[Federal Register Volume 85, Number 15 (Thursday, January 23, 2020)]
[Notices]
[Pages 4051-4054]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 2020-01097]
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SECURITIES AND EXCHANGE COMMISSION
[Release No. 34-88003; File No. SR-NYSE-2019-54]
Self-Regulatory Organizations; New York Stock Exchange LLC; Order
Instituting Proceedings To Determine Whether To Approve or Disapprove a
Proposed Rule Change To Permit the Exchange To List and Trade Exchange
Traded Products
January 17, 2020.
On October 3, 2019, New York Stock Exchange LLC (``Exchange'' or
``NYSE'') filed with the Securities and Exchange Commission
(``Commission''), pursuant to Section 19(b)(1) of the Securities
Exchange Act of 1934 (``Act'') \1\ and Rule 19b-4 thereunder,\2\ a
proposed rule change to list and trade Exchange Traded Products that
have a component NMS Stock listed on the Exchange or that are based on,
or represent an interest in, an underlying index or reference asset
that includes an NMS Stock listed on the Exchange. The proposed rule
change was published for comment in the Federal Register on October 23,
2019.\3\ On December 5, 2019, pursuant to Section 19(b)(2) of the
Act,\4\ the Commission designated a longer period within which to
approve the proposed rule change, disapprove the proposed rule change,
or institute proceedings to determine whether to disapprove the
proposed rule change.\5\ The Commission has received no comment letters
on the proposal. This order institutes proceedings under Section
19(b)(2)(B) of the Act \6\ to
[[Page 4052]]
determine whether to approve or disapprove the proposed rule change.
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\1\ 15 U.S.C. 78s(b)(1).
\2\ 17 CFR 240.19b-4.
\3\ See Securities Exchange Act Release No. 87329 (Oct. 17,
2019), 84 FR 56864 (``Notice'').
\4\ 15 U.S.C. 78s(b)(2).
\5\ See Securities Exchange Act Release No. 87671 (Dec. 5,
2019), 84 FR 67763 (Dec. 11, 2019). The Commission designated
January 21, 2020, as the date by which it should approve or
disapprove, or institute proceedings to determine whether to
disapprove, the proposed rule change.
\6\ 15 U.S.C. 78s(b)(2)(B).
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I. Summary Description of the Proposal
The Exchange proposes to expand the Exchange Traded Products
(``ETPs'') that would be eligible to list and trade on the Exchange to
include ETPs that have a component NMS Stock \7\ or that are based on,
or represent an interest in, an underlying index or reference asset
that includes an NMS Stock listed on the Exchange. To effectuate this
change, the Exchange proposes to delete the preambles to NYSE Rules 5P
and 8P currently providing that the Exchange will not list such ETPs.
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\7\ NMS Stock is defined in Rule 600 of Regulation NMS, 17 CFR
242.600(b)(48) as ``any NMS security other than an option.'' ``NMS
Security'' means any security or class of securities for which
transaction reports are collected, processed, and made available
pursuant to an effective transaction reporting plan, or an effective
national market system plan for reporting transactions in listed
options.'' See 17 CFR 242.600(b)(47). ``NMS Security'' refers to
``exchange-listed equity securities and standardized options, but
does not include exchange-listed debt securities, securities
futures, or open-end mutual funds, which are not currently reported
pursuant to an effective transaction reporting plan.'' See Question
1.1 in the ``Responses to Frequently Asked Questions Concerning
Large Trader Reporting,'' available at: https://www.sec.gov/divisions/marketreg/large-trader-faqs.htm.
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The proposal would permit the Exchange to list and trade on the
NYSE Trading Floor \8\ both ETPs and one or more component NMS Stocks
forming part of the underlying ETP index or portfolio (``side-by-side
trading'' \9\). Because listed securities are assigned to a Designated
Market Maker (``DMM''), the proposed elimination of the current
restriction could result in DMMs being assigned ETPs that may have one
or more component NMS Stocks forming part of the underlying ETP index
or portfolio that are also assigned to the DMM (``integrated market
making'').\10\ The Commission has approved integrated market making and
side-by-side trading for ``broad-based'' ETPs and related options.\11\
According to the Exchange, the test for whether a product is ``broad-
based'', and therefore is not readily susceptible to manipulation, is
whether the individual components of the ETP are sufficiently liquid
and well-capitalized and the product is not over-concentrated.\12\ When
an ETP meets both criteria, and therefore can be considered ``broad-
based,'' the Commission has explicitly permitted integrated market
making and side-by-side trading in both the ETP and related options,
with no requirement for information barriers or physical or
organizational separation.\13\
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\8\ The term ``Trading Floor'' is defined in NYSE Rule 6A to
mean the restricted-access physical areas designated by the Exchange
for the trading of securities, commonly known as the ``Main Room''
and the ``Buttonwood Room.''
