[Federal Register: January 2, 2009 (Volume 74, Number 1)]
[Notices]
[Page 133-139]
From the Federal Register Online via GPO Access [wais.access.gpo.gov]
[DOCID:fr02ja09-57]
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SECURITIES AND EXCHANGE COMMISSION
[Release No. 34-59165; File No. S7-35-08]
Order Pursuant to Section 36 of the Securities Exchange Act of
1934 Granting Temporary Exemptions From Sections 5 and 6 of the
Exchange Act for Broker-Dealers and Exchanges Effecting Transactions in
Credit Default Swaps
December 24, 2008.
I. Background
In response to the recent turmoil in the financial markets, the
Securities and Exchange Commission (``Commission'') has taken multiple
actions to protect investors and ensure the integrity of the nation's
securities markets.\1\ Today, we are taking further action designed to
address concerns related to the market in credit default swaps
(``CDS''). The over-the-counter (``OTC'') market for CDS has been a
source of concerns to us and other financial regulators. These concerns
include the systemic risk posed by CDS, highlighted by the possible
inability of parties to meet their obligations as counterparties and
the potential resulting adverse effects on
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other markets and the financial system.\2\ Recent credit market events
have demonstrated the seriousness of these risks in a CDS market
operating without meaningful regulation, transparency,\3\ or central
counterparties (``CCPs'').\4\ These events have emphasized the need for
CCPs as mechanisms to help control such risks.\5\ A CCP for CDS could
be an important step in reducing the counterparty risks inherent in the
CDS market, and thereby help mitigate potential systemic impacts. In
November 2008, the President's Working Group on Financial Markets
stated that the implementation of a CCP for CDS was a top priority \6\
and, in furtherance of this recommendation, the Commission, the FRB and
the Commodity Futures Trading Commission (``CFTC'') signed a Memorandum
of Understanding \7\ that establishes a framework for consultation and
information sharing on issues related to CCPs for CDS. Given the
continued uncertainty in this market, taking action to help foster the
prompt development of CCPs, including granting conditional exemptions
from certain provisions of the federal securities laws, is in the
public interest.
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\1\ A nonexclusive list of the Commission's actions to stabilize
financial markets during this credit crisis includes: Adopting a
package of measures to strengthen investor protections against naked
short selling, including rules requiring a hard T+3 close-out,
eliminating the options market maker exception of Regulation SHO,
and expressly targeting fraud in short selling transactions (See
Securities Exchange Act Release No. 58572 (September 17, 2008), 73
FR 54875 (September 23, 2008)); issuing an emergency order to
enhance protections against naked short selling in the securities of
primary dealers, Fannie Mae, and Freddie Mac (See Securities
Exchange Act Release No. 58166 (July 15, 2008), 73 FR 42379 (July
21, 2008)); taking temporary emergency action to ban short selling
in financial securities (See Securities Exchange Act Release No.
58592 (September 18, 2008), 73 FR 55169 (September 24, 2008));
approving emergency rulemaking to ensure disclosure of short
positions by hedge funds and other institutional money managers (See
Securities Exchange Act Release No. 58591A (September 21, 2008), 73
FR 55557 (September 25, 2008)); proposing rules to strengthen the
regulation of credit rating agencies and making the limits and
purposes of credit ratings clearer to investors (See Securities
Exchange Act Release No. 57967 (June 16, 2008), 73 FR 36212 (June
25, 2008); entering into a Memorandum of Understanding with the
Board of Governors of the Federal Reserve System (``FRB'') to make
sure key federal financial regulators share information and
coordinate regulatory activities in important areas of common
interest (See Memorandum of Understanding Between the U.S.
Securities and Exchange Commission and the Board of Governors of the
Federal Reserve System Regarding Coordination and Information
Sharing in Areas of Common Regulatory and Supervisory Interest (July
7, 2008), http://www.sec.gov/news/press/2008/2008-134_mou.pdf).
\2\ In addition to the potential systemic risks that CDS pose to
financial stability, we are concerned about other potential risks in
this market, including operational risks, risks relating to
manipulation and fraud, and regulatory arbitrage risks.
\3\ See Policy Objectives for the OTC Derivatives Market, The
President's Working Group on Financial Markets (November 14, 2008),
http://www.ustreas.gov/press/releases/reports/policyobjectives.pdf
(``Public reporting of prices, trading volumes and aggregate open
interest should be required to increase market transparency for
participants and the public.'').
