliverable supply of the underlying security
exceeds 20 million shares, a DCM may adopt a higher position limit.
Furthermore, as discussed below, given that SFPs and security
options may serve economically equivalent or similar functions, 12.5
percent of estimated deliverable supply is half the level for DCM-
set spot month speculative position limits for physical delivery
contracts in current Commission regulation 150.5(c).
\74\ 7 U.S.C. 7(d)(3) and 7 U.S.C. 7(d)(5).
---------------------------------------------------------------------------
The Commission notes that the lowest position limits adopted for
equity option positions on NSEs are 25,000 100-share option contracts
on the same side of the market.\75\ Thus, the final rule allows a DCM
to harmonize the default position limit level for SFPs to that of
equity options traded on an NSE. Accordingly, this default level for
SFP limits would closely resemble existing minimum limit levels on
security options.
---------------------------------------------------------------------------
\75\ See, e.g., the Cboe Exchange, Inc. (``CBOE'') rule 4.11,
Nasdaq ISE, LLC (``ISE'') rule 412, NYSE American LLC (``NYSE'')
rule 904, and Nasdaq PHLX LLC (``PHLX'') rule 1001.
---------------------------------------------------------------------------
As noted above, SFPs and security options may serve economically
equivalent or similar functions. However, under current Commission
regulation 41.25(a)(3), as previously detailed, the default level for
position limits for SFPs must be set no greater than 13,500 (100-share)
contracts, while security options on the same security may be, and
currently are, set at a much higher default level of 25,000 contracts,
which may place SFPs at a competitive disadvantage. Comparability of
limit levels is intended to provide a more level regulatory playing
field.
Because limit levels would not apply to a market participant's
combined position between SFPs and security options, the Commission did
not propose a default limit level for an SFP higher than 12.5 percent
of estimated deliverable supply. That is, under the final rule, a
market participant with positions at the limits in each of an SFP and a
security option on the same underlying security might be equivalent to
about 25 percent of estimated deliverable supply, which is at the outer
bound of where the Commission has historically permitted spot month
limit levels.\76\
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\76\ See appendix C to 17 CFR part 38, noting the guidance of 17
CFR 150.5.
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2. Higher Position Limits in Equity SFPs--Commission Regulation
41.25(b)(3)(i)(A)
The Proposal would change the criteria that DCMs use to set equity
SFP speculative position limit levels above the default level. Under
the existing rules, a DCM may establish a position limit for an equity
SFP of no more than 22,500 contracts (rather than the default level of
no greater than 13,500 (100-share) contracts) if the security
underlying the SFP has either (i) an average daily trading volume of at
least 20 million shares; or (ii) an average daily trading volume of at
least 15 million shares and at least 40 million shares outstanding.\77\
Under the Proposal, a DCM would be able to establish a position limit
for an equity SFP of no more than 12.5 percent of the estimated
deliverable supply of the relevant underlying security (rather than the
default level of no greater than 25,000 100-share contracts) if the
estimated deliverable supply of the underlying security exceeds 20
million shares and the limit would be ``appropriate in light of the
liquidity of
[[Page 51010]]
trading'' in that security.\78\ The Commission invited comment on
whether providing a DCM with discretion in its assessment of liquidity
in the underlying security, rather than the Commission imposing a
volume requirement, would be appropriate and on whether estimated
deliverable supply alone serves as an adequate proxy for market
impact.\79\
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\77\ 17 CFR 41.25(a)(3)(i)(A).
\78\ Proposal at 36804-05 and 12.
\79\ Core Principle 5 requires DCMs to adopt, as is necessary
and appropriate, position limits to reduce the potential threat of
market manipulation or congestion. 7 U.S.C. 7(d)(5).
---------------------------------------------------------------------------
OneChicago recommended using 25 percent of estimated deliverable
supply, as opposed to the 12.5 percent proposed by the Commission, to
set the level of the position limit, because, in the Exchange's view,
there is no justification for a lower level, other than the
misconception that SFPs and security options compete.\80\ The Exchange
believes the 25 percent level is justified for two reasons: (i) To
reduce the regulatory disparity between OTC and SSF markets; and (ii)
SSFs are almost exclusively used for riskless financing and transfer
transactions.\81\ OneChicago agreed that it is appropriate to use a
linear approach to set position limit levels based on estimated
deliverable supply.\82\ That is, a doubling of estimated deliverable
supply of a security would result in the doubling of the level of the
position limit on an SFP based on that security.
---------------------------------------------------------------------------
\80\ OneChicago Letter at 8.
\81\ Id.
\82\ Id.
---------------------------------------------------------------------------
OneChicago supported the proposal to give DCMs the discretion to
determine if the liquidity in an SFP justifies setting the position
limit lower than the default level. OneChicago stated that DCMs are
flexible and can adjust to changing market conditions quickly.\83\
Moreover, OneChicago believes the Commission's approach may not
accurately take account of borrowable shares.\84\
---------------------------------------------------------------------------
\83\ Id.
\84\ Id.
---------------------------------------------------------------------------
For underlying securities with more than 20 million shares of
estimated deliverable supply, the Commission is adopting as proposed
the rule that permits DCMs to set the position limit equivalent to no
more than 12.5 percent of estimated deliverable supply. By way of
example, if the estimated deliverable supply were 40 million shares,
then the rule would permit a DCM to set a limit level of no greater
than 50,000 100-share contracts; computed as 40 million shares times
12.5 percent divided by 100 shares per contract. This level of 50,000
100-share contracts is the same as permitted under current rules of
NSEs for an underlying security with 40 million shares outstanding,
although an NSE would also require the most recent six-month trading
volume of the underlying security to have totaled at least 15 million
shares.\85\
---------------------------------------------------------------------------
\85\ See, e.g., CBOE rule 4.11, ISE rule 412, NYSE rule 904, and
PHLX rule 1001.
---------------------------------------------------------------------------
While this provision for SFP position limits more closely resembles
existing limits on security options, the final rule permits a DCM to
use its discretion in assessing the liquidity of trading in the
underlying security, rather than imposing a prescriptive trading volume
requirement.\86\ The Commission does not believe that trading volume
alone is an appropriate indicator of liquidity. Thus, the rule permits
a DCM to set a position limit at a level lower than 12.5 percent of
estimated deliverable supply.
---------------------------------------------------------------------------
\86\ Generally, under CEA section 5(d)(1)(B), unless otherwise
restricted by a Commission regulation, a DCM has reasonable
discretion in establishing the manner in which it complies with core
principles, including Core Principle 5 regarding position limits or
position accountability. See 7 U.S.C. 7(d)(1) and (5).
---------------------------------------------------------------------------
The Commission expects a DCM to conduct a reasoned analysis as to
whether setting a level for a limit based on such criterion is
appropriate. In this regard, for example, assume security QRS and
security XYZ have equal free float of shares. Assume, however, that
trading in QRS is not as liquid as trading in XYZ. Under these
assumptions, it may be appropriate for a DCM to adopt a position limit
for XYZ equivalent to 12.5 percent of deliverable supply, but to adopt
a lower limit for QRS because a lesser number of shares would be
readily available for shorts to acquire to make delivery.
Under the current SFP-listing practices of DCMs (with OneChicago
being the only domestic DCM that lists SFPs), SFPs require delivery of
the underlying shares. Relatedly, NSEs also may list equity options
that require delivery of the underlying shares. Given this situation,
the Commission believes that in adopting the SFP position limit rule
the Commission should take into consideration the impact on deliverable
supply of both an option on a particular security being listed for
trading on an NSE and an SFP on that same security being listed for
trading on a DCM.\87\
---------------------------------------------------------------------------
\87\ It should be noted that the SEC, as the secondary regulator
of OneChicago, has the authority to abrogate a rule change proposed
by OneChicago if it appears to the SEC that such proposed rule
change unduly burdens competition or efficiency, conflicts with the
securities laws, or is inconsistent with the public interest and the
protection of investors. See Section 202(b) of the CFMA, which added
section 19(b)(7)(C) to the Exchange Act. Public Law 106-554, 114
Stat. 2763 (2000).
---------------------------------------------------------------------------
The Commission notes that the criterion of 12.5 percent of
estimated deliverable supply is half the level for DCM-set spot month
speculative position limits for physical delivery contracts in current
Commission regulation 150.5(c).\88\ That provision requires that for
spot month limit levels of no greater than one-quarter of the estimated
spot month deliverable supply.\89\ The Commission is adopting a lower
percent of estimated deliverable supply for SFPs in light of current
limits on equity options listed at NSEs. In this regard, the final rule
results in SFP position limits that closely resemble the existing
25,000 and 50,000 contract limits for equity options at NSEs, set when
certain trading volume or a combination of trading volume and shares
currently outstanding have been met. For example, a position at a
50,000 (100-share) option contract limit is equivalent to five million
shares. Twelve and one-half percent of 40 million shares equals five
million shares; that is, the criterion for a DCM to set a limit is
similar to that of the criteria for an NSE to set such a limit. Under
this final rule, a similar 50,000 contract position limit on an SFP on
such a security is an increase from the 22,500 contract limit currently
permitted for such an SFP. The Commission believes this incremental
approach to increasing SFP limits is a measured response to changes in
the SFP markets, while retaining consistency with the existing
requirements for equity options listed by NSEs.
---------------------------------------------------------------------------
\88\ 17 CFR 150.5(c).
\89\ 17 CFR 150.5(c)(1).
---------------------------------------------------------------------------
Moreover, as noted above, SFPs and equity options in the same
underlying security are not subject to a combined position limit across
DCMs and NSEs. Accordingly, the SFP limit level is half the level for
DCM-set spot month futures contract limits applicable to physical
delivery contracts of 25 percent of estimated deliverable supply.
Further, the Commission notes that limits for equity options at
NSEs do not increase in a linear manner for all increases in shares
outstanding.\90\ For example, upon a tripling of shares outstanding
from 40 million shares to 120 million shares, the 100-share equity
option contract limit increases only to 75,000 contracts from 50,000
contracts,\91\ while, under similar circumstances of a doubling of
estimated deliverable supply, the Commission proposes to permit a
linear
[[Page 51011]]
increase for a SFP limit to 100,000 contracts from 50,000 contracts.
---------------------------------------------------------------------------
\90\ Proposal at 36801.
\91\ In this example using shares outstanding, in order to
increase the equity option position limit, the total six-month
trading volume also would have had to increase to at least 30
million shares from at least 15 million shares.
---------------------------------------------------------------------------
The Commission will continue to monitor trading activity and
positions in the SFP market to assess whether the levels of position
limits unduly restrict trading.