\9\ ``Side-by-side trading'' refers to the trading of an equity
security and its related derivative product at the same physical
location, though ``not necessarily by the same specialist or
specialist firm.'' Securities Exchange Act Release No. 46213 (July
16, 2002), 67 FR 48232, 48233 (July 23, 2002) (SR-Amex-2002-21)
(``Release No. 46213'') (order approving side-by-side trading and
integrated market making of broad index-based ETFs and related
options); see also Securities Exchange Act Release No. 45454
(February 15, 2002), 67 FR 8567, 8568 n.7 (February 25, 2002) (SR-
NYSE-2001-43) (``Release No. 45454'') (order approving approved
person of a specialist to act as a specialist or primary market
maker with respect to an option on a stock in which the NYSE
specialist is registered on the Exchange).
\10\ ``Integrated market making'' refers to the practice of the
same person or firm making markets in an equity security and its
related option. See Release No. 45454, 67 FR at 8568 n.7.
\11\ See Release No. 46213, 67 FR at 48232 (approving side-by-
side trading and integrated market making for certain Exchange
Traded Funds (``ETF'') and Trust Issued Receipts (``TIR'') and
related options); see also Securities Exchange Act Release No.
62479 (July 9, 2010), 75 FR 41264 (July 15, 2010) (SR-Amex-2010-31)
(``Release No. 62479'') (order approving side-by-side trading and
integrated market making in the QQQ ETF and certain of its component
securities where the QQQs met the composition and concentration
measures to be classified as a broad-based ETF).
\12\ See Release No. 62479, id., 75 FR at 41272. The Commission
has expressed its belief ``that, when the securities underlying an
ETF consist of a number of liquid and well-capitalized stocks, the
likelihood that a market participant will be able to manipulate the
price of the ETF is reduced.'' See id. See generally Securities
Exchange Act Release Nos. 56633 (October 9, 2007), 72 FR 58696
(October 16, 2007) (SR-ISE-2007-60) (order approving generic listing
standards for ETFs based on both U.S. and international indices,
noting they are ``sufficiently broad-based in scope to minimize
potential manipulation.''); 55621 (April 12, 2007), 72 FR 19571
(April 18, 2007) (SR-NYSEArca-2006-86); 54739 (November 9, 2006), 71
FR 66993 (November 17, 2006) (SR-Amex-2006-78); 57365 (February 21,
2008), 73 FR 10839 (February 28, 2008) (SR-CBOE-2007-109) (order
approving generic listing standards for ETFs based on international
indices, noting they are ``sufficiently broad-based in scope to
minimize potential manipulation.''); 56049 (July 11, 2007), 72 FR
39121 (July 17, 2007) (SR-Phlx-2007-20); 55113 (January 17, 2007),
72 FR 3179 (January 24, 2007) (SR-NYSE-2006-101); and 55269
(February 9, 2007), 72 FR 7490 (February 15, 2007) (SR-NASDAQ-2006-
50).
\13\ See note 11, supra.
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In making a determination of whether an ETP is broad-based, the
Commission has relied on an exchange's listing standards. According to
the Exchange, in permitting integrated market making and side-by-side
trading for two types of ETPs and their related options, the Commission
looked to the American Stock Exchange LLC's listing standards that are
very similar to the Exchange's current listing standards.
The Exchange notes that the relationship between an ETP and its
underlying listed NMS Stock component or components is fundamentally
different than that between an ETP and its related option. In the
latter case, a small move in the price of the listed security can
trigger a large move in the price of the related option, increasing the
incentive for a market maker or specialist to manipulate the security
or coordinate trading with the options market maker or specialist.
Here, the Exchange asserts that there is no similar outsized
correlation between a move in the price of a listed ETP and one or more
of its underlying NMS Stock components. The potential for manipulation
or coordinated trading is significantly attenuated for listed ETPs and
their underlying NMS Stock components because the Exchange's generic
listed standards are designed to ensure that the Exchange will only
list ETPs that are ``broad-based''--that is, the ETP's underlying
component securities must be sufficiently liquid and well-capitalized,
and the ETP must not be unduly concentrated.