\4\ See The Role of Credit Derivatives in the U.S. Economy
Before the H. Agric. Comm., 110th Cong. (2008) (Statement of Erik
Sirri, Director of the Division of Trading and Markets, Commission).
\5\ See id.
\6\ See Policy Objectives for the OTC Derivatives Market, The
President's Working Group on Financial Markets (November 14, 2008),
http://www.ustreas.gov/press/releases/reports/policyobjectives.pdf.
See also Policy Statement on Financial Market Developments, The
President's Working Group on Financial Markets (March 13, 2008),
http://www.treas.gov/press/releases/reports/
pwgpolicystatemktturmoil_03122008.pdf; Progress Update on March
Policy Statement on Financial Market Developments, The President's
Working Group on Financial Markets (October 2008), http://
www.treas.gov/press/releases/reports/q4progress%20update.pdf.
\7\ See Memorandum of Understanding Between the Board of
Governors of the Federal Reserve System, the U.S. Commodity Futures
Trading Commission and the U.S. Securities and Exchange Commission
Regarding Central Counterparties for Credit Default Swaps (November
14, 2008), http://www.treas.gov/press/releases/reports/finalmou.pdf.
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A CDS is a bilateral contract between two parties, known as
counterparties. The value of this financial contract is based on
underlying obligations (``reference obligations'') of a single entity
(a ``reference entity'') or on a particular security or other debt
obligation (``reference security''), or an index of several such
entities, securities, or obligations. The obligation of a seller under
a CDS to make payments under a CDS contract is triggered by a default
or other credit event as to such entity or entities or such security or
securities. Investors may use CDS for a variety of reasons, including
to offset or insure against risk in their fixed-income portfolios, to
take positions in bonds or in segments of the debt market as
represented by an index, or to capitalize on the volatility in credit
spreads during times of economic uncertainty. In recent years, CDS
market volumes have rapidly increased.\8\ This growth has coincided
with a significant rise in the types and number of entities
participating in the CDS market.\9\
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\8\ See Semiannual OTC derivatives statistics at end-December
2007, Bank for International Settlements (``BIS''), http://
www.bis.org/statistics/otcder/dt1920a.pdf.
\9\ CDS were initially created to meet the demand of banking
institutions looking to hedge and diversify the credit risk
attendant with their lending activities. However, financial
institutions such as insurance companies, pension funds, securities
firms, and hedge funds have entered the CDS market.
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The Commission's authority over this OTC market for CDS is limited.
Specifically, section 3A of the Securities Exchange Act of 1934
(``Exchange Act'') limits the Commission's authority over swap
agreements, as defined in section 206A of the Gramm-Leach-Bliley
Act.\10\ For those CDS that are swap agreements, the exclusion from the
definition of security in section 3A of the Exchange Act, and related
provisions, will continue to apply. The Commission's action today does
not affect these CDS, and this order does not apply to them. For those
CDS that are not swap agreements (``non-excluded CDS''), the
Commission's action today provides certain exemptions to exchanges that
effect transactions in such non-excluded CDS and to brokers and dealers
that effect transactions in non-excluded CDS on exchanges, and is
designed to facilitate the development of one or more CDS
exchanges.\11\
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\10\ 15 U.S.C. 78c-1. Section 3A excludes both a non-security-
based and a security-based swap agreement from the definition of
``security'' under Section 3(a)(10) of the Exchange Act, 15 U.S.C.
78c(a)(10). Section 206A of the Gramm-Leach-Bliley Act defines a
``swap agreement'' as ``any agreement, contract, or transaction
between eligible contract participants (as defined in section 1a(12)
of the Commodity Exchange Act* * *) * * * the material terms of
which (other than price and quantity) are subject to individual
negotiation.'' 15 U.S.C. 78c note.
\11\ The Commission found that credit default options and credit
default basket options, which are essentially exchange-traded
equivalents of OTC CDS, proposed by the Chicago Board Options
Exchange, were securities because they are options based on the
value of a security or securities, options on an interest in a
security or securities, or options based on the value of an interest
in a security or securities. See Securities Exchange Act Release No.