3. Alternative Criteria for Setting Levels of Limits
As an alternative to the proposed criteria for setting position
limit levels based on estimated deliverable supply, the Commission
invited comments on whether the Commission should permit a DCM to
mirror the position limit level set by an NSE in a security option with
the same underlying security or securities as that of the DCM's
SFP.\92\ OneChicago opposed this proposed alternative because,
according to OneChicago, it perpetuates the myth that the two products
are equivalent.\93\
---------------------------------------------------------------------------
\92\ Proposal at 36805.
\93\ OneChicago Letter at 8.
---------------------------------------------------------------------------
The Commission is not adopting this proposed alternative. NSEs may
set an equity option's position limit by the use of trading volume as a
sole criterion.\94\ That approach is not consistent with existing
Commission policy regarding use of estimated deliverable supply to
support position limits in an expiring contract month, as stated in
part 150 of the Commission's regulations.\95\ Use of trading volume as
a sole criterion for setting the level of a position limit could result
in a position limit that exceeds the number of outstanding shares when
the underlying security exhibits a very high degree of turnover and a
relatively low number of shares outstanding.\96\ Such a resulting high
limit level would render position limits ineffective.
---------------------------------------------------------------------------
\94\ See, e.g., the CBOE rule 4.11, ISE rule 412, NYSE rule 904,
and PHLX rule 1001.
\95\ For example, Cboe rules also permit a 50,000 contract
position limit based on the total most recent six-month trading
volume of 20 million shares, without regard to shares outstanding.
See, e.g., the CBOE rule 4.11, and 17 CFR 150.5(c)(1).
\96\ For example, suppose a company has issued 21 million shares
which are so frequently traded that the trading volume for those
shares over a six month period is 275 million shares. Under the
rules of an NSE, the position limit for an option on that security
could be 250,000 100-share contracts, which is equivalent to 25
million shares, which is greater than the number of shares
outstanding.
---------------------------------------------------------------------------
4. Position Accountability in Lieu of Limits--Commission Regulation
41.25(b)(3)(i)(B)
The Commission proposed to change the criteria for when a DCM would
be permitted to substitute position accountability for a position limit
in an equity SFP.\97\ Specifically, under the Proposal, a DCM would be
permitted to adopt a position accountability rule where the underlying
security has an estimated deliverable supply of more than 40 million
shares and a six-month total trading volume that exceeds 2.5 billion
shares,\98\ instead of the existing criteria that the underlying
security has an average daily trading volume that exceeds 20 million
shares and more than 40 million shares outstanding.\99\ In addition,
the Proposal stated that the maximum accountability level would be
increased from 22,500 contracts to 25,000 contracts.\100\
---------------------------------------------------------------------------
\97\ Proposal at 36805 and 12-13.
\98\ Id.
\99\ See 17 CFR 41.25(a)(3)(i)(B).
\100\ Proposal at 36805 and 12-13.
---------------------------------------------------------------------------
OneChicago recommended that the Commission authorize position
accountability for all SFPs based on ETFs at a level of 25,000
contracts, or perhaps at a lower level for ETFs with low
liquidity.\101\ Because authorized participants may increase or
decrease the number of outstanding shares to keep the price of the ETF
in line with the value of the underlying assets, the Exchange believes
that estimated deliverable supply of an ETF and trading volume of an
ETF are unsuitable for assessing an ETF's liquidity.\102\ The Exchange
suggested setting a lower position accountability level, in lieu of
position limits, for an ETF with lower estimated deliverable supply of
the ETF's underlying components.\103\ The Exchange believes that a DCM
could assess whether a participant had the ability to deliver, and
whether a participant was attempting to manipulate the market, under a
position accountability regime.\104\
---------------------------------------------------------------------------
\101\ OneChicago Letter at 7.
\102\ Id.
\103\ Id.
\104\ Id.
---------------------------------------------------------------------------
The Commission is adopting, as proposed, the amended position
accountability provisions in Commission regulation
41.25(b)(3)(i)(B).\105\ Under this provision, a DCM could substitute
position accountability for position limits when six-month total
trading volume in the underlying security exceeds 2.5 billion shares
and there are more than 40 million shares of estimated deliverable
supply. This provision is roughly equivalent to the existing criteria
of more than 20 million shares of six-month average daily trading
volume in the underlying security and of more than 40 million
outstanding shares of the underlying security.\106\
---------------------------------------------------------------------------
\105\ The Commission has added clarifying language to Commission
regulation 41.25(b)(3)(i)(B) articulating that a position
accountability level is in lieu of a position limit level, as set
forth in Commission regulation 41.25(b)(3)(i)(A).
\106\ Twenty million shares times 125 trading days in a typical
six-month period equals 2.5 billion shares. In regards to total
trading volume rather than average daily trading volume, the
Commission notes that use of total trading volume is consistent with
the rules of NSEs.
---------------------------------------------------------------------------
Rather than the existing requirement that the underlying security
have more than 40 million shares outstanding, the rule requires the
underlying security to have more than 40 million shares of estimated
deliverable supply, which generally would be smaller than shares
outstanding. This change conforms to the use of estimated deliverable
supply of underlying shares in setting a position limit as discussed
above. The Commission believes an appropriate refinement to its
criterion for position accountability is to quantify those equity
shares that are readily available in the market, rather than all shares
outstanding. Generally, a short position holder may expect to obtain at
or close to fair value shares that are readily available in the market
and a long position holder may expect to be able to sell such shares at
or close to fair value. However, in contrast, shares that are issued
and outstanding by a corporation may not be readily available in a
timely manner, such as shares held by the corporation as treasury
stock. Therefore, to ensure that short position holders generally will
be able to obtain equity shares at or close to fair value, the DCM
should consider whether the shares are readily available in the market
when estimating deliverable supply.\107\
---------------------------------------------------------------------------
\107\ See appendix C to part 38, paragraph (b)(1)(i).
---------------------------------------------------------------------------
In addition, the Commission is increasing the maximum position
accountability level to 25,000 contracts from the current level of
22,500 contracts. The Commission notes a DCM would be able to set a
lower accountability level, should it desire. The Commission believes
it is appropriate to set a position accountability level no higher than
25,000 contracts because the Commission believes a DCM should have the
authority, but not the obligation, to inquire with very large position
holders as to the nature of the position and to order such position
holders not to increase positions.\108\ As stated in the Proposal, the
Commission believes a maximum position accountability level of 25,000
contracts is at the outer bounds for purposes of
[[Page 51012]]
providing a DCM with authority to obtain information from position
holders.\109\
---------------------------------------------------------------------------
\108\ By way of comparison, under 17 CFR 15.03, the Commission's
reporting level for large traders (``reportable position'') is 1,000
contracts for individual equity SFPs and 200 contracts for narrow-
based SFPs. Under 17 CFR 18.05, the Commission may request any
pertinent information concerning such a reportable position.
\109\ Proposal at 36805.
---------------------------------------------------------------------------
The Commission is not adopting a position accountability rule as
the default for all SFPs based on ETFs. The Commission notes that ETFs
are structured such that pre-approved groups of institutional firms,
known as authorized participants, are the only set of persons permitted
to create or redeem shares in an ETF. Moreover, to create ETF shares,
the authorized participant must have the requisite shares in the
securities underlying the ETF. It is not clear that the process to
create new shares in an ETF could be accomplished quickly enough during
the period leading to delivery to ensure that the ETF's price remains
in line with the prices in the underlying shares. Therefore, the
Commission will require in Commission regulation 41.25(b)(3)(i)(A)
position limits on ETFs as appropriate.
In addition, the Commission is adopting its proposed guidance,
including paragraph (d) to appendix A, which provides that a DCM may
adopt a position accountability rule for any SFP, in addition to a
position limit rule required or adopted under this section.\110\
Consistent with the requirements of the amended Commission regulation
41.25(b)(3)(i)(B), the DCM's position accountability rule must provide,
at a minimum, that the DCM have authority to obtain any information it
would need from a market participant with a position at or above the
accountability level and that the DCM have authority, in its
discretion, to order such a market participant to halt increasing their
position. Position accountability can work in tandem with a position
limit rule, particularly where the accountability level is set below
the level of the position limit. Further, the DCM may adopt a position
accountability rule to provide authority to the DCM to order market
participants to reduce position sizes, for example, to maintain orderly
trading or to ensure an orderly delivery.
---------------------------------------------------------------------------
\110\ Proposal at 36814.
---------------------------------------------------------------------------
D. Limits for Other SFPs--Commission Regulation 41.25(b)(3)(ii)-(iv)
The Proposal also included specific position limits requirements
and guidance directed at SFPs based on products other than a single
equity security: A physically-delivered basket equity SFP, a cash-
settled equity index SFP, and an SFP on one or more debt securities.
1. Limits for SFPs on More Than One Equity Security--Commission
Regulation 41.25(b)(3)(ii) and (iii)
The existing SFP rule provides that, for an SFP comprised of more
than one equity security, the DCM must apply the position limit or
position accountability level applicable to the security in the index
with the lowest average daily trading volume.\111\ The Proposal
distinguished between physically-delivered basket equity SFPs and cash-
settled equity index SFPs, though the Commission notes that neither
currently is listed for trading on a DCM.
---------------------------------------------------------------------------
\111\ 17 CFR 41.25(a)(3)(ii).
---------------------------------------------------------------------------
OneChicago believes the current general framework is sufficient and
recommended that the Commission not finalize regulations for types of
SFPs that currently are not listed for trading, unless there is
interest in listing such SFPs.\112\ OneChicago expressed concern that
issuing these regulations would risk stifling innovation.\113\ Rather,
OneChicago believes the Commission should have a regulatory scheme that
can quickly adapt to market developments.\114\
---------------------------------------------------------------------------
\112\ OneChicago Letter at 9.
\113\ Id.
\114\ Id.
---------------------------------------------------------------------------
The Commission is adopting the changes to the general framework for
types of SFPs not currently listed for trading, as proposed. The
Commission is concerned that the existing general framework applicable
to SFPs, as noted in the Proposal, does not take into account the
characteristics of other types of SFPs, such as an SFP on one or more
debt securities, SFPs based on physically-delivered baskets of
equities, and cash-settled SFPs based on equity indexes. Absent
revisions, the Commission is concerned that the existing general
framework could impede innovation because a DCM may not be able to
tailor a product's terms to comply with the framework.\115\
---------------------------------------------------------------------------
\115\ See Proposal at 36807.