According to the Exchange, the listing standards for Units based on
an index of both US Component Stocks and Non-US Component Stocks; \14\
Equity-Index Linked securities (commonly referred to as Exchange Traded
Notes or ``ETNs''); \15\ Portfolio Depositary Receipts under NYSE Rule
8.100 with underlying component stocks consisting of an index or
portfolio of US Component Stocks; \16\ and actively managed funds under
NYSE Rule 8.600 \17\ are all broadly similar. The Exchange could not
list an ETP that does not meet these generic listing requirements
without a proposed rule change being filed with the Commission.
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\14\ See NYSE Rule 5.2(j)(3), Supp. Material .01(a)(B)(1)-(5).
The index or portfolio must include a minimum of 20 component
stocks.
\15\ See NYSE Rule 5.2(j)(6)(B)(I).
\16\ See NYSE Rule 8.100.
\17\ See NYSE Rule 8.600.
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The Exchange believes that listed ETPs meeting these composition
and concentration measures would be sufficiently broad-based to allow
integrated market making and side-by-side trading in both the ETP and
the component NMS securities with no requirement for information
barriers or physical or organizational separation.
As noted by the Exchange, equity-based ETPs that do not meet the
applicable generic listing standards would require a rule filing with
the Commission prior to commencement of Exchange listing or trading.
The rule filing would set forth the initial and continued listing
requirements in order for such a product to be listed and traded on the
Exchange. In order for a rule proposal to be consistent with the
[[Page 4053]]
Act, it must, among other things, further the objectives of Section
6(b)(5) of the Act \18\ in that it is designed to prevent fraudulent
and manipulative acts and practices. The Exchange believes that equity-
based ETPs whose underlying component composition varies greatly from
the generic listing standards, i.e., an ETP whose components are
insufficiently liquid or well-capitalized or unduly concentrated, would
be unlikely to meet this requirement. Accordingly, the Exchange
believes that ETPs listed and traded via the rule filing process would
also be sufficiently broad-based in order to minimize potential
manipulation, thus justifying integrated market making and side-by-side
trading in both the ETP and the component NMS securities.
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\18\ 15 U.S.C. 78f(b)(5).
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While the ``broad-based'' nature of listed ETPs under either the
generic listing standards or via a rule filing makes manipulation less
likely, the Exchange also believes that the potential for manipulation
of listed ETPs is minimal because ETP pricing is based on an
``arbitrage function'' performed by market participants that affects
the supply of and demand for ETP shares and, thus, ETP prices. This
``arbitrage function'' is effectuated by creating new ETP shares and
redeeming existing ETP shares based on investor demand; thus, ETP
supply is open-ended. As the Commission has acknowledged, the arbitrage
function helps to keep an ETP's price in line with the value of its
underlying portfolio, i.e., it minimizes deviation from NAV. Generally,
the higher the liquidity and trading volume of an ETP, the more likely
the ETP's price will not deviate from the value of its underlying
portfolio. Market makers registered in ETPs play a key role in this
arbitrage function and DMMs, along with other market participants,
would perform this role for ETPs listed on the Exchange. In short, the
Exchange believes that the arbitrage mechanism is an effective and
efficient means of ensuring that intraday pricing in ETPs closely
tracks the value of the underlying portfolio or reference assets.
The Exchange believes that the price regulating function played by
the arbitrage mechanism renders attempts to influence or manipulate the
price of an ETP more difficult and more susceptible to immediate
detection and correction. The fact that an ETP and one or more of its
underlying components are traded in the same physical space on the
Exchange or by the same DMM on the Exchange does not alter this dynamic
in the slightest, nor does it make price manipulation more likely.
Rather, the Exchange believes the arbitrage mechanism would make price
manipulation more difficult and, thus, less likely. Attempts by Floor-
based market participants to influence the price of an ETP by, for
instance, manipulating one or more component securities would be
reflected in the deviation of the price from the NAV just as similar
attempts today by upstairs traders would be reflected in the deviation
of the price from the NAV. Moreover, the Exchange asserts that a broad-
based ETP would, as shown above, be even less susceptible to price
manipulation. The Exchange thus believes that the type of broad-based
equity ETPs eligible for listing under the generic listing standards,
coupled with the arbitrage mechanism, sufficiently minimize the
potential for manipulation of ETPs listed and traded on the Trading
Floor.