55871 (June 6, 2007), 72 FR 32372, 32375-77 (June 12, 2007) (File
No. SR-CBOE-2006-84) (``CBOE CDO Order''); Securities Exchange Act
Release No. 56275 (August 17, 2007), 72 FR 47297 (August 22, 2008)
(File No. SR-CBOE-2007-26) (together with the CBOE CDO Order, the
``CBOE Orders''). The Commission made special note that, ``because
credit default options will be exchange-traded and not individually
negotiated, * * * they are not qualifying swap agreements under
Section 206A of the Gramm-Leach-Bliley Act, * * * and, therefore,
not excluded from the definition of security by Section 3A of the
Exchange Act.'' 72 FR at 32376 n. 39. Unlike the options at issue in
the CBOE Orders, which had fixed payouts in the event of a default
or other credit event, the CDS that are the subject of the
Commission's actions today may provide for the delivery of a debt
security or securities against a specified amount, or a cash payment
based on the value of a debt security or securities. For those CDS
that are not qualifying swap agreements, that have payouts tied to
the delivery of debt securities, or that are based on the value of
debt securities, there may be arguments in addition to those in the
CBOE Orders that such CDS are security options.
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In companion actions today, the Commission is temporarily
exempting, subject to conditions, LCH.Clearnet Ltd. from the
requirement to register as a clearing agency under section 17A of the
Exchange Act solely to perform the functions of a clearing agency for
non-excluded CDS transactions.\12\ To facilitate the operation of one
or more CCPs for the CDS market, the Commission has also approved
interim final temporary rules providing exemptions under the Securities
Act of 1933 and Exchange Act for non-excluded CDS.
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\12\ See Securities Exchange Act Release No. 59164 (December 24,
2008) (File No. S7-34-08).
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In conjunction with these exemptions, the Commission in this order
is providing a temporary exemption to any exchange that effects or
reports transactions in non-excluded CDS and is not otherwise subject
to the requirements under Sections 5 and 6 of the Exchange Act \13\
from the requirement to register as a national securities exchange, and
to any broker or dealer that effects or reports transactions in non-
excluded CDS on such an exempt exchange.\14\ The
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exemptions in this order are subject to the conditions discussed below.
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\13\ 15 U.S.C. 78e and 78f.
\14\ A national securities exchange that effects transactions in
CDS would continue to be required to comply with all requirements
under the Exchange Act applicable to such transactions. A national
securities exchange could form subsidiaries or affiliates that
operate exchanges exempt under this order. Any subsidiary or
affiliate of a registered exchange could not integrate, or otherwise
link, the exempt CDS exchange with the registered exchange,
including the premises or property of such exchange for effecting or
reporting a transaction, without being considered a ``facility of
the exchange.'' See Section 3(a)(2) of the Exchange Act, 15 U.S.C.
78c(a)(2).
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The Commission believes that the CDS market would benefit from the
development of exchanges for non-excluded CDS. As the Commission has
previously noted when approving a proposed rule change by the Chicago
Board Options Exchange to list and trade certain CDS contracts, there
are several benefits to trading such products on exchanges rather than
over-the-counter.\15\ These benefits include a centralized market,
standardized contract specifications, transparent quotations, and
transaction reporting.\16\ Exchange trading would permit real-time
matching of orders, and enhance transparency of the CDS market by
promoting dissemination of pre-trade quotations as well as post-trade
transaction information. Additional pre-trade and post-trade
transparency would enable exchange subscribers to better assess market
depth and liquidity and allow regulators to better surveil for
violations of the securities laws.
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\15\ See CBOE Orders, supra note 11.
\16\ Id.
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Accordingly, the Commission is using its authority under section 36
of the Exchange Act \17\ to exempt temporarily any exchange that
effects transactions in non-excluded CDS and is not otherwise subject
to the requirements under Sections 5 and 6 of the Exchange Act,\18\ and
the rules and regulations thereunder, from the requirement to register
as a national securities exchange under section 6 of the Exchange
Act,\19\ and from the prohibition in section 5 of the Exchange Act \20\
against effecting transactions as an exchange unless it is registered
as a national securities exchange or exempt from registration due to
the limited volume of its transactions. The Commission finds that such
action is necessary and appropriate in the public interest and
consistent with the protection of investors to facilitate the operation
of one or more CDS exchanges in connection with the establishment of
one or more CCP that clear and settle non-excluded CDS.\21\ The
Commission is also temporarily exempting brokers and dealers from the
section 5 prohibition against effecting or reporting transactions in
securities otherwise than on a national securities exchange or an
exchange that is exempt from registration due to its limited volume.
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\17\ 15 U.S.C. 78mm.
\18\ 15 U.S.C. 78e and 78f.
\19\ 15 U.S.C. 78f.
\20\ 15 U.S.C. 78e.
\21\ See supra note 12.