---------------------------------------------------------------------------
a. Physically-Delivered Basket Equity SFPs--Commission Regulation
41.25(b)(3)(ii)
With respect to a physically-delivered SFP on more than one equity
security, the Proposal provided that the DCM must adopt the position
limit for the SFP based on the underlying security with the lowest
estimated deliverable supply and that the position accountability level
would only be allowable if each of the underlying equity securities in
the basket of deliverable securities is eligible for a position
accountability level.\116\ The Commission proposed the existing
position limits and position accountability provisions for a
physically-delivered SFP comprised of more than one equity security
\117\ by basing the criteria on the underlying equity security with the
lowest estimated deliverable supply, rather than the lowest average
daily trading volume.\118\
---------------------------------------------------------------------------
\116\ Proposal at 36805-06 and 13.
\117\ The Commission notes that there is not a limit per se on
the maximum number of securities in a narrow-based security index.
Rather, under CEA section 1a(35), a narrow-based security index
generally means an index that has nine or fewer component
securities; a component security comprises more than 30 percent of
the index's weighting; the five highest weighted component
securities in the aggregate comprise more than 60 percent of the
index's weight; or the lowest weighted component securities,
comprising no more than 25 percent of the index's weight, have an
aggregate dollar value of average daily trading volume of less than
$50 million. 7 U.S.C. 1a(35).
\118\ This means that, under proposed 17 CFR 41.25(b)(3)(i), the
default level position limit would be no greater than the equivalent
of 25,000 100-share contracts in the security with the lowest
estimated deliverable supply, unless that underlying equity security
supports a higher level.
---------------------------------------------------------------------------
The Commission is adopting Commission regulation 41.25(b)(3)(ii) as
proposed. The rule is based on the premise that the limit on a
physically-delivered equity basket SFP should be consistent with the
most restrictive limit applicable to SFPs based on each component of
such basket of deliverable securities. This restricts a person from
obtaining a larger exposure to a particular component security through
a physically-delivered basket equity SFP than could be obtained
directly in a single equity SFP. However, the rule does not aggregate
positions in single equity SFPs with positions in basket deliverable
SFPs.
b. Cash-Settled Equity Index SFPs--Commission Regulation
41.25(b)(3)(iii)
With respect to a cash-settled SFP based on a narrow-based security
index of equity securities, the Proposal simply provided that the DCM
must adopt a position limit level and offered relevant guidance and
acceptable practices.\119\ Under the proposed guidance a DCM could set
the position limit for a cash-settled SFP on a narrow-based equity
security index equal to that of a similar narrow-based equity security
index option listed on an NSE.\120\ As an alternative for setting the
level based on that of a similar equity index option, the proposal
provided guidance and acceptable practices that would allow a DCM, in
setting a limit, to consider the deliverable supply of securities
underlying the equity index, and the
[[Page 51013]]
equity index weighting and SFP contract multiplier.\121\
---------------------------------------------------------------------------
\119\ Proposal at 36806, 13, and 14.
\120\ Proposal at 36814.
\121\ Id.
---------------------------------------------------------------------------
As an example of an acceptable practice in paragraph (b)(2) of
appendix A, for a cash-settled equity index SFP on an equity security
index weighted by the number of shares outstanding, a DCM could set a
position limit as follows: First, compute the limit on an SFP on each
underlying security under proposed regulation (b)(3)(i)(A) (currently
designated as (a)(3)(i)(A)); second, multiply each such limit by the
ratio of the 100-share contract size and the shares of the security in
the index; and third, determine the minimum level from step two and set
the limit to that level, given a contract size of one dollar times the
index, or for a larger contract size, reduce the level
proportionately.\122\ As with physically-delivered basket equity SFPs,
the Proposal is based on the premise that the limit on a cash-settled
SFP on a narrow-based security index of equity securities should be as
restrictive as the limit for an SFP based on the underlying security
with the most restrictive limit.
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\122\ Id.
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The Commission is adopting Commission regulation 41.25(b)(3)(iii)
and its associated guidance and acceptable practices as proposed. For
setting levels of limits on an SFP comprised of more than one security,
existing Commission regulation 41.25(a)(3)(ii) specifies certain
criteria for trading volume and shares outstanding that must be applied
to the security in the index with the lowest average daily trading
volume. However, the Commission did not propose to retain those
criteria for setting levels of limits for cash-settled equity index
SFPs. For an equity index that is price weighted, it appears that use
of shares outstanding or trading volume may result in an
inappropriately restrictive level for a position limit. For an equity
index that is value weighted, it also appears that such use may result
in an inappropriately restrictive level for a position limit. For
example, suppose a price weighted index has a component with a high
price and a large number of shares outstanding, but a low trading
volume. Specifically, this stock has the lowest trading volume in this
index. If trading volume is used to establish the position limit for an
SFP based on this index, then the position limit would be excessively
restrictive because this specific component with a high index weight
and low trading volume would force such a tight position limit to
ensure that a trader could not attain a notional position in this stock
that is in excess of a position limit that would apply to an SFP on
that stock. The Commission observes that while trading volume, as an
indicator of liquidity, may be an appropriate factor for a DCM to
consider in setting position limits, trading volume is not generally
used in construction of equity indexes.
2. Debt SFPs--Commission Regulation 41.25(b)(3)(iv)
Although no DCM currently lists for trading SFPs based on one or
more debt securities, the Proposal provided that if a DCM listed such
SFPs, the DCM must adopt a position limit level and offered relevant
guidance.\123\ The Proposal provided guidance that an appropriate level
for limits on debt SFPs generally would be no greater than the
equivalent of 12.5 percent of the par value of the estimated
deliverable supply of the underlying debt security.\124\ Similarly, the
Proposal provided guidance that an appropriate level for limits on an
index composed of debt securities generally should be set based on the
component debt security with the lowest estimated deliverable
supply.\125\ The Commission invited comment on whether a level based on
par value is appropriate, or whether some other metric would be
appropriate.\126\ The Commission received no comments on this question.
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\123\ The requirements for a security underlying an SFP permit
the listing of SFPs on debt securities (other than exempted
securities). See 17 CFR 41.21(a)(2)(iii) (providing that the
underlying security of an SFP may include ``a note, bond, debenture,
or evidence of indebtedness''); see also 71 FR 39534 (Jul. 13, 2006)
(describing debt securities to include ``notes, bonds, debentures,
or evidences of indebtedness''). While an SFP may not be listed on a
debt security that is an exempted security, futures contracts may be
listed on an exempted security.
\124\ Proposal at 36807-08 and 14.
\125\ Proposal at 36814.
\126\ Proposal at 36808.
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The Commission is adopting Commission regulation 41.25(b)(3)(iv)
and the associated guidance as proposed. Although no DCM currently
lists an SFP based on a debt security, the Commission believes a
framework for position limits may reduce uncertainty regarding
acceptable practices for listing such contracts on non-exempted
securities and, thereby, may facilitate listing of such contracts. The
Commission notes that futures contracts in exempted securities, such as
U.S. Treasury notes, have been listed for many years.
The Commission is adopting this approach as guidance because there
may be other reasonable bases for setting position limits for debt
SFPs, and the Commission does not want to foreclose those bases. For
example, a coupon stripped from an interest-bearing corporate bond does
not have a par value in terms of such corporate bond, but instead such
coupon is the amount of interest due at the time the corporate issuer
is scheduled to pay such coupon under the corporate bond indenture. The
Commission elected not to apply the criteria of trading volume and
shares outstanding for setting levels of limits for debt SFPs because
debt securities generally are neither issued in terms of shares nor
trading volume measured in terms of shares.
E. General Requirements
1. Time Period During Which Position Limits Must Be Effective
The Commission proposed to maintain the requirement that position
limits and position accountability levels be applied during a period of
time no shorter than the last five trading days in an expiring contract
month.\127\ The Commission also proposed a new requirement that
position limits become effective no later than the first day that long
position holders may be assigned delivery notices in the event that the
terms of an SFP provided for delivery prior to the last five trading
days.\128\
---------------------------------------------------------------------------
\127\ Proposal at 36806 and 13.
\128\ Id.
---------------------------------------------------------------------------
OneChicago believes positions limits should only be in effect on
the expiration day, because its experience has been that the short side
is always pre-hedged and prepared to go through delivery, and the long
side simply needs money to pay for delivery at its brokerage firm. The
Exchange stated, ``All FCM customers roll their positions forward or
extinguish the positions prior to expiration as taking delivery of
securities, while theoretically possible, is not practical and the FCM
[sic] make the process uneconomical for the customers.'' \129\
---------------------------------------------------------------------------
\129\ OneChicago Letter at 6.
---------------------------------------------------------------------------
The Commission is amending the existing provision in Commission
regulation 41.25(a)(3) that requires position limits to be applied in
an expiring contract month for at least the last five trading days of
the contract month. Specifically, the Commission is decreasing the time
during which position limits must be in effect to at least the last
three trading days of the contract month. However, Commission
regulation 41.25(b)(3) of the final rule nevertheless requires position
limits be in effect for a period longer than three trading days in the
event that the terms of an SFP provide for delivery prior to
[[Page 51014]]
the last three trading days.\130\ For example, if a DCM's rules provide
for delivery notices to be assigned to long traders beginning on the
first day of the contract month, then a position limit would have to be
in effect no later than the trading day prior to the first day of the
delivery month.
---------------------------------------------------------------------------
\130\ Currently, there are no SFPs that allow delivery prior to
the last trading day.
---------------------------------------------------------------------------
The Commission notes that other DCMs have experience in applying
spot month position limits to the last few days of trading, where
delivery occurs after the close of trading on the last trading
day.\131\ The Commission has noted that in its experience with
surveillance of futures markets, the potential for manipulation and
price distortion based on extraordinarily large positions is highest
during the time period near contract expirations.\132\ The Commission
required position limits on SFPs during the last five trading days when
settlement of security transactions was on a T+3 basis. This provided a
two day buffer during which short hedgers could acquire shares in the
underlying market to make delivery. Currently, settlement of security
transactions in the underlying market occurs on a T+2 basis. The
Commission notes that the two-day buffer may be longer than is
necessary to prevent market distortions caused by extraordinarily large
positions and believes that a one-day buffer is adequate. Therefore,
the Commission believes that positions limits that are in effect during
the last three days of trading should be sufficient to minimize
potential distortion if traders need to acquire securities in order to
deliver on an expiring SFP.
---------------------------------------------------------------------------
\131\ For example, position limits for NYMEX's WTI Crude Oil and
Natural Gas futures contracts are in effect during the last three
days of trading. Delivery on those contracts occurs after
expiration.
\132\ See 2001 Final SFP Rules at 55082.
---------------------------------------------------------------------------
The time period during which position limits are in effect for SFPs
need not be consistent with that of position limits on security
options, which are in effect at all times, because security options
typically have American-style exercise provisions and can be exercised
at any time prior to expiration. The unanticipated need to acquire
securities to make delivery on an exercised security option, therefore,
does not exist with SFPs. For the reasons noted above, the Commission
is decreasing to three days from five days the period during which SFP
position limits will be in effect.
