Comment Text:
10-007
COMMENT
CL-00002
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Architzel, Paul
Thursday, July 8, 2010 5:33 PM
hardeightfutures ; secretary
'Francis' ; Gensler, Gary ; Dunn,
Michael ; Chilton, Bart ; Sommers, Jill
; O'Malia, Scott ; Berkovitz, Dan M
; Hammar, Julian ; Yoshimura,
Edwin J ; Shilts, Richard A. ; Leahy,
Thomas M., Jr. ; Stephen Lee ;
Architzel, Paul
Comment on Petition for Rulemaking of Hard Eight Futures LLC
31997703_1.pdf
Dear Mr. Stawick:
We are filing the attached comment on behalf of our client, Hard Eight Futures LLC. We appreciate the
Commission publishing our Petition for Rulemaking for public comment and we appreciate the Commission's
consideration of our views on the matter. As we note in our comment letter, we believe that the requested
relief will promote market integrity, enhance transparency, reduce possible systemic risk and encourage
competition.
Please feel free to call me if you have any question about our submission.
Respectfully submitted,
Paul M. Architzel
Alston & Bird LLP
The Atlantic Building
950 F Street, N.W.
Washington, D.C. 20004-1404
Tel: 202 756-3492
Fax: 202-654-4893
Mobile: 301 785-0115
email: [email protected]
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Paul M. Architzel
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July 8, 2010
VIA E-MAIL to [email protected]
David A. Stawick
Secretary
Commodity Futures Trading Commission
1155 21st Street, N.W.
Washington, D.C. 20581
Re:
Hard Eight Futures Petition for Exemption from Section 2(a)(1(C)(iv) of
the Act and Appendix D to Part 30 of the Rules of the Commission
Dear Mr. Stawick:
We are submitting this comment on behalf of our client, Hard Eight Futures,
L.L.C. (“Hard Eight”). Hard Eight appreciates the opportunity to respond to the
Commodity Futures Trading Commission’s (“CFTC” or “Commission”) request for
comment on Hard Eight’s Petition permitting appropriate persons to trade non-narrow
security indexes on foreign boards of trade.1
Currently, no prior qualifying action by the Commission or its staff is required in
order for U.S. persons to enter into futures contracts traded on a foreign board of trade.
Rather, U.S. customers are permitted to access the products offered by a foreign board of
trade through a U.S. registered futures commission merchant (“FCM”) or introducing
broker or through a foreign firm that has received an exemption from registration as a
U.S. FCM under Commission Rule 30.10, 17 C.F.R. §30.10.
In contrast, U.S. persons
may not enter into futures contracts on a non-narrow security index traded on a foreign
board of trade unless the foreign board of trade has applied for, and has been granted, a
no-action letter by the Commission’s Office of the General Counsel (“OGC”).2
Hard
1 “Petition of Hard Eight Futures, LLC for Exemptive Relief, Pursuant to Section 4(c) of the Commodity
Exchange Act, from Section 2(a)(1)(C)(iv) of the Commodity Exchange Act and Appendix D to Part 30 of
the Rules of the Commodity Futures Trading Commission,” 75 Fed. Reg. 34429 (June 17, 2010) (“Request
for Comment”).
2 The OGC No-action procedure, which is discussed in greater detail below, is a substitute means for
foreign boards of trade to comply with Section 2(a)(1)(C)(iv)’s prohibition on the general offer and sale of
stock index contracts except as permitted under Section 2(a)(1)(C)(ii) of the Act. Section 2(a)(1)(C)(ii) of
the Act in turn provides that the Commission may only designate a board of trade as a contract market for
contracts on a security index that meet the requirements contained in that provision. See e.g. CFTC LetterDavid A. Stawick
July 8, 2010
Page 2
Eight’s Petition seeks an exemption upon claim of notice to the Commission so that
eligible contract participants3 (“ECP”) may trade on a foreign board of trade futures
contracts on non-narrow indexes of foreign securities under the same conditions that
apply to trading any other futures contract on a foreign board of trade. Granting Hard
Eight’s petition will also bring greater consistency and harmony in the manner in which
futures contracts on foreign non-narrow security indexes, narrow security indexes and
single securities are treated.4
Hard Eight’s petition for exemption would require that persons wishing to trade a
particular non-narrow security index on a foreign board of trade that is not subject to an
OCG no-action letter notify the Commission of the person’s intent to do so. The notice
would require the claimant to demonstrate his or her qualification for the exemption and
that the index is not narrow-based. This exemption would be available only with respect
to contracts traded on foreign boards of trade the regulator of which has entered into a
Memorandum of Understanding with respect to information sharing and cooperation with
the Commission.
