[Federal Register: May 14, 2007 (Volume 72, Number 92)]
[Notices]
[Page 27091-27093]
From the Federal Register Online via GPO Access [wais.access.gpo.gov]
[DOCID:fr14my07-21]
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COMMODITY FUTURES TRADING COMMISSION
Proposal To Exempt the Trading and Clearing of Certain Credit
Default Products Traded on the Chicago Board Options Exchange and
Cleared Through the Options Clearing Corporation Pursuant to the
Exemptive Authority in Sec. 4(c) of the Commodity Exchange Act
AGENCY: Commodity Futures Trading Commission.
ACTION: Notice of proposed order and request for comment.
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SUMMARY: The Commodity Futures Trading Commission (``CFTC'' or the
``Commission'') is proposing to exempt the trading and clearing of
certain credit default products that are proposed to be traded on the
Chicago Board Options Exchange (``CBOE'') and cleared through the
Options Clearing Corporation (``OCC'') from any applicable provisions
of the Commodity Exchange Act (``CEA'').\1\ Authority for this
exemption is found in Section 4(c) of the CEA.\2\
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\1\ 7 U.S.C. 1 et seq.
\2\ 7 U.S.C. 6(c).
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DATES: Comments must be received on or before May 29, 2007.
ADDRESSES: Comments may be submitted by any of the following methods:
Federal eRulemaking Portal: http://www.regulations.gov/
http://frwebgate.access.gpo/cgi-bin/leaving. Follow the instructions
for submitting comments.
E-mail: secretary@cftc.gov. Include ``OCC Clearing Credit
Default Options'' in the subject line of the message.
Fax: 202-418-5521.
Mail: Send to Eileen A. Donovan, Acting Secretary,
Commodity Futures Trading Commission, Three Lafayette Centre, 1155 21st
Street, NW., Washington, DC 20581.
Courier: Same as mail above.
All comments received will be posted without change to http://www.CFTC.gov/
.
FOR FURTHER INFORMATION CONTACT: John C. Lawton, Deputy Director and
Chief Counsel, 202-418-5480, jlawton@cftc.gov, and Robert B. Wasserman,
Associate Director, 202-418-5092, rwasserman@cftc.gov, Division of
Clearing and Intermediary Oversight, Commodity Futures Trading
Commission, Three Lafayette Centre, 1151 21st Street, NW., Washington,
DC 20581.
SUPPLEMENTARY INFORMATION:
I. Introduction
The OCC is both a Derivatives Clearing Organization (``DCO'')
registered pursuant to Section 5b of the CEA, 7 U.S.C. 7a-1, and a
securities clearing agency registered pursuant to Section 17A of the
Securities Exchange Act of 1934 (``1934 Act'').\3\ The CBOE is a
national securities exchange registered as such under Section 6 of the
1934 Act.\4\
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\3\ 15 U.S.C. 78q-l.
\4\ 15 U.S.C. 78f.
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CBOE has filed with the Securities and Exchange Commission
(``SEC'') proposed rule changes to provide for the listing and trading
on CBOE of cash-settled, binary call options based on credit events in
one or more debt securities.\5\ These options are referred to as Credit
Default Options (``CDOs''), and would pay the holder a specified amount
upon the occurrence, as determined by CBOE, of a ``Credit Event,''
defined to mean an ``Event of Default'' on any debt security issued or
guaranteed by a specified ``Reference Entity.''
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\5\ See Release No. 34-55251, 72 FR 7091 (Feb. 14, 2007).
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CBOE has also filed with the SEC proposed rule changes to provide
for the listing and trading on CBOE of Credit Default Basket Options
(``CDBOs'').\6\ These are similar in concept to CDOs, except that a
CDBO covers more than one Reference Entity, and for each Basket
Component (that is, a single Reference Entity) a notional value (a
fraction of the aggregate Notional Face Value of the basket) and a
recovery rate is specified. Upon the occurrence of a Credit Event
involving a particular Reference Entity, the payout to the holder is
equal to the product of (a) The Notional Face Value of that Basket
Component multiplied by (b) one minus the recovery rate specified in
advance for that Basket Component. CDBOs may be of the multiple-payout
variety, or of the single-payout variety, where a payout occurs only
the first time a Credit Event is confirmed with respect to a Reference
Entity prior to expiration.
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\6\ See SR-CBOE-2007-026.
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OCC has filed with the CFTC, pursuant to Section 5c(c) of the CEA
and Commission Regulations 39.4(a) and 40.5 thereunder,\7\ requests for
approval of rules and rule amendments that would enable OCC to clear
and settle these CDOs and CDBOs in its capacity as a registered
securities clearing agency (and not in its capacity
[[Page 27092]]
as a DCO).\8\ Section 5c(c)(3) provides that the CFTC must approve any
such rules and rule amendments submitted for approval unless it finds
that the rules or rule amendments would violate the CEA.
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\7\ 7 U.S.C. 7a-2(c), 17 CFR 39.4(a), 40.5.