2. Applying Position Limits and Accountability Levels on a Net and
Gross Basis
The Proposal generally allowed DCMs the discretion to apply
position limits and position accountability levels on either a net, as
under existing regulations, or a gross (``same side of the market'')
basis.\133\ If a DCM imposes limits on the same side of the market,
then the DCM could not net positions in SFPs in the same security on
opposite sides of the market. The Proposal provided, however, that if a
DCM lists both physically-delivered contracts and cash-settled
contracts in the same security, it may not permit netting of positions
in the physically-delivered contract with that of the cash-settled
contract for purposes of determining compliance with position
limits.\134\
---------------------------------------------------------------------------
\133\ Proposal at 36803 and 12.
\134\ Proposal at 36802, 03-04, and 13.
---------------------------------------------------------------------------
OneChicago did not support the use of gross position limits for
SSFs. The Exchange noted that it does not permit a customer to hold
both a long and short SSF with the same symbol and expiration, making
the application of this proposed rule meaningless under the Exchange's
rules.\135\
---------------------------------------------------------------------------
\135\ OneChicago Letter at 8.
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The Exchange believes cash-settled and physically-delivered SFPs on
the same underlying security should be combined for the same expiration
date for purposes of position limits.\136\ The Exchange agrees with the
proposal to expand the limits for physically-delivered contracts, but
believes that cash-settled contracts pose a greater danger of
manipulation on the closing price of the underlying security and should
be constrained at the position limit levels that are currently in
force.\137\ The Exchange noted that with physical settlement, a long
position holder taking delivery, in an attempt to manipulate the
underlying security price upwards, would take delivery at an artificial
price ``which should correct the next day.'' \138\ The Exchange noted
that with cash settlement, a long holder attempting to manipulate the
underlying security price, does not take delivery at an artificial
price, but collects profits through variation margin based on a higher
artificial price.\139\ According to the Exchange, this difference
between physical delivery and cash settlement produces an incentive to
attempt a distortion in the price of the underlying market.\140\
---------------------------------------------------------------------------
\136\ OneChicago Letter at 5.
\137\ Id.
\138\ Id.
\139\ Id.
\140\ Id.
---------------------------------------------------------------------------
The Commission is adopting its proposal to give a DCM discretion to
apply position limits or position accountability levels either on a net
basis, as under current regulations, or on the same side of the
market.\141\ Under Commission regulation 41.25(b)(3)(vii), if a DCM
imposes limits based upon positions on the same side of the market,
then the DCM could not net positions in SFPs in the same security on
opposite sides of the market.
---------------------------------------------------------------------------
\141\ The Commission notes that, although it did not propose or
adopt an aggregation rule to define ``person'' for purposes of SFP
position limits, current 17 CFR 150.5(g) addresses aggregation
standards for exchange-set position limits. The Commission believes
a DCM should have reasonable discretion to set aggregation standards
based on a person's control or ownership of SFP positions, including
using any aggregation standards used by an NSE in connection with
equity options.
---------------------------------------------------------------------------
For example, if there were a physically-delivered SFP on equity
XYZ, a dividend-adjusted SFP on equity XYZ, and a cash-settled SFP on
equity XYZ, then a DCM's rules could provide that long positions held
by the same person across each of these classes of SFP based on equity
XYZ would be aggregated for the purpose of determining compliance with
the position limit. A gross position in a futures contract is larger
than a net position in the event a person holds positions on opposite
sides of the market. That is, a net basis is computed by subtracting a
person's short futures position from that person's long futures
position, and, under current regulations, a single position limit
applies on a net basis to that net long or net short position. Under
the final rule, at the discretion of a DCM, a person's long futures
position is subject to the position limit and, separately, a person's
short futures position also is subject to the position limit.
Adding this gross basis approach (in addition to net basis) to SFP
limits more closely resembles existing limits on security options that
apply on the same side of the market per the rules of the NSEs.\142\ A
DCM that elects to implement limits on a gross basis would be providing
its market participants with the same metric for position limit
compliance as is currently the case on NSEs, which may reduce
compliance costs and encourage cross-market participation. However,
limits on a gross basis may be more restrictive than limits
[[Page 51015]]
on a net basis, which could reduce the position sizes that may be held
without an applicable exemption.
---------------------------------------------------------------------------
\142\ For example, Cboe applies limits to an aggregate position
in an option contract ``of the put type and call type on the same
side of the market.'' Cboe rule 4.11. For this purpose, under the
rule, long positions in put options are combined with short
positions in call options; and short positions in put options are
combined with long position in call options.
---------------------------------------------------------------------------
The Commission notes that a DCM need not use this alternative
approach. The Commission continues to permit DCMs to apply SFP limits
on a net basis at the DCM's discretion. In this regard, the Commission
believes it is possible for a DCM's application of limits to further
the goals of the CEA whether applied on a net or a gross basis.\143\
This is true, for example, if a DCM applied limits on a net basis and
did not permit netting of physically-delivered contracts with cash-
settled contracts. But if, instead, the DCM permitted netting of
physically-delivered contracts and cash-settled contracts in the same
security, it would render position limits ineffective.\144\ For
example, a person should not be permitted to avoid limits by obtaining
a large long position in a physically-delivered contract (which could
be used to corner or squeeze) and a similarly large short position in a
cash-settled contract that would net to zero.
---------------------------------------------------------------------------
\143\ CEA section 2(a)(1)(D)(i)(VII) requires that trading in
SFPs is not readily susceptible to manipulation of the price of the
SFP, the SFP's underlying security, or an option on the SFP's
underlying security. 7 U.S.C. 2(a)(1)(D)(i)(VII).
\144\ Although no DCM currently lists both physically-delivered
SFP contracts and cash-settled SFP contracts for the same underlying
security, and this concern may be theoretical, the Commission
believes that providing clarity reduces uncertainty regarding
netting in such circumstances, which may facilitate listing of such
contracts in the future. Therefore, 17 CFR 41.25(b)(3)(vii) of the
final rule provides that, for a DCM applying limits on a net basis,
netting of physically-delivered contracts and cash-settled contracts
in the same security is not permitted as it would render position
limits ineffective. This concern is not applicable to a DCM applying
limits on the same side of the market, as limits are applied
separately to long positions and to short positions.
---------------------------------------------------------------------------
3. Requirements for Resetting Position Limit Levels--Commission
Regulation 41.25(b)(3)(vi)
The Commission proposed to require a DCM to consider, on at least a
semi-annual basis, whether SFP position limits were set at appropriate
levels, through consideration of estimated deliverable supply.\145\
Under the Proposal, DCMs would be required to calculate estimated
deliverable supply and six-month total trading volume no less
frequently than semi-annually, rather than the existing requirement to
calculate average daily trading volume on a monthly basis.\146\ In the
event that estimated deliverable supply has decreased, then a DCM would
be required to lower the level of a position limit in light of that
decreased deliverable supply. In the event that estimated deliverable
supply has increased, then a DCM would have discretion to increase the
level of a position limit for that contract. In addition, a DCM that
has substituted a position accountability rule for a position limit
would be required to consider whether estimated deliverable supply and
total six-month trading volume continue to justify that position
accountability rule.\147\
---------------------------------------------------------------------------
\145\ Proposal at 36806-07 and 13.
\146\ Id.
\147\ The Commission also proposed a non-substantive change to
the filing requirement whenever a DCM makes such changes to limit
levels. While the Proposal provided that changes to limit levels be
filed pursuant to the requirements of Commission regulation 41.24,
it removed the superfluous provision in the current regulation that
provides that the change be effective no earlier than the day after
the DCM has provided notification to the Commission and to the
public. Instead, the regulation simply cites to Commission
regulation 41.24.
---------------------------------------------------------------------------
OneChicago supported the proposal to allow DCMs to recalculate
levels of position limits on a semiannual basis, instead of a monthly
basis. In this regard, OneChicago noted that in its experience
resetting levels monthly provides very little value.\148\
---------------------------------------------------------------------------
\148\ OneChicago Letter at 8.
---------------------------------------------------------------------------
The Commission is adopting Commission regulation 41.25(b)(3)(vi) as
proposed. The Commission believes that review of position limit levels
and position accountability rules on at least a semi-annual basis
rather than a monthly basis generally should be adequate to ensure
appropriate levels because deliverable supply generally does not change
to a great degree from month to month. For example, the number of
shares outstanding may increase through periodic issuance of additional
shares, and may decrease through stock repurchase programs, but, as a
general observation, such issuance or repurchases are not a large
percentage of free float. Of course, there could be situations where
deliverable supply changes to a great degree before the semi-annual
period and the rule does not prevent a DCM from considering those
changes before such period.
4. Proposed Guidance on Exemptions for Limits
Under the existing SFP rule in Commission regulation
41.25(a)(3)(iii), DCMs are authorized to approve exemptions from SFP
position limits, provided the exemptions are consistent with Commission
regulation 150.3, which addresses exemptions from Commission-set
position limits set forth in Commission regulation 150.2.\149\ The
Proposal would have deleted Commission regulation 41.25(a)(3)(iii) and
created guidance that DCMs may approve exemptions provided they are
consistent with either Commission regulations 150.5(d), (e), and (f),
which addresses exemptions from exchange-set position limits, or the
exemptions of an NSE.\150\
---------------------------------------------------------------------------
\149\ Commission regulation 150.2 sets forth speculative
position limits for nine agricultural commodities. 17 CFR 150.2.
\150\ NSEs permit certain exemptions, including for qualified
hedging transactions and for facilitation of orders with customers.
---------------------------------------------------------------------------
OneChicago did not comment on the Commission's proposed guidance
regarding exemptions from SFP position limits, but requested that the
Commission give DCMs the authority to exempt spread transactions
designed to facilitate the transfer and return of securities as a pure
financing trade. On OneChicago, such transactions are called Securities
Transfer and Return Spreads (``STARS'').\151\ In a OneChicago STARS
transaction, the front leg in the spread expires on the date of the
OneChicago STARS transaction and the deferred leg in the spread will
expire at a distant date. The Exchange noted the expiration of the
front leg triggers the transfer of securities for cash on T+1, that is,
on the next business day following the trade date. According to the
Exchange, the spread transactions are similar to an exchange for
physical transaction that results in the transfer of the underlying
commodity in exchange for a futures transaction on the other side of
the market, but the two parties transfer the underlying security via
the SFP rather than crossing the stock themselves.
---------------------------------------------------------------------------
\151\ OneChicago Letter at 6.