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The conditions to these exemptions will enable to the Commission to
oversee the development of CDS exchanges, and to take such additional
action as we may deem necessary to promote the public interest and the
protection of investors. Moreover, the limited duration of the
exemptions provided today will enable one or more CDS exchanges to
become operational while we gain experience with the CDS market and
evaluate public input, including comments we receive on the temporary
exemptions granted in today's order.
II. Discussion
Section 5 of the Exchange Act states that ``[i]t shall be unlawful
for any broker, dealer, or exchange, directly or indirectly, to make
use of the mails or any means or instrumentality of interstate commerce
for the purpose of using any facility of an exchange * * * to effect
any transaction in a security, or to report any such transactions,
unless such exchange (1) is registered as a national securities
exchange under section 6 of [the Exchange Act], or (2) is exempted from
such registration * * * by reason of the limited volume of transactions
effected on such exchange* * *.'' \22\ Section 6 of the Exchange Act
sets forth a procedure whereby an exchange \23\ may register as a
national securities exchange.\24\
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\22\ 15 U.S.C. 78e.
\23\ Section 3(a)(1) of the Exchange Act, 15 U.S.C. 78c(a)(1),
defines ``exchange.'' Rule 3b-16 under the Exchange Act, 17 CFR
240.3b-16, defines certain terms used in the statutory definition of
exchange. See Securities Exchange Act Release No. 40760 (December 8,
1998), 63 FR 70844 (December 22, 1998) (``Regulation ATS Adopting
Release'') (adopting Rule 3b-16 in addition to Regulation ATS).
\24\ 15 U.S.C. 78f. Section 6 of the Exchange Act also sets
forth various requirements to which a national securities exchange
is subject.
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Section 36 of the Exchange Act provides that the Commission, ``by
rule, regulation, or order, may conditionally or unconditionally exempt
any person, security, or transaction, or any class or classes of
persons, securities, or transactions, from any provision or provisions
of [the Exchange Act] or of any rule or regulation thereunder, to the
extent that such exemption is necessary or appropriate in the public
interest, and is consistent with the protection of investors.'' To
facilitate the establishment of one or more exchanges for non-excluded
CDS, the Commission is exercising its authority under section 36 of the
Exchange Act to temporarily exempt any exchange, broker or dealer that
effects transactions in non-excluded CDS from the prohibition in
Section 5 of the Exchange Act and (in the case of exchanges) the
requirements in Section 6 of the Exchange Act and the rules and
regulations thereunder. These temporary exemptions are subject to
certain conditions, discussed further below. These conditions on
exchanges generally mirror those applicable to alternative trading
systems, which are securities trading systems that the Commission
previously exempted from exchange registration.\25\
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\25\ See Regulation ATS, 17 CFR 242.300 et seq. In 1998, the
Commission exercised its exemptive authority under Section 36 of the
Exchange Act and its general authority under Section 11A of the
Exchange Act, 15 U.S.C. 78k-1, to establish a regulatory framework
for ``alternative trading systems,'' which perform many of the same
functions as exchanges. Under this framework, an entity that, like
an exchange, matches the orders in securities of multiple buyers and
sellers according to established, non-discretionary methods is
exempt from the definition of ``exchange'' if it instead registers
as a broker-dealer and complies with Regulation ATS. Regulation ATS
is designed, among other things, ``to adopt a regulatory framework
that addresses [the Commission's] concerns without jeopardizing the
commercial viability of these markets.'' Regulation ATS Adopting
Release, supra note 23, 63 FR at 70846.
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This temporary exemption is designed to allow brokers, dealers, and
exchanges to effect transactions in non-excluded CDS on exchanges,
subject to certain conditions. The Commission believes the exemption,
together with the conditions, is necessary in the public interest and
consistent with the protection of investors. In addition, the
Commission believes that these conditions will not impede the ability
of brokers, dealers, and exchanges to compete in the market for CDS.
The limited term of this exemption will provide the Commission with
adequate time to evaluate the application of this exemption to non-
excluded CDS exchanges, and whether such conditions should be modified.
In particular, the Commission will be considering whether Regulation
ATS, with or without modifications, could apply to systems that match
orders in non-excluded CDS of multiple buyers and sellers.
This temporary exemption is available only to exchanges that effect
transactions in non-excluded CDS. To the extent that an exchange is
otherwise subject to the requirements of section 5 of the Exchange Act,
it must register with the Commission as a national securities exchange
under Section 6 of the Exchange Act and the rules and regulations
thereunder or comply with the terms of another exemption. Similarly, a
broker or dealer is temporarily exempt from the prohibition in Section
5 only to the extent that it effects transactions in non-
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excluded CDS on an exchange or reports such transactions on an
exchange.