The exemption would be effective with respect to that person and
index unless the Commission notifies the person within ten business days that the
claimant does not meet the requirements of the exclusion or the index does not qualify
under section 1a(25) of the Commodity Exchange Act, 7 U.S.C. §1 et sea. (“Act”), as a
non-narrow index and provides the person with an explanation of why it considers the
person not to be qualified or the index not to be narrow-based, respectively. Under Hard
Eight’s Petition, the current OGC no-action requirement would continue to apply before
the general public would be permitted to enter into such foreign stock index contracts.
Hard Eight, in its Petition, explained that the requested exemption is in the public
interest. The current OCG No-action procedure was established in response to the 1982
amendments to the Act5 and has operated without modification since that time. However,
since that time there have been fundamental changes in the Act, in particular, the
No. 99-25 (July 14, 1999) at http://www.cftc.gov/tm/letters/99letters/tm/99-25.htm. These provisions of
the Act were formerly found at Sections 2(a)(1)(B)(v) and 2(a)(1)(B)(ii) respectively. Thus, the OGC no-
action process relieves foreign boards of trade from the requirement that they become designated contract
markets in order to offer stock indexes traded thereon to U.S. persons.
3 The term “eligible contract participant” is defined in section 1a(12) of the Commodity Exchange Act.
4 On June 30, 2010, the Securities and Exchange Commission (“SEC”) issued an Order which permits
qualified institutional buyers (“QIB”) to access single security and narrow-based security index futures
contracts traded on foreign boards of trade under certain conditions. No additional prior qualifying action
by the SEC or its staff—such as issuance of an OGC no-action letter as required by the CFTC--is necessary
for an eligible person to trade a narrow-based security index on a foreign board of trade. The Hard Eight
Petition would result in CFTC procedures relating to the trading of foreign non-narrow security indexes
being brought into greater alignment with the conditions that apply to the trading of narrow-based security
indexes. See “Order Under Section 36 of the Securities Exchange Act of 1934 Granting an Exemption
From Exchange Act Section 6(h)(1) for Certain Persons Effecting Transactions in Foreign Security Futures
and Under Exchange Act Section 15(a)(2) and Section 36 Granting Exemptions From Exchange Act
Section 15(a)(1) and Certain Other Requirements,” 74 Fed. Reg. 32200 (July 7, 2009) (“SEC Order”).
5See Futures Trading Act of 1982, Pub. Law 97-444, 96 Stat. 2294.David A. Stawick
July 8, 2010
Page 3
recognition that differences in regulatory treatment are appropriate between ECPs and
less sophisticated traders. There have also been profound changes in the markets as well.
The exemption is conditioned upon a trader notifying the Commission prior to
using the exemption, demonstrating that the index qualifies as a non-narrow index and
that the regulator of the foreign board of trade has entered into a regulatory information-
sharing agreement with the Commission. Accordingly, although the exemption would
establish a more streamlined process, it is grounded in the most salient criteria that are
currently used by OGC in making its determinations in issuing a no-action letter.
The Petition notes that the operation of the current OGC no-action process has the
effect of preventing ECPs from trading such contracts in the more regulated exchange
environment when they are permitted to enter into economically equivalent transactions
in the less-regulated over-the-counter (“OTC”) market. Moreover, because transactions
on foreign boards of trade generally are intermediated by U.S. registered entities or firms
exempt from such registration under Commission rules, the exemption would not lessen
the regulatory protections that are afforded to customers when trading on a foreign board
of trade. Moreover, by making it possible for ECPs to execute such transactions in a
cleared, exchange environment, the exemption would assist in preserving market
integrity, enhancing transparency, reducing possible systemic risk and promoting
competition.
It is important to note that the current prohibition on trading futures contracts on
non-narrow security indexes on foreign boards of trade acts as an incentive for ECPs to
move their trading operations off-shore. U.S. trading firms compete in an international
environment. Non-U.S. firms do not face similar trading restrictions and currently there
is no process through which a U.S. trading firm is able to seek permission to trade such a
futures contract.