---------------------------------------------------------------------------
The Exchange stated that it sees no value in requiring market
participants to seek a hedge exemption for the expiring nearby contract
in the OneChicago STARS transaction. The Exchange noted its rules allow
customers to request an exemption for a position that was established
the day before, which, for a OneChicago STARS transaction, would be for
a nearby leg that no longer exists. Since the market participant can
seek an exemption the day after the OneChicago STARS transaction when
the nearby leg would no longer exist, the Exchange views such an
exemption request as unnecessary paperwork. OneChicago, therefore,
requests that the Commission give DCMs the authority to exempt
transactions such as OneChicago STARS transactions from SFP position
limits.
The Commission is deleting existing Commission regulation
41.25(a)(3)(iii) and adopting the guidance in paragraph (e) to appendix
A as proposed. The Commission also believes that OneChicago's
recommendation regarding the OneChicago STARS
[[Page 51016]]
transactions has merit. In this regard, the nearby short position is a
hedged (covered) position that would not require a subsequent
acquisition of shares to make delivery. Thus, there is no concern
regarding a distortion in the underlying cash market caused by
acquiring a large number of shares in a short period of time.
Therefore, as long as the DCM is aware that nearby short positions
created by transactions such as OneChicago STARS transactions are
covered, DCMs may adopt rules that exempt positions created through
such transactions from position limits. Moreover, a DCM could exempt
positions or portions of a total position created by transactions such
as OneChicago STARS transactions while enforcing limits on positions
created through outright transactions.
IV. Related Matters
A. Regulatory Flexibility Act
The Regulatory Flexibility Act (``RFA'') \152\ requires federal
agencies, in promulgating regulations, to consider whether the rules
they issue will have a significant economic impact on a substantial
number of small entities and, if so, provide a regulatory flexibility
analysis of the impact on those entities. The final rule generally
applies to exchange-set position limits. The final rule permits a DCM
to increase the level of position limits for SFPs and may change the
application of those limits from a trader's net position to a trader's
gross position. The final rule will affect DCMs. The Commission has
previously established certain definitions of ``small entities'' to be
used in evaluating the impact of its rules on small entities in
accordance with the RFA, and has previously determined that DCMs are
not small entities for purposes of the RFA.\153\ The Commission
requested comments with respect to the Proposal's RFA discussion and
received no comments.
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\152\ 5 U.S.C. 601 et seq.
\153\ See Policy Statement and Establishment of Definitions of
``Small Entities'' for Purposes of the Regulatory Flexibility Act,
47 FR 18618, 18619 (Apr. 30, 1982).
---------------------------------------------------------------------------
For all these reasons, the Commission believes that the amendments
to the SFP position limits regulations will not have a significant
economic impact on a substantial number of small entities. Accordingly,
the Chairman, on behalf of the Commission, hereby certifies, pursuant
to 5 U.S.C. 605(b), that the final rule will not have a significant
economic impact on a substantial number of small entities.
B. Paperwork Reduction Act
The Paperwork Reduction Act of 1995 (``PRA'') \154\ provides that a
federal agency may not conduct or sponsor, and a person is not required
to respond to, a collection of information unless it displays a
currently valid control number issued by the Office of Management and
Budget (``OMB''). The collection of information related to the amended
rule is OMB control number 3038-0059--Security Futures Products.\155\
As a general matter, the final rule: (i) Permits a DCM to increase the
level of limits; (ii) allows a DCM to change the application of
exchange-set limits from a net basis to a gross basis; and (iii)
reduces the time during which the position limits are in effect from
the last five days of the contract month to the last three days of the
contract month. The Commission believes that the final rule will not
impose any new information collection requirements that require
approval of OMB under the PRA. As such, these final rule amendments do
not impose any new burden or any new information collection
requirements in addition to those that already exist in connection with
filings to list SFPs under Commission regulation 41.23 or to amend
exchange rules for SFPs under Commission regulation 41.24.\156\
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\154\ 44 U.S.C. 3501 et seq.
\155\ Regarding Security Futures Products (OMB Control No. 3038-
0059), the Commission recently published a notice of a request for
extension of the currently approved information collection. See 82
FR 48496 (Oct. 18, 2017).
\156\ Similarly, the Commission previously determined that a
rule expanding the listing standards for security futures did not
require a new collection of information on the part of any entities.
See 71 FR 39534 at 39539 (Jul. 13, 2006) (adopting a rule to permit
security futures to be based on individual debt securities or a
narrow-based security index comprised of such securities).
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C. Cost-Benefit Considerations
1. Introduction
Section 15(a) of the CEA requires the CFTC to consider the costs
and benefits of its actions before promulgating a regulation under the
CEA.\157\ CEA section 15(a) further specifies that the costs and
benefits shall be evaluated in light of five broad areas of market and
public concern: (1) Protection of market participants and the public;
(2) efficiency, competitiveness, and financial integrity of futures
markets; (3) price discovery; (4) sound risk management practices; and
(5) other public interest considerations. The CFTC considers the costs
and benefits resulting from its discretionary determinations with
respect to the section 15(a) factors below.
---------------------------------------------------------------------------
\157\ 7 U.S.C. 19(a).
---------------------------------------------------------------------------
Where reasonably feasible, the CFTC has endeavored to estimate
quantifiable costs and benefits. Where quantification is not feasible,
the CFTC identifies and describes costs and benefits qualitatively.
The CFTC requested comments on the costs and benefits associated
with the proposed rule amendments. In particular, the CFTC requested
that commenters provide data and any other information or statistics
that the commenters relied on to reach any conclusions regarding the
CFTC's proposed considerations of costs and benefits. The Commission
received comments that indirectly address the costs and benefits of the
Proposal. These comments are discussed as relevant below.
2. Economic Baseline
The CFTC's economic baseline for this analysis of the final rule is
the SFP position limits rule requirement that was adopted in 2001 and
exists today in Commission regulation 41.25(a)(3). In the 2001 Final
SFP Rules, the Commission adopted an SFP position limits rule that is
consistent with the statutory requirements of CEA section 2(a)(1)(D).
In particular, CEA section 2(a)(1)(D)(i)(VII) requires generally that
trading in an SFP not be readily susceptible to manipulation of the
price of that SFP or its underlying security. In this connection,
Commission regulation 41.25(a)(3) currently states that the DCM shall
have rules in place establishing position limits or position
accountability procedures for the expiring futures contract month.\158\
The 2001 Final SFP Rules also provide criteria for a default level of
position limits and criteria that permit a DCM to adopt an exchange
rule for position accountability in lieu of position limits.\159\ In
addition, the 2001 Final SFP Rules permit a DCM to approve exemptions
from position limits pursuant to exchange rules that are consistent
with Commission regulation 150.3.
---------------------------------------------------------------------------
\158\ 17 CFR 41.25(a)(3).
\159\ 17 CFR 41.25(a)(3).
---------------------------------------------------------------------------
The CFTC analyzed the costs and benefits of the final rule against
the current default net position limit level of 13,500 (100-share)
contracts; or a higher net position limit level of 22,500 (100-share)
contracts for equity SFPs meeting either: (i) A criterion of at least
20 million shares of average daily trading volume, or (ii) criteria of
at least 15 million shares of average daily trading volume and more
than 40
[[Page 51017]]
million shares of the underlying security outstanding. The current
regulation permits (but does not require) a DCM to adopt an exchange
rule for position accountability in lieu of position limits, provided
that average daily trading volume in the underlying security exceeds 20
million shares and there are more than 40 million shares of the
underlying security outstanding. The current regulation specifies that
the six-month average daily trading volume in the underlying security
be calculated at least monthly and applies limits to positions held
during the last five trading days of an expiring contract month.
3. Summary of the Final Rule
For equity SFPs, the final rule increases the default position
limit level from 13,500 (100-share) contracts to 25,000 (100-share)
contracts and permits a DCM to establish a position limit level higher
than 25,000 (100-share) contracts based on the estimated deliverable
supply of the underlying security. The final rule provides guidance on
estimating delivery supply, and in connection with this change,
requires a DCM to estimate deliverable supply at least semi-annually,
rather than calculating the six-month average daily trading volume at
least monthly.
Also for equity SFPs, the final rule changes the criteria that
permit a DCM to adopt an exchange rule for position accountability in
lieu of position limits. Under the final rule, for a DCM to adopt an
exchange rule for position accountability in lieu of position limits,
the underlying security must have an estimated deliverable supply of
more than 40 million shares and a total trading volume of more than 2.5
billion shares over a six-month period.
For physically-delivered basket equity SFPs, the final rule, in
addition to requiring a position limit, specifies that the position
limit be based on the underlying security in the index with the lowest
estimated deliverable supply. The final rule also clarifies that an
appropriate adjustment must be made to the level of the limit for a
contract size different than 100 shares per underlying security.
For SFPs that are cash settled to a narrow-based security index of
equity securities, the final rule requires a position limit and
provides guidance that a DCM may set the limit level to that of a
similar narrow-based security index equity option. The final rule also
provides guidance and an acceptable practice, which sets forth a safe
harbor whereby a DCM itself may establish such a limit level.
For SFPs in debt securities, the final rule establishes a
requirement that a DCM must adopt a position limit either net or on the
same side of the market, and provides guidance that the level of such
limit generally should be set no greater than the equivalent of 12.5
percent of the par value of the estimated deliverable supply of the
underlying debt security.
The final rule shortens the time period during which position
limits must be in effect from the last five trading days to the last
three trading days. The final rule also establishes a required minimum
position limit time period beginning no later than the first day that a
holder of a long position may be assigned a delivery notice, if such
period is longer than the last three trading days, where the SFP
permits delivery notices to be sent to long traders before the
termination of trading.
The final rule provides DCMs with the discretion to alter the basis
for applying a position limit from a net position to a gross position
on the same side of the market.\160\
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\160\ In this regard, OneChicago permits the holding of
concurrent long and short positions. See OneChicago exchange rule
424, available at https://www.onechicago.com/wp-content/uploads/content/OneChicago_Current_Rulebook.pdf.
---------------------------------------------------------------------------
The final rule establishes guidance that a DCM may adopt an
exchange rule for position accountability in addition to an exchange
rule for a position limit.
The final rule amends the guidance for exemptions from SFP position
limits by changing the reference to CFTC regulation 150.3, regarding
exemptions to federal position limits, to CFTC regulation 150.5,
regarding exchange-set limits. The final rule also adds guidance for
exemptions from SFP position limits to permit a DCM to provide
exemptions consistent with those of an NSE regarding securities options
position limits or exercise limits.
The final rule amends the requirements for resetting levels of SFP
position limits by changing the required review period from monthly to
semi-annually; and imposing a requirement that a DCM must lower the
position limit for an SFP if the data no longer justify a higher limit
level. The final rule also makes clear that a DCM must adopt a position
limit for an SFP if data no longer justify an exchange rule for
position accountability in lieu of a position limit. The final rule
continues to permit a DCM to use discretion as to whether to increase
the level of a position limit for an SFP if the data justify a higher
level.