The Commission believes that this order will facilitate the
establishment of one or more exchanges that effect transactions in non-
excluded CDS. For this reason and the reasons discussed above,\26\ the
Commission believes that these exemptions are necessary or appropriate
in the public interest and consistent with the protection of investors.
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\26\ See supra notes 15-16 and accompanying text.
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As noted, the conditions under which CDS exchanges must operate to
qualify for the exemption from exchange registration being granted
today are modeled on requirements applicable to alternative trading
systems. Like an alternative trading system, a CDS exchange must keep
records about its operations, its subscribers, and their orders.\27\ A
CDS exchange also must provide the Commission with trading information
on a quarterly basis \28\ and establish procedures to ensure the
confidential treatment of trading information.\29\ Likewise, a CDS
exchange must permit the Commission to examine its premises, systems,
and records and must cooperate with the examination of its
subscribers.\30\ These requirements are designed to allow the
Commission to monitor market developments, to ascertain how new
entrants are affecting the national market system, and to promote
compliance with the federal securities laws generally. The Commission
believes that temporarily exempting exchanges that effect transactions
in non-excluded CDS from exchange registration, subject to these
conditions, is necessary or appropriate in the public interest and is
consistent with the protection of investors.
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\27\ Compare 17 CFR 242.301(b)(8), 242.302, and 242.303.
\28\ Compare 17 CFR 242.301(b)(9).
\29\ Compare 17 CFR 242.301(b)(10).
\30\ Compare 17 CFR 242.301(b)(7).
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A. Exemption From Sections 5 and 6 of the Exchange Act for Exchanges
1. No Self-Regulatory Authority
To be exempt under this order, the exchange must not: (a) Set rules
governing the conduct of subscribers other than the conduct of such
subscribers trading on such exchange; or (b) discipline subscribers
under the Exchange Act other than by exclusion from trading. That is,
an exempted exchange may not exercise self-regulatory authority over
its subscribers. The Commission intends this condition to be the same
requirement as applies to alternative trading systems under Regulation
ATS. As described in the Regulation ATS Adopting Release, self-
regulatory authority would include, for example, any restrictions on
subscribers' activities outside of the exchange or imposing as a
condition of participation any requirement for which the exchange would
examine subscribers for compliance. The requirement in Regulation ATS
and this condition are based on the Commission's belief that a
organization, association, or group of persons that could exercise
self-regulatory authority over its subscribers should be registered as
a self-regulatory organization (``SRO'') and subject to the full
responsibilities and supervision that registration entails. The
Commission continues to believe that rules governing exchange
subscriber conduct may be imposed and enforced only by SROs because of
the potential that they may be applied for anti-competitive purposes.
However, as we noted in connection with adopting Regulation ATS, the
Commission does not intend this condition to preclude a trading system
from applying credit standards to its subscribers or requiring
subscribers to provide financial information relevant to their activity
on the system.\31\
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\31\ See Regulation ATS Adopting Release, supra note 23, 63 FR
at 70859.
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2. Recordkeeping
In addition, to be exempt under this order, an exchange must
maintain an audit trail of orders that it receives and transactions
that it effects. These records are critical to the Commission's ability
to oversee the CDS market, detect and deter illicit market activity,
and take action as necessary to address manipulation and fraud,
including insider trading. These recordkeeping and record preservation
requirements are comparable to those required under Regulation ATS and
tailored to apply to non-excluded CDS.\32\ Specifically, an exchange
must make and keep the following records for a period of not less than
three years, the first two years in an easily accessible place:
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\32\ See 17 CFR 242.301(b)(8), 242.302, and 242.303.