Granting Hard Eight’s Petition would address this situation by
providing a means through which a U.S. ECP can gain permission to trade such a
contract on a foreign board of trade and would thereby enable U.S. firms to compete with
foreign firms more effectively.
Finally, the Petition should be favorably considered in light of the recent Order of
the Securities and Exchange Commission permitting institutional investors to trade
certain foreign narrow based security index (and single security) futures products. On
July 7, 2009, the SEC issued an Order permitting Qualified Institutional Buyers (“QIB”)
to trade foreign security futures products (narrow-based security indexes and futures on
individual securities) traded on a foreign board of trade that meet certain conditions. In
this regard, for qualifying foreign narrow-based indexes, 90% of the underlying securities
in number and weighting must be issued by foreign private issuers where the primary
trading market of each such security is outside of the U.S.; the futures contract must be
traded on a foreign exchange or contract market; clearance and settlement must beDavid A. Stawick
July 8, 2010
Page 4
outside of the U.S. and the position may not be off-set through the facility of a U.S.
exchange.6
With that background, we are pleased to respond to the specific questions posed
by the Commission in its Request for Comment.
Question 1
Should an order granting the request for relief include any one or more of the
conditions proposed by HEF in its Petition?
The conditions proposed by Hard Eight are grounded in the current structure and
requirements of Appendix D to Part 30 of the Commission’s rules, the rules governing
the OGC no-action procedures. First, and most importantly, the Petition provides that a
participant notify the Commission of its intent to claim the exemption prior to trading in
reliance on the exemption. The Commission has ten business days during which time it
may notify the participant that the exemption may not be made effective and the reason
for so finding. The notice is required to include a demonstration that the index meets the
statutory definition of being a “narrow based index.” Finally, the exemption would be
conditioned upon the regulator of the foreign board of trade on which the index is traded
having entered into an information sharing arrangement with the Commission.
These conditions are appropriate. By providing that the exemption is available
only after the requestor has filed a notification with the Commission, the Commission
will have an opportunity to validate the claim of exemption. Moreover, because the
exemption is not self-effectuating, those trading in reliance on the exemption will be
identified to the Commission making it possible for the Commission to communicate on
an on-going basis as it deems appropriate.
The requirement that the claim of exemption include a demonstration that the
index is not narrow-based is appropriate. Non-narrow security indexes are within the
Commission’s exclusive jurisdiction. If the contract is not narrow based, the trading
mechanics for participants claiming the exemption will be the same as for any other
futures contract traded on a foreign board of trade. If on the other hand, the index is, or
becomes, narrow the petitioned-for exemption would not be applicable and the
participant would look to the Order of the Securities and Exchange Commission7 and
CFTC requirements8 to determine whether he or she is eligible to trade the security future
product and the trading mechanics which would apply. In this regard, the criterion for
6 SEC Order at 32206.
7 See note 4 supra.
8 See, “Division of Clearing and Intermediary Oversight Advisory Concerning the Offer and Sale of
Foreign Security Futures Products to Customers Located in the United States,”
http://www.cftc.gov/ucm/groups/public/@internationalaffairs/documents/file/fsfpadvisory.pdf (June 8,
2010).David A. Stawick
July 8, 2010
Page 5
distinguishing between narrow-based and not-narrow based contracts is straightforward.
The test is easily quantifiable and is readily determined by sophisticated participants,
such as ECPs, based on objective factors.9
The requirement that the non-U.S. regulator have in place a Memorandum of
Understanding is grounded in the requirement of Appendix D to Part 30, of the
Commission’s rules that the request for an OGC foreign stock index no-action letter
include assurances that the foreign board of trade will share information with the
Commission, either directly or indirectly.10 Because the claim of exemption comes from
the market participant and not the foreign board of trade, the existence of a Memorandum
of Understanding between the regulators will ensure that if it becomes necessary for the
Commission to obtain information with respect to trading in the foreign index, there is a
path for such information to be provided.