With respect to integrated market making, the Commission has
approved changes to NYSE Rule 98 that permit a DMM unit to engage in
integrated market making with off-Floor market making units in related
products.\19\ NYSE Rule 98(c)(6) prohibits DMM units from operating as
a specialist or market maker on the Exchange in related products,
unless specifically permitted in Exchange rules. NYSE Rule 98(b)(7)
defines ``related products'' as ``any derivative instrument that is
related to a DMM security.'' \20\ Accordingly, consistent with the
proposal, the Exchange proposes to amend NYSE Rule 98(b)(7) to
specifically exclude ETPs from the definition of ``related products.''
The Exchange believes that ETPs are different from other types of
related products such as single-stock options or futures and that,
given the broad-based nature of listed ETPs, integrated market making
and side-by-side trading in both the ETP and underlying NMS stock
components is appropriate with no requirement for information barriers
or physical or organizational separation.
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\19\ See Securities Exchange Act Release No. 58328 (August 7,
2008), 73 FR 48260 (August 18, 2008) (SR-NYSE-2008-45) (order
approving amendments to NYSE Rule 98 that permit specialist firms to
integrate with off-Floor trading desks that trade in ``related
products,'' as that term is defined in NYSE Rule 98).
\20\ Under NYSE Rule 98(b)(7), derivative instruments include
options, warrants, hybrid securities, single-stock futures,
security-based swap agreement, a forward contract, or ``any other
instrument that is exercisable into or whose price is based upon or
derived from a security traded at the Exchange.''
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According to the Exchange, trading on the Exchange is subject to a
comprehensive regulatory program that includes a suite of surveillances
and routine examinations that review trading by DMMs and other market
participants on the Exchange's trading Floor. Market participants on
the trading Floor, including DMMs, are also required to implement
policies and procedures reasonably designed to detect and to deter
inappropriate conduct and prevent the misuse of material, non-public
information or disclosure of Floor-based non-public order
information.\21\
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\21\ See, e.g., NYSE Rule 98(c)(3) (setting forth restrictions
on trading for member organizations operating a DMM unit).
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II. Proceedings To Determine Whether To Approve or Disapprove SR-NYSE-
2019-54 and Grounds for Disapproval Under Consideration
The Commission is instituting proceedings pursuant to Section
19(b)(2)(B) of the Act \22\ to determine whether the proposed rule
change should be approved or disapproved. Institution of such
proceedings is appropriate at this time in view of the legal and policy
issues raised by the proposed rule change. Institution of proceedings
does not indicate that the Commission has reached any conclusions with
respect to any of the issues involved. Rather, as described below, the
Commission seeks and encourages interested persons to provide comments
on the proposed rule change.
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\22\ 15 U.S.C. 78s(b)(2)(B).
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Pursuant to Section 19(b)(2)(B) of the Act,\23\ the Commission is
providing notice of the grounds for disapproval under consideration.
The Commission is instituting proceedings to allow for additional
analysis of the proposed rule change's consistency with Section 6(b)(5)
of the Act, which requires, among other things, that the rules of a
national securities exchange be ``designed to prevent fraudulent and
manipulative acts and practices, to promote just and equitable
principles of trade,'' and ``to protect investors and the public
interest.'' \24\
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\23\ Id.
\24\ 15 U.S.C. 78f(b)(5).
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The Commission asks that commenters address the sufficiency of the
Exchange's statements in support of the proposal, which are set forth
in the Notice,\25\ in addition to any other comments they may wish to
submit about the proposed rule change. In particular, the Commission
seeks comment on the following questions and asks commenters to submit
data where appropriate to support their views.
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\25\ See Notice, supra note 3.
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[[Page 4054]]
1. What are commenters' views generally on whether the Exchange's
proposal to implement side-by-side trading and integrated market making
for ETPs to be listed and traded on the Exchange is consistent with
Section 6(b)(5) of the Act, which requires that the Exchange's rules be
designed to, among other things, prevent fraudulent and manipulative
acts and practices?
2. With respect to ETPs that meet their respective generic listing
requirements, is the ``broad-based'' test as outlined by the Exchange
the appropriate standard that should be equally applied to all ETPs,
including ETFs, TIRs, and ETNs? Specifically, are the ETPs included in
the proposal ``broadly similar'' as the Exchange asserts and therefore
subject to the same analysis? If so, why? If not, what factors, if any,
should the Commission consider in its review of side-by-side trading
and integrated market making related to each category of ETPs, such as
ETFs, TIRs, and ETNs?
3. What are commenters' views about whether, as a result of the
proposal to implement side-by-side trading and integrated market
making, certain Exchange members may acquire an informational advantage
over other market participants with respect to trading in the ETP and
the underlying securities? What are commenters' views on whether such
informational advantage, if any, presents concerns regarding the
potential for misuse of material, non-public information?