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A record of subscribers in the exchange (identifying any
affiliations between the exchange and subscribers in the exchange,
including common directors, officers, or owners);
Daily summaries of trading, including: (a) Information
identifying CDS in which transactions are effected; and (b) transaction
volume, expressed in terms of number of trades and total U.S. dollar
notional value;
Time-sequenced records of order information, including:
(a) Identity of the party entering an order; (b) identification of non-
excluded CDS contract (including the reference entity, security, or
index, and notional value); (c) date and time that order was received;
(d) price (whether expressed as credit spread, rate, strike, or
coupon); (e) whether the order is to buy or sell and any order
conditions; (f) any subsequent modification or cancellation of the
order; (g) date and time the order was executed, the size (e.g.,
notional value amount) executed, and the price; and (h) identity of the
parties to the transaction.\33\
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\33\ These information items, with one exception, must be
recorded and kept current by alternative trading systems pursuant to
Regulation ATS. See 17 CFR 242.301(b)(8) and 242.302(c). Alternative
trading systems are not required by Regulation ATS to keep records
of the identity of the party entering an order. The Commission
believes, however, that such information could be important to its
ability to enforce the securities laws and is, therefore, to be kept
as a condition to this exemption. Alternative trading systems must
be registered with the Commission as a broker-dealer, and are
therefore subject to additional Commission recordkeeping rules. See
17 CFR 242.301(b)(1). An exchange that avails itself of this
exemption, however, may not otherwise be subject to requirements
under the Exchange Act.
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In addition, as a condition of this exemption, an exchange must
preserve the following records:
For a period of not less than three years, the first two
years in an easily accessible place, all notices provided by such
exchange to subscribers generally, whether written or communicated
through automated means, including, but not limited to, notices
addressing hours of system operations, system malfunctions, changes to
system procedures, maintenance of hardware and software, instructions
pertaining to access to the market and denials of, or limitations on,
access to the exchange; and
During the life of the enterprise and of any successor
enterprise, the exchange's organizational documents and copies of
reports filed with the Commission pursuant to this exemption.
An exchange exempt pursuant to this order may comply with these
recordkeeping and record preservation requirements through use of a
service bureau, depository, or other recordkeeping service that
maintains and preserves these records on behalf of the exchange. An
agreement with a service bureau, depository, or other recordkeeping
service will not relieve the exchange from the responsibility to
prepare and maintain the specified records.
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The Commission believes that the types of records an exchange would
be required to make and keep pursuant to this condition are records an
exchange would keep in the normal course of its business and,
therefore, that this condition is not unduly burdensome.
3. Regulatory Reporting
An exchange that relies on this order must, within five days of
commencing operation, submit a notice to the Commission \34\ that
includes the following information:
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\34\ Any such notice should be sent to: Secretary, Securities
and Exchange Commission, 100 F Street, NE., Washington, DC 20549,
and be noted as regarding ``CDS Exchange Exemption from
Registration.''
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1. Full legal name of the exchange;
2. A description of the exchange's ownership structure;
3. Contact person and contact information;
4. A general description of the CDS contracts that trade on the
exchange; and
5. A description of how the exchange operates.
This information is essential for the Commission to understand
developments in the CDS market. Any subsequent action regarding this
exemption--for example, whether it should be modified, extended, or
allowed to expire--is predicated on understanding which market
participants are relying on it. In the future, different regulatory
frameworks may be appropriate for different market participants. These
notices will enable the Commission to commence a dialog with the
relevant market participants.
In addition, an exchange that relies on this exemption must report
the following information to the Commission within 30 days of the end
of each quarter:
1. The total dollar volume of transactions executed during the
quarter, broken down by reference entity, security, or index;
2. The total unit volume and/or notional amount executed during the
quarter, broken down by reference entity, security, or index; and
3. A list of all subscribers that effected transactions on the
exchange during the quarter.
Reporting of this information will assist the Commission in carrying
out its responsibility to supervise and regulate the securities
markets. This information is similar to that which an alternative
trading system must provide quarterly.\35\
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\35\ See 17 CFR 242.301(b)(9)(i); Form ATS-R, 17 CFR 249.638.
The Commission notes that an alternative trading system is not
required to report to the Commission its transaction volume by
security; only aggregate volumes must be reported to the Commission.
Reports in most equity securities and many debt securities traded on
an ATS are required to be reported to an SRO on a transaction-by-
transaction basis. This is the not the case for CDS. For this
reason, the Commission is conditioning this exemption on an exchange
providing quarterly information to the Commission on trading volume
broken down by reference entity, security, or index. The Commission
believes it is appropriate to require this more specific information
from CDS exchanges to better understand the development of the
exchange-traded market in non-excluded CDS.
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4. Confidentiality of Trading Information
An exchange relying on this order also must establish adequate
safeguards and procedures to protect subscribers' confidential trading
information. Such safeguards and procedures shall include: (a) Limiting
access to the confidential trading information of subscribers to those
employees of the exchange who are operating the system or responsible
for its compliance with this exemption or any other applicable rules;
and (b) implementing standards controlling employees of the exchange
trading for their own accounts. The exchange must adopt and implement
adequate oversight procedures to ensure that the safeguards and
procedures established pursuant to this condition are followed. This
condition, which closely tracks a requirement applicable to alternative
trading systems,\36\ is designed to prevent the misuse of subscriber
trading information that is available to the exchange. This should
strengthen confidence in the exchange, promoting participation.