These conditions are appropriate in light of the fact that the regulatory interest of
the Commission in regulating the conduct of U.S. persons that trade on foreign boards of
trade is limited. In this regard, the Futures Trading Act of 1982 clarified the Act’s
applicability with respect to foreign boards of trade in new Section 4(b).11 As the House
Committee on Agriculture explained, “Section 4(b) expressly empowers the Commission
to protect the interests of United States residents against fraudulent or other harmful
practices by a vendor of foreign futures who is located in the United States. . . .”12
We believe that the exemptive relief requested by Hard Eight’s Petition should be
understood in this context, especially in light of the fact that: 1) only sophisticated traders
would be eligible for the exemptive relief, and 2) the exemptive relief would not apply
where the foreign security index can be traded by directly accessing the foreign board of
trade from within the U.S.
Question 2
In granting no-action relief to a foreign board of trade seeking to offer and sell a
futures contract on a foreign security index to U.S. persons, Commission staff
generally rely on surveillance sharing agreements between the securities exchanges
on which the securities comprising the index are traded, and the foreign board of
trade. Also, before issuing such no-action relief, Commission staff often requests a
representation or commitment from the foreign board of trade of its willingness and
ability to share information with the Commission. . . . To ensure that there are
9 Section 1a(25) of the Act sets forth the definition of “narrow-based security index.” The numeric test of
the statute is given further meaning by Commission rules 41.11 through 41.15, 17 C.F.R. §§41.11-41.15,
which provide specific guidance on calculating whether an index is narrow-based and on changes in status
from one type of index to the other.
10 See 17 C.F.R. Part 30, Appendix D paragraph G(3).
11 Pub. Law 97-444, 96 Stat 2294.
12 H.R. Rep. No 97-565 at 85.David A. Stawick
July 8, 2010
Page 6
similar protections in place in the circumstances posed by HEF’s Petition, should an
order granting the request for relief require that the foreign board of trade that lists
the foreign security index futures contract to be traded by the ECP have: (i)
submitted a pending request for no-action relief with respect to that futures
contract; (ii) received a prior no action letter for another foreign security index
futures contract; and/or (iii) received a foreign direct access no action letter?
Hard Eight agrees that the ability and willingness of the foreign board of trade to
share information with the Commission, directly or indirectly, could be demonstrated by
the prior issuance by OGC of a security index no-action letter or by staff of the Division
of Market Oversight of a direct-access no-action letter.
However, Hard Eight believes that such a condition would be overly restrictive.
A foreign board of trade may not have previously requested an OGC or direct-access no-
action letter for a variety of reasons. For example, the foreign board of trade may believe
that there is not enough trading interest on the part of the general public in the U.S. to
merit the time, attention and cost necessary to prosecute such a request. However, it may
be precisely this type of market that is attractive to the sophisticated ECP trader. Indeed,
it is likely that as a market becomes more attractive to U.S. ECPs, its appeal may become
more generalized, at which point the foreign market would be more likely to commit the
substantial resources necessary to gaining an OGC or a direct-access no-action letter.
Moreover, limiting the granting of the requested relief to instances where the
foreign board of trade has a request for an OGC no-action letter pending would undercut
much of the potential value of the requested relief. Although enabling ECPs to trade
futures contracts on a foreign stock index during the sometime lengthy period that such
no-action requests may be under consideration by OGC would be in the public interest,
such a limitation would deny ECPs the more substantial benefit of trading such a contract
in instances where no request has yet been submitted by the foreign board of trade.
The suggestion posed by the Commission of precluding ECPs from requesting
relief unless the foreign board of trade has already been granted no-action relief or such a
request is pending would potentially have a far-reaching anti-competitive effect. As
noted above, a foreign board of trade may refrain from requesting no-action relief for a
variety of reasons. One possible reason might be that the foreign market, by virtue of an
outsourcing or other similar cooperation agreement, enters into a covenant that precludes
it from seeking such OGC or direct-access no-action relief. If that were the case, the
Commission’s tying the ECP’s ability to seek relief to the foreign board of trade’s
decision to first do so would reinforce and strengthen any such non-compete agreement
by the exchanges, reducing competition. Section 15(b) of the Act requires that the
Commission “endeavor to take the least anticompetitive means of achieving the
objectives of the Act . . . in issuing any order or adopting any Commission rule . . .David A. Stawick
July 8, 2010
Page 7
including any exemption under section 4(c).”13
Because there are other means of
achieving the regulatory goal of ensuring that information sharing between the foreign
board of trade and the Commission is possible, adopting such a limitation on the ECP’s
ability to request exemptive relief would be highly suspect under Section 15(b)
requirement of taking the least anticompetitive means of achieving the goals of the Act.