\8\ See SR-OCC-2007-01 A-1; SR-OCC-2007-06. OCC has filed
identical proposed rule changes with the SEC.
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The request for approval concerning the CDO product was filed
effective March 8, 2007. On April 23, 2007, the review period was
extended pursuant to Regulation 40.5(c) until June 6, 2007, on the
ground that the CDOs ``raise novel or complex issues, including the
nature of the contract, that require additional time for review.'' The
request for approval concerning the CDBO product was filed effective
April 23, 2007, and absent an extension the review period is scheduled
to run until June 7, 2007.
II. Section 4(c) of the Commodity Exchange Act
Section 4(c)(1) of the CEA empowers the CFTC to ``promote
responsible economic or financial innovation and fair competition'' by
exempting any transaction or class of transactions from any of the
provisions of the CEA (subject to exceptions not relevant here) where
the Commission determines that the exemption would be consistent with
the public interest.\9\ The Commission may grant such an exemption by
rule, regulation or order, after notice and opportunity for hearing,
and may do so on application of any person or on its own initiative.
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\9\ Section 4(c)(1) of the CEA, 7 U.S.C. 6(c)(1), provides that:
In order to promote responsible economic or financial innovation
and fair competition, the Commission by rule, regulation, or order,
after notice and opportunity for hearing, may (on its own initiative
or on application of any person, including any board of trade
designated or registered as a contract market or derivatives
transaction execution facility for transactions for future delivery
in any commodity under section 7 of this title) exempt any
agreement, contract, or transaction (or class thereof) that is
otherwise subject to subsection (a) of this section (including any
person or class of persons offering, entering into, rendering advice
or rendering other services with respect to, the agreement,
contract, or transaction), either unconditionally or on stated terms
or conditions or for stated periods and either retroactively or
prospectively, or both, from any of the requirements of subsection
(a) of this section, or from any other provision of this chapter
(except subparagraphs (c)(ii) and (D) of section 2(a)(1) of this
title, except that the Commission and the Securities and Exchange
Commission may by rule, regulation, or order jointly exclude any
agreement, contract, or transaction from section 2(a)(1)(D) of this
title), if the Commission determines that the exemption would be
consistent with the public interest.
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In enacting Section 4(c), Congress noted that the goal of the
provision ``is to give the Commission a means of providing certainty
and stability to existing and emerging markets so that financial
innovation and market development can proceed in an effective and
competitive manner.'' \10\ Permitting the CDOs and CDBOs to trade on
CBOE and be cleared on OCC as discussed above may foster both financial
innovation and competition. The CFTC believes that the venue or venues
for trading and clearing of instruments such as CDOs and CDBOs should
be determined by the competitive forces of the market, particularly
where any potential venue would be subject to federal regulatory
oversight. The CFTC is requesting comment on whether it should exempt
CDOs and CDBOs, as described above, that are traded on CBOE and cleared
through OCC, from any provision of the CEA that might be transgressed
by trading and clearing those transactions as described above.
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\10\ HOUSE CONF. REPORT NO. 102-978, 1992 U.S.C.C.A.N. 3179,
3213 (``4(c) Conf. Report'').
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In proposing this exemption, the CFTC need not--and does not--find
that the CDOs and CDBOs are (or are not) subject to the CEA. During the
legislative process leading to the enactment of Section 4(c) of the
CEA, the House-Senate Conference Committee noted that:
The Conferees do not intend that the exercise of exemptive
authority by the Commission would require any determination
beforehand that the agreement, instrument, or transaction for which
an exemption is sought is subject to the Act. Rather, this provision
provides flexibility for the Commission to provide legal certainty
to novel instruments where the determination as to jurisdiction is
not straightforward. Rather than making a finding as to whether a
product is or is not a futures contract, the Commission in
appropriate cases may proceed directly to issuing an exemption.\11\
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\11\ 4(c) Conf. Report at 3214-3215.
CDOs and CDBOs are ``novel instruments'' and the ``determination as to
[their] jurisdiction is not straightforward.'' Given their potential
usefulness to the significant market for credit derivatives products,
however, the Commission believes that this may be an appropriate case
for issuing an exemption without making a finding as to the nature of
these particular instruments.
Section 4(c)(2) provides that the Commission may grant exemptions
only when it determines that the requirements for which an exemption is
being provided should not be applied to the agreements, contracts or
transactions at issue, and the exemption is consistent with the public
interest and the purposes of the CEA; that the agreements, contracts or
transactions will be entered into solely between appropriate persons;
and that the exemption will not have a material adverse effect on the
ability of the Commission or any contract market or derivatives
transaction execution facility to discharge its regulatory or self-
regulatory responsibilities under the CEA.\12\
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\12\ Section 4(c)(2) of the CEA, 7 U.S.C. Sec. 6(c)(2),
provides that:
The Commission shall not grant any exemption under paragraph (1)
from any of the requirements of subsection (a) of this section
unless the Commission determines that--
(A) The requirement should not be applied to the agreement,
contract, or transaction for which the exemption is sought and that
the exemption would be consistent with the public interest and the
purposes of this Act; and
(B) The agreement, contract, or transaction--
(i) Will be entered into solely between appropriate persons; and
(ii) Will not have a material adverse effect on the ability of
the Commission or any contract market or derivatives transaction
execution facility to discharge its regulatory or self-regulatory
duties under this Act.