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\36\ See 17 CFR 242.301(b)(10).
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5. Commission Jurisdiction
Finally, an exchange that relies on this order must provide access
to the Commission to conduct on-site inspections of its facilities
(including automated systems and systems environment), records, and
personnel related to exchange activities. The exchange must cooperate
with the Commission in connection with the investigation of any
exchange subscribers. This requirement is similar to one in Regulation
ATS that applies to alternative trading systems.\37\
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\37\ See 17 CFR 242.301(b)(7).
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Recent market events have clearly demonstrated the importance of
the CDS market and its potential to impact other markets, including the
equity securities markets. It is therefore imperative that the
Commission have examination authority over any exchange that effects
transactions in non-excluded CDS, with regard to its compliance with
the conditions of the exemption provided under this order as well as
enforcement of the antifraud provisions of the securities laws,
including the prohibitions on insider trading. Particularly because the
CDS market is so large and involves many market participants that are
not directly subject to the Commission's authority, cooperation by the
CDS exchange with the Commission in any investigation or enforcement
action is crucial.
B. Exemption From Section 5 of the Exchange Act for Brokers and Dealers
Absent an exemption, section 5 of the Exchange Act \38\ would
prohibit brokers and dealers from effecting transactions in non-
excluded CDS on an exchange that is not a national securities exchange
because of that exchange's reliance on this order. The Commission finds
that temporarily exempting brokers and dealers that effect transactions
in non-excluded CDS on such an exchange from this restriction in
section 5 is necessary and appropriate in the public interest and is
consistent with the protection of investors because it will facilitate
brokers' and dealers' use of CDS exchanges, which for the reasons noted
above the Commission believes would be beneficial. Without also
exempting brokers and dealers from this section 5 requirement, the
Commission's temporary exemption of CDS exchanges would be ineffective,
because brokers and dealers would not be permitted to effect
transactions on those exchanges.
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\38\ 15 U.S.C. 78e.
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Section 5 of the Exchange Act recognizes that there are situations
where brokers and dealers should be permitted to trade on an exchange
that is not registered as a national securities exchange. Section 5
provides in relevant part that brokers and dealers may effect
transactions on an exchange that the Commission, by reason of the
limited volume of transactions effected on such exchange, has exempted
from registration under Section 6. Brokers and dealers are also
permitted to effect transactions on alternative trading systems, which
are exempted from the definition of ``exchange'' and thus do not fall
within the restriction of Section 5. For the reasons noted above, the
Commission finds that it is consistent with the public interest and the
protection of investors to grant a temporary exemption from section 5
of the Exchange Act to any broker or dealer that effects transactions
in non-excluded CDS, or reports such transactions, on an exchange that
is exempted pursuant to this order.
[[Page 138]]
C. Solicitation of Comments
The Commission intends to monitor closely the development of the
CDS market and intends to determine to what extent, if any, additional
regulatory action may be necessary. For example, as circumstances
warrant, certain conditions could be added, altered, or eliminated.
Moreover, because this exemption is temporary, the Commission will in
the future consider whether it should be extended or allowed to expire.
The Commission believes it would be prudent to solicit public comment
on its action today, and what action it should take with respect to the
CDS market in the future. The Commission is soliciting public comment
on all aspects of this exemption, including:
1. Whether the length of this temporary exemption (until September
25, 2009) is appropriate. If not, what should the appropriate duration
be?
2. Whether the conditions to the exemption are appropriate. Why or
why not? Should other conditions apply? Are any of the present
conditions to the exemption provided in this order unnecessary? If so,
please specify and explain why such conditions are not needed.
3. Whether exchanges relying on this exemption should ultimately be
required to register under the Exchange Act. Why or why not?
4. Whether exchanges for non-excluded CDS can reasonably comply
with Regulation ATS. Why or why not? If not, what aspects or conditions
of Regulation ATS are problematic?
Comments may be submitted by any of the following methods:
Electronic Comments
Use the Commission's Internet comment form (http://
www.sec.gov/rules/other.shtml);
Send an e-mail to rule-comments@sec.gov. Please include
File Number S7-35-08 on the subject line; or
Use the Federal eRulemaking Portal (http://
www.regulations.gov/). Follow the instructions for submitting comments.