The final rule establishes a general definition of estimated
deliverable supply, consistent with the guidance on estimating
deliverable supply in appendix C to part 38 of the Commission's
regulations, and provides guidance on estimating deliverable supply
that is specific to an SFP.
Lastly, the final rule establishes a definition of ``estimated
deliverable supply,'' which reflects the general definition of
deliverable supply in the Commission's appendix C to part 38, paragraph
(b)(1)(i),\161\ and ``same side of the market,'' for clarity regarding
the application of the final rule's limit levels on a gross basis. This
definition of ``same side of the market'' distinguishes long positions
for an SFP in the same security from short positions in an SFP in the
same security.\162\
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\161\ See 17 CFR part 38 appendix C.
\162\ These two definitions would be added into a new paragraph
(a) of 17 CFR 41.25; in conjunction with the addition of the new
paragraph (a), current paragraphs (a) through (d) would be re-
designated as paragraphs (b) through (e).
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4. Costs
As a general matter, the Commission believes that the final rule
will reduce costs relative to existing Commission regulation
41.25(a)(3),\163\ since the final rule will likely reduce the need for
and number of hedge exemption requests (as discussed in the benefits
section, below) and the frequency of required DCM reviews of SFP
position limits from monthly to semi-annually. Under the final rule,
DCMs that list SFPs for trading will continue to be required to adopt
position limits or position accountability, but the final rule is
expected to generally increase the levels of any such position limits.
The Commission recognizes that the final rule will impose certain
compliance, monitoring and implementation costs on such DCMs in
connection with establishing new position limits or position
accountability trigger levels based on deliverable supply and such
additional criteria that the listing DCM determines to be appropriate.
Such costs might include those related to the monitoring of positions
in the SFP and related underlying security; related filing, reporting,
and recordkeeping requirements; and the costs of changes to information
technology systems. The Commission believes that these costs will be
incremental and are mitigated because DCMs currently are required to
comply with comparable requirements such as calculating average daily
trading volume.
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\163\ Re-designated under the proposal as 17 CFR 41.25(b)(3).
---------------------------------------------------------------------------
However, the Commission notes that these costs will now be incurred
only on a semi-annual basis rather than monthly
[[Page 51018]]
as is the case under current regulations. The Commission believes that
DCMs will be able to exercise a certain degree of control over the
extent of these costs depending on the amount of standardization such
DCMs use to determine position limits and accountability. For example,
a DCM could, consistent with the final rule, adopt a simple rule for
equity SFPs based on the number of free-float outstanding shares of the
underlying security. For equity securities, free-float information is
readily available on certain publicly-available market websites and on
Bloomberg terminals and similar services to which DCMs are likely to
have access for other business reasons. Reducing the frequency with
which DCMs are required to review position limits and accountability to
semi-annually from monthly will reduce costs to DCMs. Thus, the
Commission anticipates that estimating deliverable supply will not be
more costly, and likely will be less costly, than estimating average
daily trading volume as required under current regulations.
The Commission notes that under the final rule, DCMs have the
discretion to implement the default position limit of 25,000 contracts,
and that this may result in position limit levels in some contracts
greater than 12.5 percent of deliverable supply. However, this
discretion is limited by Core Principle 5 (which requires DCMs to set
position limits at necessary and appropriate levels to deter
manipulation) and by Core Principle 3 (which requires that DCMs only
list contracts that are not readily susceptible to manipulation). To
the extent that DCMs comply with these core principles, any such
discretion regarding the setting of position limits should not impair
the protection of market participants and the public or otherwise
impose significant costs on the markets for SFPs or related securities.
To the extent that a DCM lists equity SFPs on deliverable baskets,
the costs of implementing the amended position limit provisions for
such SFPs would be similar to the costs of the analogous provisions for
single stock SFPs. As compared to the existing rule, there is likely to
be a small incremental cost to DCMs because a DCM would be required to
apply a position limit or position accountability rule based on the
security in the basket with the lowest estimated deliverable supply
rather than the existing lowest average daily trading volume. The
determination of estimated deliverable supply is expected to take more
time and effort since it is not merely a formulaic number like
``average daily trading volume'' but instead may require additional
subjective analysis. However, since DCMs do not currently list and
trade any equity SFPs on deliverable baskets there will be no
additional costs associated with the final rule at this time.
For a DCM that may list SFPs on debt securities, the final rule is
expected to provide an incremental increase in costs as compared to the
existing regulation. Under the current regulation, a DCM is permitted
to list an SFP based on a debt security, however, the existing
regulation does not specify the position limit or position
accountability requirements for SFPs on debt securities largely due to
the focus in the existing requirements on equity securities. As a
result, a DCM could under the final rule set position limits or
position accountability rules for SFPs on a single debt security based
on the guideline of 12.5 percent of the par value of the estimated
deliverable supply or for a basket of debt securities based on 12.5
percent of the par value of the debt security with the lowest estimated
deliverable supply. However, a DCM could, if it has a reasonable basis,
adopt a different approach for SFPs based on debt securities. The cost
for DCMs applying this position limit framework will be mitigated by
the systems currently in place for equity securities and the fact that
DCMs do not currently list any SFPs on a single debt security or basket
of debt securities.
To the extent that there is less publicly-available information
related to the deliverable supply of debt securities, estimating
deliverable supply may be more costly for debt securities than for
equity securities. However, these costs will only be incurred in the
event that a DCM begins listing SFPs on non-exempted debt securities.
Moreover, these deliverable supply provisions are set out as guidance
so that DCMs are free to implement less costly methods to comply with
the rule, which provides only that SFPs on debt securities must have
position limits. Although DCMs have not listed debt security SFPs to
date, absent the changes to the regulation, it is theoretically
possible that the costs associated with estimating deliverable supply
or otherwise determining position limit levels may affect future
decisions regarding whether or not to list such SFPs. The costs of the
final rule for SFPs on debt securities would be otherwise similar to
the costs of the final rule for equity SFPs.
The rule permitting DCMs to implement position limits on a net
basis or on positions on the same side of the market (e.g., on
physically-delivered and cash-settled contracts on the same security,
should a DCM ever list both types of contracts) will not require DCMs
to change their current practice, and therefore will not impose new
costs on DCMs. Any change that imposes new costs on market participants
would be made at the discretion of the DCM (as constrained by DCM Core
Principles).
The reduction in the time period during which position limits must
be in effect from five to three days imposes no additional costs on
DCMs, and the Commission believes the implementation costs for DCMs
will be low. This change merely delays by two days the need for a
hedger to apply for a hedge exemption and the DCM to process that hedge
exemption request, if necessary. The establishment in the final rule of
a required minimum position limit time period beginning no later than
the first day that a holder of a long position may be assigned a
delivery notice, if such period is longer than the last three trading
days, in instances where the SFP permits delivery before the close of
trading, currently imposes no costs since contracts of this nature are
not currently listed for trading. If a DCM listed such contracts, the
final rule would require market participants to incur the costs of
complying with position limits or applying for hedge exemptions (and
would require DCMs to incur the costs of reviewing such applications)
earlier in the life of the contract than absent this rule.
The Commission does not believe that the final rule will impose any
significant additional costs or burdens to the market or to market
participants. The final rule is likely to impose incremental additional
costs on market participants related to compliance, monitoring, and
implementation. As noted above for DCMs, these costs may include the
monitoring of positions in the SFP and related underlying security;
related filing, reporting, and recordkeeping requirements; and the
costs of changes to information technology systems. It is likely that
these additional costs of the rule will be significantly mitigated
because market participants that currently engage in the SFP market are
required to comply with existing comparable requirements.
DCMs that list SFPs may adopt position limits that are either
equivalent to the default level for security options (i.e., 25,000 100-
share contracts) or proportional to estimated deliverable supply.
Although the final rule likely will result in position limits for SFPs
that are higher than current limits and only require those limits
during fewer days of the contract period, the
[[Page 51019]]
Commission does not believe these changes will lead to excessive
speculation or have an adverse effect on market integrity because the
Commission's reporting requirements will provide the Commission with
sufficient visibility of positions that are larger than the reporting
levels. In this respect, the Commission's large trader reporting rules
require FCMs to report to the Commission all positions greater than
1,000 contracts for SFPs based on a single equity and 200 contracts for
SFPs based on a narrow-based security index.\164\
---------------------------------------------------------------------------
\164\ See 17 CFR 15.03. The Commission did not propose to amend,
and is not amending, the reporting levels.
---------------------------------------------------------------------------
5. Benefits
The Commission from time-to-time reviews its regulations to help
ensure they keep pace with technological developments and industry
trends, and to reduce regulatory burden where needed. The final rule
will provide to DCMs greater flexibility to adopt SFP position limits
that they deem to be appropriate while not having an adverse effect on
market integrity. In this respect, the Commission believes that DCMs
will adopt position limits that are large enough not to significantly
inhibit liquidity, but also appropriate to mitigate potential
manipulations and other concerns that may be associated with overly
large positions in SFPs in line with the Core Principles. Moreover, to
the extent that the final rule would lead to position limits that are
higher than current position limits, the final rule could alleviate the
costs to hedgers of filing hedge exemption requests for positions that
are larger than a current position limit, but lower than a new position
limit under the final rule. The Commission notes, however, that, based
on an analysis by Commission staff, there do not appear to have been
any positions in SFPs during calendar year 2018 that exceeded current
position limits, although there were some SFP positions in 2017 that
did exceed current position limits.\165\ The Commission also notes that
higher limits could lead to increased trading activity that could
improve liquidity in the SFP markets.
---------------------------------------------------------------------------
\165\ As noted in the NPRM, Commission staff reviewed the
largest positions in SFPs that were held during the calendar year
2017 and found that there were 16 positions held during the last
five trading days of expiring SFP contract months across all listed
SFPs on OneChicago that exceeded current position limits (and which
appear to have been eligible for a hedge exemption). If the new
default position limit of 25,000 contracts had been in effect in
2017, most of these positions would have been below the default
position limit. For this adopting release, Commission staff reviewed
the largest positions in SFPs that were held during the calendar
year 2018 and found no positions during that year that exceeded
current position limits during the last five trading days of a
contract month.
---------------------------------------------------------------------------
The Commission believes that the provision requiring DCMs to set
position limits and accountability based on deliverable supply
estimates calculated no less frequently than semi-annually should help
ensure on an ongoing basis that position limits and accountability are
set at levels that are necessary and appropriate to deter manipulation
consistent with DCM Core Principles 3 and 5. OneChicago supported this
aspect of the proposal, noting that resetting position limits on a
monthly basis as required by current rules provides very little
value.\166\
---------------------------------------------------------------------------
\166\ OneChicago Letter at 8.