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The purposes of the CEA include ``promot[ing] responsible
innovation and fair competition among boards of trade, other markets
and market participants.'' \13\ It may be consistent with these and the
other purposes of the CEA, and with the public interest, for the mode
of trading of these transactions--whether it is to be through CFTC-
regulated markets and clearing organizations or SEC-regulated markets
and clearing organizations--to be determined by competitive market
forces rather than by regulatory line-drawing. Accordingly, the CFTC is
requesting comment as to whether an exemption from the requirements of
the CEA should be granted in the context of these transactions.
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\13\ CEA Sec. 3(b), 7 U.S.C. 5(b). See also CEA Sec. 4(c)(1),
7 U.S.C. 6(c)(1) (purpose of exemptions is ``to promote responsible
economic or financial innovation and fair competition.'')
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Section 4(c)(3) includes within the term ``appropriate persons'' a
number of specified categories of persons, and also in subparagraph (K)
thereof ``such other persons that the Commission determines to be
appropriate in light of * * * the applicability of appropriate
regulatory protections.'' Both CBOE and OCC, as well as their members
who will intermediate these transactions, are subject to extensive and
detailed regulation by the SEC under the 1934 Act. The CFTC is
requesting comment as to whether all persons trading CDOs and CDBOs
traded on CBOE and cleared on OCC are appropriate persons.
In light of the above, the Commission also is requesting comment as
to whether this exemption will interfere with its ability to discharge
its regulatory responsibilities under the CEA, including its ability to
determine whether the listing of similar or
[[Page 27093]]
identical products on a designated contract market or derivatives
transaction execution facility would or would not violate the CEA, or
with the self-regulatory duties of any contract market or derivatives
transaction execution facility.
III. Request for Comment
The Commission requests comment on all aspects of the issues
presented by this proposed order.
IV. Related Matters
A. Paperwork Reduction Act
The Paperwork Reduction Act of 1995 (``PRA'') \14\ imposes certain
requirements on federal agencies (including the Commission) in
connection with their conducting or sponsoring any collection of
information as defined by the PRA. The proposed exemptive order would
not, if approved, require a new collection of information from any
entities that would be subject to the proposed order.
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\14\ 44 U.S.C. 3507(d).
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B. Cost-Benefit Analysis
Section 15(a) of the CEA, as amended by Section 119 of the
Commodity Futures Modernization Act of 2000 (``CFMA''),\15\ requires
the Commission to consider the costs and benefits of its action before
issuing an order under the CEA. By its terms, Section 15(a) as amended
does not require the Commission to quantify the costs and benefits of
an order or to determine whether the benefits of the order outweigh its
costs. Rather, Section 15(a) simply requires the Commission to
``consider the costs and benefits'' of its action.
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\15\ 7 U.S.C. 19(a).
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Section 15(a) of the CEA further specifies that costs and benefits
shall be evaluated in light of five broad areas of market and public
concern: Protection of market participants and the public; efficiency,
competitiveness, and financial integrity of futures markets; price
discovery; sound risk management practices; and other public interest
considerations. Accordingly, the Commission could in its discretion
give greater weight to any one of the five enumerated areas and could
in its discretion determine that, notwithstanding its costs, a
particular order was necessary or appropriate to protect the public
interest or to effectuate any of the provisions or to accomplish any of
the purposes of the CEA.
The proposed exemptive order may facilitate market competition. The
Commission is considering the costs and benefits of this proposed order
in light of the specific provisions of Section 15(a) of the CEA, as
follows:
1. Protection of market participants and the public. CBOE, OCC and
their members who would intermediate CDOs and CDBOs are subject to
extensive SEC oversight.
2. Efficiency, competition, and financial integrity. The proposed
exemption may enhance market efficiency and competition since it could
encourage potential trading of CDOs and CDBOs on markets other than
designated contract markets or derivative transaction execution
facilities. Financial integrity will not be affected since the CDOs and
CDBOs will be cleared by OCC, a DCO and SEC-registered clearing agency,
and intermediated by SEC-registered broker-dealers.
3. Price discovery. Price discovery may be enhanced through market
competition.
4. Sound risk management practices. OCC has described appropriate
risk-management practices that it will follow to margin CDOs and CDBOs.
5. Other public interest considerations. The proposed exemption may
encourage development of credit derivative products through market
competition without unnecessary regulatory burden.
After considering these factors, the Commission has determined to
seek comment on the proposed order as discussed above. The Commission
invites public comment on its application of the cost-benefit
provision.
* * * * *
Issued in Washington, DC, on May 9, 2007 by the Commission.
Eileen A. Donovan,
Acting Secretary of the Commission.
[FR Doc. E7-9212 Filed 5-11-07; 8:45 am]
BILLING CODE 6351-01-P