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 S7-35-08. This file number
should be included on the subject line if e-mail is used. To help us
process and review your comments more efficiently, please use only one
method. The Commission will post all comments on the Commission's
Internet Web site (http://www.sec.gov/rules/other.shtml). Comments are
also available for public inspection and copying in the Commission's
Public Reference Room, 100 F Street, NE., Washington, DC 20549, on
official business days between the hours of 10 a.m. and 3 p.m. All
comments received will be posted without change; we do not edit
personal identifying information from submissions. You should submit
only information that you wish to make available publicly.
III. Conclusion
It is hereby ordered pursuant to section 36 of the Exchange Act
that until September 25, 2009, an exchange is exempt from the
requirements of sections 5 and 6 of the Exchange Act \39\ and the rules
and regulations thereunder to the extent that such exchange effects or
reports transactions in non-excluded CDS and is not otherwise required
to register as a national securities exchange, subject to the following
conditions:
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\39\ 15 U.S.C. 78e and 78f.
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(1) The exchange must not: (a) Set rules governing the conduct of
subscribers other than the conduct of such subscribers trading on such
exchange; or (b) discipline subscribers other than by exclusion from
trading;
(2) The exchange must make and keep for a period of not less than
three years, the first two years in an easily accessible place, the
following records:
A record of subscribers in the exchange (identifying any
affiliations between the exchange and subscribers in the exchange,
including common directors, officers, or owners);
Daily summaries of trading, including (a) information
identifying CDS in which transactions are effected; and (b) transaction
volume, expressed in terms of number of trades and total U.S. dollar
notional value;
Time-sequenced records of order information, including:
(a) Identity of the party entering an order; (b) identification of non-
excluded CDS contract (including the reference entity, security, or
index, and notional value); (c) date and time that order was received;
(d) price (whether expressed as credit spread, rate, strike, or
coupon); (e) whether the order is to buy or sell and any order
conditions; (f) any subsequent modification or cancellation of the
order; (g) date and time the order was executed, the size (e.g.,
notional value amount) executed, and the price; and (h) identity of the
parties to the transaction;
(3) The exchange must preserve the following records:
For a period of not less than three years, the first two
years in an easily accessible place, all notices provided by such
exchange to subscribers generally, whether written or communicated
through automated means, including, but not limited to, notices
addressing hours of system operations, system malfunctions, changes to
system procedures, maintenance of hardware and software, instructions
pertaining to access to the market and denials of, or limitations on,
access to the exchange; and
During the life of the enterprise and of any successor
enterprise, the exchange's organizational documents and copies of
reports filed with the Commission pursuant to this exemption;
(4) An exchange must, within five days of commencing operation,
submit a notice to the Commission that includes the following
information:
Full legal name of the exchange;
A description of the exchange's ownership structure;
Contact person and contact information;
A general description of what CDS contracts trade on the
exchange; and
A description of how the exchange operates;
(5) An exchange must report the following information to the
Commission within 30 days of the end of each quarter:
The total dollar volume of transactions executed during
the quarter, broken down by reference entity, security, or index;
The total unit volume and/or notional amount executed
during the quarter, broken down by reference entity, security, or
index; and
A list of all subscribers that effected transactions on
the exchange during the quarter;
(6) The exchange must establish adequate safeguards and procedures
to protect subscribers' confidential trading information. Such
safeguards and procedures shall include: (a) Limiting access to the
confidential trading information of subscribers to those employees of
the exchange who are operating the system or responsible for its
compliance with this exemption or any other applicable rules; and (b)
implementing standards controlling employees of the exchange trading
for their own accounts. The exchange must adopt and implement adequate
oversight procedures to ensure that the safeguards and procedures
established pursuant to this condition are followed; and
[[Page 139]]
(7) The exchange must provide access to the Commission to conduct
on-site inspections of its facilities (including automated systems and
systems environment), records, and personnel related to exchange
activities. The exchange must cooperate with the Commission in
connection with the investigation of any exchange subscribers.
It is further ordered pursuant to section 36 of the Exchange Act
that until September 25, 2009, a broker or dealer that effects
transactions in non-excluded CDS, or reports such transactions, on an
exchange that is exempted pursuant to this order is exempt from section
5 of the Exchange Act.
By the Commission.
Florence E. Harmon,
Acting Secretary.
[FR Doc. E8-31190 Filed 12-31-08; 8:45 am]
BILLING CODE 8011-01-P