---------------------------------------------------------------------------
The final rule permits DCMs to implement position limits on a net
basis or on positions on the same side of the market (such as
physically-delivered or cash-settled contracts on the same security,
should a DCM ever list both types of contracts) and gives DCMs the
discretion to choose the alternative they deem appropriate as
constrained by DCM core principles, meaning DCMs are unlikely to alter
their position limit rules in this regard unless they determine doing
so would be beneficial.
The final rule establishes a required minimum position limit time
period beginning no later than the first day that a holder of a long
position may be assigned a delivery notice, if such period is longer
than the last three trading days, where the SFP permits delivery before
the close of trading. This provision will ensure that such contracts
are subject to appropriate position limits or position accountability
during the entire delivery period. Although DCMs do not currently list
for trading SFPs of this nature, any future listings would benefit from
this change. Reducing the minimum position time limit period from the
last five trading days to the last three trading days, while also
likely raising limits levels for SFPs, may also reduce monitoring and
compliance costs for traders.
6. CEA Section 15(a) Factors
i. Protection of Market Participants and the Public
The Commission believes that the final rule maintains the
protection of market participants and the public provided by the
current regulation. The final rule will continue to protect market
participants and the public by maintaining the requirement that DCMs
that list SFPs adopt and enforce appropriate position limits or
position accountability consistent with DCM Core Principle 5 and
implementing for SFPs the longstanding Commission policy that spot-
month position limits should be set based on estimates of deliverable
supply. Linking the levels of position limits and position
accountability to deliverable supply for equity securities that have an
estimated deliverable supply of more than 20 million shares protects
market participants and the public by helping prevent congestion,
manipulation, or other problems that can be associated with speculative
positions in expiring contracts that are overly large relative to
deliverable supply. While DCMs will have the discretion to implement
the default position limit of 25,000 contracts regardless of
deliverable supply, and this may result in position limit levels in
some contracts greater than 12.5 percent of deliverable supply, DCMs
continue to be required to comply with core principle 3, which states
that DCMs shall only list contracts for trading that are not readily
susceptible to manipulation, and core principle 5, which requires that
positon limits and accountability be set at levels that reduce the
threat of manipulation or congestion.
As noted above, DCMs that list other commodity futures contracts
providing for delivery after the termination of trading have adopted
position limits during the last few days of trading. These DCMs have
demonstrated that the underlying cash market and market participants
can be protected from congestion and squeezes entering the delivery
period for these contracts. Likewise, the Commission believes that the
underlying equities market and market participants also can continue to
be protected from market manipulation and other distortions after
decreasing to three days the time period during which position limits
are in effect prior to the termination of trading.
ii. Efficiency, Competitiveness, and Financial Integrity of Markets
As discussed above, it is reasonable to anticipate that many or
most SFPs will be subject to higher position limits under the final
rule compared to the current position limits. Therefore, hedgers may be
able to take larger positions without the need to apply for hedge
exemptions. This also could alleviate a DCM's need to review hedge
exemptions, improving resource allocation efficiency for exchanges and
certain market participants. Moreover, with less restrictive position
limits, it is theoretically possible that more traders could be enticed
into the market and
[[Page 51020]]
thus improve the liquidity and pricing efficiency of the SFP market.
The current position limit regulation for SFPs (a default of 13,500
contracts) often leads to position limits that are tighter than
analogous position limits for security options (a default of 25,000
contracts). The final rule raises the default limit level in equity
SFPs to match that for security options. More closely aligning the
position limits in SFPs to those in securities options may help to
enhance the competitiveness of the SFP market relative to the security
options market.
iii. Price Discovery
The Commission believes that price discovery occurs in the liquid
and transparent security markets underlying existing SFPs rather than
the relatively low-volume SFPs themselves. Nevertheless, as noted
above, to the extent that trading activity in SFP markets increases due
to less restrictive position limits, the price discovery function of
SFPs could be enhanced by reducing liquidity risk and thereby
facilitating arbitrage between the underlying security and SFP markets.
iv. Sound Risk Management Practices
The current position limit regulation often leads to position
limits that are tighter than analogous position limits for security
options. It is conceivable that this could encourage potential hedgers
or other risk managers to use security options rather than SFPs because
of burdens associated with the SFP's hedge exemption process. Risk
managers might also find that the liquidity risk in the current SFP
market is too high, due to a lack of speculators in the SFP market
(among other causes). In this regard, it is possible that the current
position limits might be too tight for speculators to perform
adequately their role of providing liquidity in a futures market.
Because the final rule raises the default limit to 25,000 contracts to
match the default in security options, and thus would likely lead to
higher position limits for many SFPs, it is possible that both risk
managers and speculators enter or increase trading in the SFP market.
v. Other Public Interest Considerations
The Commission has not identified any additional public interest
considerations associated with the final rule.
7. Consideration of Alternatives
The Commission considered the various alternatives put forth in
comments. These considerations are discussed in this section. The
Commission notes as a general matter that while SFPs are commonly used
for securities lending transactions that are eligible for hedge
exemptions, SFPs could be used for speculation in the future and that
Core Principle 5 requires speculative position limits or accountability
as appropriate.
OneChicago stated that position limits should only be in effect on
expiration day rather than the last five trading days as under current
rules and under the proposed rules.\167\ OneChicago argued that
position limits before expiration are not necessary because
OneChicago's traders are pre-hedged and prepared to go to delivery or
have rolled over positions. The Commission notes that the transactions
described by OneChicago would be eligible for hedge exemptions. The
Commission believes that any speculative positions that may arise in
SFP markets should be subject to speculative position limits before
expiration because such limits would provide the benefit of ensuring
that large speculative positions can be wound down in an orderly
manner. Additionally, the Commission is reducing in the final rule the
applicability of speculative position limits to the last three days of
trading rather than the last five days, which may reduce compliance
costs for traders.
---------------------------------------------------------------------------
\167\ OneChicago Letter at 6.
---------------------------------------------------------------------------
OneChicago also stated that the Commission should authorize
position accountability for all SFPs on ETFs and stated that estimated
deliverable supply and trading volume are unsuitable metrics for ETFs
because authorized participants can increase or decrease the number of
shares.\168\ The Commission believes that there likely are benefits in
certain instances to implementing position limits on ETF SFPs and that
authorized participants may not be able to adjust the number of shares
quickly enough to affect the susceptibility of an ETF SFP to
manipulation. The Commission notes that exchanges can implement
position accountability on ETFs where the underlying security meets the
volume and deliverable supply requirements discussed above.
---------------------------------------------------------------------------
\168\ OneChicago Letter at 7.
---------------------------------------------------------------------------
OneChicago also recommended that position limits be set based on 25
percent of estimated deliverable supply, as opposed to the 12.5 percent
proposed by the Commission because, in the Exchange's view, there is no
justification for a lower level, other than the misconception that SFPs
and security options compete.\169\ While the Commission understands
from OneChicago that SFPs are commonly used for securities lending
agreements and security options are not, both security options and SFPs
could be used for speculation. Thus, a combined position limit of about
25 percent of deliverable supply for SFPs and security options on the
same security may provide a similar benefit of protecting against
manipulation as is provided in futures contracts on other commodities.
---------------------------------------------------------------------------
\169\ OneChicago Letter at 8.
---------------------------------------------------------------------------
The Commission invited comment on whether to adopt a rule that
would permit DCMs to adopt position limits equivalent to the level of
corresponding security option position limits on the same
security.\170\ OneChicago objected to this proposal because OneChicago
believes that SFPs and security options should not be regulated
similarly.\171\ Although the Commission believes that this alternative
method for setting position limits would provide DCMs flexibility in
setting position limits and would be easier and less costly than
estimating deliverable supply, the Commission is not adopting this
proposal. In this regard, the only DCM that currently lists SFPs
objected to this alternative, and as noted in the Proposal, the
Commission views position limits on security options that are based on
trading volume as inconsistent with existing Commission policy
regarding use of estimated deliverable supply to support position
limits in an expiring contract month.\172\
---------------------------------------------------------------------------
\170\ Proposal at 36805.
\171\ OneChicago Letter at 8.
\172\ Proposal at 36805.
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OneChicago opined that the current position limit framework is
``sufficient to give innovators a clear view of regulation in the SSF
marketplace,'' and that issuing regulations for SFPs that currently are
not listed for trading ``would risk stifling innovation.'' \173\ The
Commission believes that the frameworks for position limits in SFPs on
deliverable equity baskets and debt securities (all based on
deliverable supply estimates) in the final rule will help ensure that
such products, if they are listed for trading, are reasonably protected
from manipulation. Further, the Commission believes that the final rule
may help foster position limits consistent with those in analogous
securities options (where applicable).
---------------------------------------------------------------------------
\173\ OneChicago Letter at 9.
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D. Anti-Trust Considerations
CEA section 15(b) requires the Commission to take into
consideration the public interest to be protected by the antitrust laws
and endeavor to take the least anticompetitive means of achieving the
objectives, polices, and
[[Page 51021]]
purposes of the CEA, in issuing any order or adopting any Commission
rule or regulation (including any exemption under section 4(c) or
4c(b)), or in requiring or approving any bylaw, rule, or regulation of
a contract market or registered futures association established
pursuant to CEA section 17.\174\
---------------------------------------------------------------------------
\174\ 7 U.S.C. 19(b).
---------------------------------------------------------------------------
The Commission has determined that the final rule is not
anticompetitive and has no anticompetitive effects. In the Proposal,
the Commission requested comment on whether there are less
anticompetitive means of achieving the relevant purposes of the CEA
that would further the objective of the Proposal, such as leveling the
regulatory playing field between SFPs and security options listed on
NSEs. As noted above, OneChicago argued that it is not appropriate to
regulate derivatives containing optionality similarly to derivatives
not containing optionality. The Exchange noted different regulation of
Delta One derivatives traded on a DCM and Delta One derivatives traded
overseas or OTC creates an uneven playing field. The Commission notes,
however, that given the statutory constraints that require similar
regulation of SFPs and security options, discussed above, the
Commission has not identified any less anticompetitive means of
achieving the purposes of the CEA.
List of Subjects in 17 CFR Part 41
Brokers, Position accountability, Position limits, Reporting and
recordkeeping requirements, Securities, Security futures products.
For the reasons discussed in the preamble, the Commodity Futures
Trading Commission amends 17 CFR part 41 as follows:
PART 41--SECURITY FUTURES PRODUCTS
0
1. The authority citation for part 41 continues to read as follows:
Authority: Sections 206, 251 and 252, Pub. L. 106-554, 114
Stat. 2763, 7 U.S.C. 1a, 2, 6f, 6j, 7a-2, 12a; 15 U.S.C. 78g(c)(2).