4. What are commenters' views on the Exchange's assertion that ETPs
listed and traded via the rule filing process ``would also be
sufficiently broad-based'' in order to minimize potential manipulation,
thus justifying integrated market making and side-by-side trading in
both the ETP and the component NMS securities? Specifically, what are
commenters' views on whether the Exchange's application of the ``broad-
based'' test to equity-based ETPs that do not comply with their
respective generic listing requirements is appropriate? If not, why
not? What are other factors, if any, that ought to be considered with
respect to these types of equity-based ETPs, specifically? What are
other factors, if any, that ought to be considered for all ETPs,
including ETPs that are not primarily based on equity securities, but
nevertheless include NMS stocks in their indexes or portfolios, that do
not satisfy their respective generic listing requirements in some form
or manner?
5. What are commenter's views on the Exchange's assertions that the
potential for manipulation of listed ETPs would be minimal because ETP
pricing is based on an ``arbitrage function'' performed by market
participants that affects the supply of, and demand for, ETP shares
and, thus, ETP prices?
III. Procedure: Request for Written Comments
The Commission requests that interested persons provide written
submissions of their views, data, and arguments with respect to the
issues identified above, as well as any other concerns they may have
with the proposal. In particular, the Commission invites the written
views of interested persons concerning whether the proposal is
consistent with Section 6(b)(5) or any other provision of the Act, or
the rules and regulations thereunder. Although there do not appear to
be any issues relevant to approval or disapproval that would be
facilitated by an oral presentation of views, data, and arguments, the
Commission will consider, pursuant to Rule 19b-4, any request for an
opportunity to make an oral presentation.\26\
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\26\ Section 19(b)(2) of the Act, as amended by the Securities
Act Amendments of 1975, Public Law 94-29 (June 4, 1975), grants the
Commission flexibility to determine what type of proceeding--either
oral or notice and opportunity for written comments--is appropriate
for consideration of a particular proposal by a self-regulatory
organization. See Securities Act Amendments of 1975, Senate Comm. on
Banking, Housing & Urban Affairs, S. Rep. No. 75, 94th Cong., 1st
Sess. 30 (1975).
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Interested persons are invited to submit written data, views, and
arguments regarding whether the proposal should be approved or
disapproved by February 13, 2020. Any person who wishes to file a
rebuttal to any other person's submission must file that rebuttal by
February 27, 2020. The Commission asks that commenters address the
sufficiency of the Exchange's statements in support of the proposal, in
addition to any other comments they may wish to submit about the
proposed rule change.
Comments may be submitted by any of the following methods:
Electronic Comments
Use the Commission's internet comment form (http://www.sec.gov/rules/sro.shtml); or
Send an email to [email protected]. Please include
File Number SR-NYSE-2019-54 on the subject line.
Paper Comments
Send paper comments in triplicate to Secretary, Securities
and Exchange Commission, 100 F Street NE, Washington, DC 20549-1090.
All submissions should refer to File Number SR-NYSE-2019-54. This file
number should be included on the subject line if email is used. To help
the Commission process and review your comments more efficiently,
please use only one method. The Commission will post all comments on
the Commission's internet website (http://www.sec.gov/rules/sro.shtml).
Copies of the submission, all subsequent amendments, all written
statements with respect to the proposed rule change that are filed with
the Commission, and all written communications relating to the proposed
rule change between the Commission and any person, other than those
that may be withheld from the public in accordance with the provisions
of 5 U.S.C. 552, will be available for website viewing and printing in
the Commission's Public Reference Room, 100 F Street NE, Washington, DC
20549 on official business days between the hours of 10:00 a.m. and
3:00 p.m. Copies of the filing also will be available for inspection
and copying at the principal office of the Exchange. All comments
received will be posted without change. Persons submitting comments are
cautioned that we do not redact or edit personal identifying
information from comment submissions. You should submit only
information that you wish to make available publicly. All submissions
should refer to File Number SR-NYSE-2019-54 and should be submitted by
February 13, 2020. Rebuttal comments should be submitted by February
27, 2020.
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\27\ 17 CFR 200.30-3(a)(57).
For the Commission, by the Division of Trading and Markets,
pursuant to delegated authority.\27\
J. Matthew DeLesDernier,
Assistant Secretary.
[FR Doc. 2020-01097 Filed 1-22-20; 8:45 am]
BILLING CODE 8011-01-P