0
2. Amend Sec. 41.25 as follows:
0
a. Redesignate paragraphs (a) through (d) as paragraphs (b) through
(e);
0
b. Add a new paragraph (a); and
0
c. Revise redesignated paragraphs (b)(3), (c)(2) and (3), and (e).
The addition and revisions read as follows:
Sec. 41.25 Additional conditions for trading for security futures
products.
(a) Definitions. For purposes of this section:
Estimated deliverable supply means the quantity of the security
underlying a security futures product that reasonably can be expected
to be readily available to short traders and salable by long traders at
its market value in normal cash marketing channels during the specified
delivery period. For guidance on estimating deliverable supply,
designated contract markets may refer to appendix A of this subpart.
Same side of the market means the aggregate of long positions in
physically-delivered security futures products and cash-settled
security futures products, in the same security, and, separately, the
aggregate of short positions in physically-delivered security futures
products and cash-settled security futures products, in the same
security.
(b) * * *
(3) Speculative position limits. A designated contract market shall
have rules in place establishing position limits or position
accountability procedures for the expiring futures contract month as
specified in this paragraph (b)(3).
(i) Limits for equity security futures products. For a security
futures product on a single equity security, including a security
futures product on an underlying security that represents ownership in
a group of securities, e.g., an exchange traded fund, a designated
contract market shall adopt a position limit no greater than 25,000
100-share contracts (or the equivalent if the contract size is
different than 100 shares), either net or on the same side of the
market, applicable to positions held during the last three trading days
of an expiring contract month; except where:
(A) For a security futures product on a single equity security
where the estimated deliverable supply of the underlying security
exceeds 20 million shares, a designated contract market may adopt, if
appropriate in light of the liquidity of trading in the underlying
security, a position limit no greater than the equivalent of 12.5
percent of the estimated deliverable supply of the underlying security,
either net or on the same side of the market, applicable to positions
held during the last three trading days of an expiring contract month;
or
(B) For a security futures product on a single equity security
where the six-month total trading volume in the underlying security
exceeds 2.5 billion shares and there are more than 40 million shares of
estimated deliverable supply, a designated contract market may adopt a
position accountability rule in lieu of a position limit, either net or
on the same side of the market, applicable to positions held during the
last three trading days of an expiring contract month. Upon request by
a designated contract market, traders who hold positions greater than
25,000 100-share contracts (or the equivalent if the contract size is
different than 100 shares), or such lower level specified pursuant to
the rules of the designated contract market, must provide information
to the designated contract market and consent to halt increasing their
positions when so ordered by the designated contract market.
(ii) Limits for physically-delivered basket equity security futures
products. For a physically-delivered security futures product on more
than one equity security, e.g., a basket of deliverable securities, a
designated contract market shall adopt a position limit, either net or
on the same side of the market, applicable to positions held during the
last three trading days of an expiring contract month and the criteria
in paragraph (b)(3)(i) of this section must apply to the underlying
security with the lowest estimated deliverable supply. For a
physically-delivered security futures product on more than one equity
security with a contract size different than 100 shares per underlying
security, an appropriate adjustment to the limit must be made. If each
of the underlying equity securities in the basket of deliverable
securities is eligible for a position accountability level under
paragraph (b)(3)(i)(B) of this section, then the security futures
product is eligible for a position accountability level in lieu of
position limits.
(iii) Limits for cash-settled equity index security futures
products. For a security futures product cash settled to a narrow-based
security index of equity securities, a designated contract market shall
adopt a position limit, either net or on the same side of the market,
applicable to positions held during the last three trading days of an
expiring contract month. For guidance on setting limits for a cash-
settled equity index security futures product, designated contract
markets may refer to paragraph (b) of appendix A to this subpart.
(iv) Limits for debt security futures products. For a security
futures product on one or more debt securities, a designated contract
market shall adopt a position limit, either net or on the same side of
the market, applicable to positions held during the last three trading
days of an expiring contract month. For guidance on setting limits
[[Page 51022]]
for a debt security futures product, designated contract markets may
refer to paragraph (c) of appendix A to this subpart.
(v) Required minimum position limit time period. For position
limits required under this section where the security futures product
permits delivery before the termination of trading, a designated
contract market shall apply such position limits for a period beginning
no later than the first day that long position holders may be assigned
delivery notices, if such period is longer than the last three trading
days of an expiring contract month.
(vi) Requirements for resetting levels of position limits. A
designated contract market shall calculate estimated deliverable supply
and six-month total trading volume no less frequently than semi-
annually.
(A) If the estimated deliverable supply data supports a lower
speculative limit for a security futures product, then the designated
contract market shall lower the position limit for that security
futures product pursuant to the submission requirements of Sec. 41.24.
If the data require imposition of a reduced position limit for a
security futures product, the designated contract market may permit any
trader holding a position in compliance with the previous position
limit, but in excess of the reduced limit, to maintain such position
through the expiration of the security futures contract; provided, that
the designated contract market does not find that the position poses a
threat to the orderly expiration of such contract.
(B) If the estimated deliverable supply or six-month total trading
volume data no longer supports a position accountability rule in lieu
of a position limit for a security futures product, then the designated
contract market shall establish a position limit for that security
futures product pursuant to the submission requirements of Sec. 41.24.
(C) If the estimated deliverable supply data supports a higher
speculative limit for a security futures product, as provided under
paragraph (b)(3)(i)(A) of this section, then the designated contract
market may raise the position limit for that security futures product
pursuant to the submission requirements of Sec. 41.24.
(vii) Restriction on netting of positions. If the designated
contract market lists both physically-delivered contracts and cash-
settled contracts in the same security, it shall not permit netting of
positions in the physically-delivered contract with that of the cash-
settled contract for purposes of determining applicability of position
limits.
(c) * * *
(2) Notwithstanding paragraph (c)(1) of this section, if an opening
price for one or more securities underlying a security futures product
is not readily available, the final settlement price of the security
futures product shall fairly reflect:
(i) The price of the underlying security or securities during the
most recent regular trading session for such security or securities; or
(ii) The next available opening price of the underlying security or
securities.
(3) Notwithstanding paragraph (c)(1) or (2) of this section, if a
derivatives clearing organization registered under section 5b of the
Act or a clearing agency exempt from registration pursuant to section
5b(a)(2) of the Act, to which the final settlement price of a security
futures product is or would be reported determines, pursuant to its
rules, that such final settlement price is not consistent with the
protection of customers and the public interest, taking into account
such factors as fairness to buyers and sellers of the affected security
futures product, the maintenance of a fair and orderly market in such
security futures product, and consistency of interpretation and
practice, the clearing organization shall have the authority to
determine, under its rules, a final settlement price for such security
futures product.
* * * * *
(e) Exemptions. The Commission may exempt a designated contract
market from the provisions of paragraphs (b)(2) and (c) of this
section, either unconditionally or on specified terms and conditions,
if the Commission determines that such exemption is consistent with the
public interest and the protection of customers. An exemption granted
pursuant to this paragraph (e) shall not operate as an exemption from
any Securities and Exchange Commission rule. Any exemption that may be
required from such rules must be obtained separately from the
Securities and Exchange Commission.
0
3. Add appendix A to subpart C to read as follows:
Appendix A to Subpart C of Part 41--Guidance on and Acceptable
Practices for Position Limits and Position Accountability for Security
Futures Products
(a) Guidance for estimating deliverable supply. (1) For an
equity security, deliverable supply should be no greater than the
free float of the security.
(2) For a debt security, deliverable supply should not include
securities that are committed for long-term agreements (e.g.,
closed-end investment companies, structured products, or similar
securities).
(3) Further guidance on estimating deliverable supply, including
consideration of whether the underlying security is readily
available, is found in appendix C to part 38 of this chapter.
(b) Guidance and acceptable practices for setting limits on
cash-settled equity index security futures products--(1) Guidance
for setting limits on cash-settled equity index security futures
products. For a security futures product cash settled to a narrow-
based security index of equity securities, a designated contract
market:
(i) May set the level of a position limit to that of a similar
narrow-based equity index option listed on a national security
exchange or association; or
(ii) Should consider the deliverable supply of equity securities
underlying the index, and should consider the index weighting and
contract multiplier.
(2) Acceptable practices for setting limits on cash-settled
equity index security futures products. For a security futures
product cash settled to a narrow-based security index of equity
securities weighted by the number of shares outstanding, a
designated contract market may set a position limit as follows:
First, determine the limit on a security futures product on each
underlying equity security pursuant to Sec. 41.25(b)(3)(i); second,
multiply each such limit by the ratio of the 100-share contract size
and the shares of the equity securities in the index; and third,
determine the minimum level from step two and set the limit to that
level, given a contract size of one U.S. dollar times the index, or
for a larger contract size, reduce the level proportionately. If
under these procedures each of the equity securities underlying the
index is determined to be eligible for position accountability
levels, the security futures product on the index itself is eligible
for a position accountability level.
(c) Guidance and acceptable practices for setting limits on debt
security futures products--(1) Guidance for setting limits on debt
security futures products. A designated contract market should set
the level of a position limit to no greater than the equivalent of
12.5 percent of the par value of the estimated deliverable supply of
the underlying debt security. For a security futures product on more
than one debt security, the limit should be based on the underlying
debt security with the lowest estimated deliverable supply.
(2) Acceptable practices for setting limits on debt security
futures products. [Reserved]
(d) Guidance on position accountability. A designated contract
market may adopt a position accountability rule for any security
futures product, in addition to a position limit rule required or
adopted under Sec. 41.25. Upon request by the designated contract
market, traders who hold positions, either net or on the same side
of the market, greater than such level specified pursuant to the
rules of the designated contract market must provide information to
the designated contract market and consent to halt increasing their
positions when so ordered by the designated contract market.
(e) Guidance on exemptions from position limits. A designated
contract market may
[[Page 51023]]
approve exemptions from these position limits pursuant to rules that
are consistent with Sec. 150.5 of this chapter, or to rules that
are consistent with rules of a national securities exchange or
association regarding exemptions to securities option position
limits or exercise limits.
Issued in Washington, DC, on September 17, 2019, by the
Commission.
Christopher Kirkpatrick,
Secretary of the Commission.
Note: The following appendix will not appear in the Code of
Federal Regulations.
Appendix to Position Limits and Position Accountability for Security
Futures Products--Commission Voting Summary
On this matter, Chairman Tarbert and Commissioners Quintenz,
Behnam, Stump, and Berkovitz voted in the affirmative. No
Commissioner voted in the negative.
[FR Doc. 2019-20476 Filed 9-26-19; 8:45 am]
BILLING CODE 6351-01-P