Question 3
The Commission is concerned that the condition for an MOU included in HEF’s
Petition may not be workable in practice, given the wide spectrum of information
sharing agreements to which the Commission is a party. . . . Should an order
granting the relief requested in HEF’s Petition be conditioned on the existence of an
MOU that is specifically tailored to obtain the information that the Commission
needs to assess the efficacy of the foreign board of trade and its regulator, and to
obtain surveillance information as it deems necessary? Should any such relief be
limited to foreign security index futures contracts listed in jurisdictions that are
signatories to the IOSCO Multilateral MOU?
The Commission in determining whether the MOU should be specifically tailored
to “assess the efficacy of the foreign board of trade and its regulator, and to obtain
surveillance information as it deems necessary” should bear in mind that the exemption
for ECPs should not be subject to the same requirements and in the same degree that
would apply to an OGC no-action letter, which permits any person, including retail
persons, to trade a futures contract on the index. Nor should it impose the same
requirements as a direct access no-action letter, which permits more ready access to the
foreign board of trade than that which would be permitted under the ECP exemption
request.
The Commission should also bear in mind that no prior qualifying action by the
Commission or its staff is required in order for U.S. persons to enter into futures contracts
traded on a foreign board of trade in every commodity other than a non-narrow security
index. In this regard, the SEC has not imposed any information sharing requirement as a
condition for sophisticated U.S. persons to enter into or sell foreign narrow-based
security index products.14
13 In this regard, although Appendix D to Part 30 assumes that the foreign board of trade is the entity that
requests an OGC no-action letter. However, because any U.S. person is prohibited from trading a foreign
non-narrow security index unless OGC issues a no-action letter, any U.S. person should be free to request
an OGC no-action letter. For example, it would be perfectly appropriate and in the public interest for OGC
to consider a no-action request from an association of FCMs or Part 30 firms that would be the
intermediaries handling customer orders from U.S. persons. Hard Eight’s Petition can be seen as providing
a substitute, streamlined process for an ECP, who is directly affected by the prohibition, of seeking
permission to trade a specific futures contract on a foreign non-narrow security index.
14 See “Order Under Section 36 of the Securities Exchange Act of 1934 Granting an Exemption form
Exchange Act Section 6(h)(1) for Certain Persons Effecting Transactions in Foreign Security Futures andDavid A. Stawick
July 8, 2010
Page 8
Hard Eight believes that the primary regulatory interest of the Commission in
connection with the execution by U.S. persons of off-shore transactions is customer
protection. This is reflected in Section 4(b) of the Act empowering the Commission to
protect the interests of United States residents against fraudulent or other harmful
practices by a vendor of foreign futures who is located in the United States. . . .”15
Accordingly, the Commission should accept any information sharing arrangement which
would be necessary to address any abuse of the relationship of the U.S. customer by his
intermediary in the purchase or sale of such contracts.
Question 4
As discussed above, a futures contract on a security index that moves from broad to
narrow-based thereby becomes a security future that may no longer be traded by
U.S. persons subject to the exclusive jurisdiction of the CFTC. To ensure full
compliance with the requirements of the CEA and the federal securities laws, should
an order granting the relief requested in HEF’s Petition require an undertaking by
the ECP to: (i) Continually monitor the underlying index to ensure that it remains
broad-based; (ii) notify the Commission if the index becomes a narrow-based
security index; and (iii) if the index continues to be narrow-based for more than 45
business days during 3 consecutive calendar months, to cease trading the futures
contract and liquidate existing positions in an orderly manner over the next 3
calendar months (provided, however, that if the ECP and the futures contract are
eligible for the exemptive relief granted by the SEC Order, the ECP may continue to
trade that contract as a foreign security future)?
It is possible that a foreign security index may move from broad to narrow-based.
It is reasonable for the conditions of the exemption to require that those entities receiving
the exemption monitor the foreign stock index and to notify the Commission of a change
in the index’s status from broad to narrow-based. Such monitoring of an index can be
readily accomplished by sophisticated traders who would be eligible for the exemption.
As the Commission rightly points out, the trader might be able to continue trading the
contract as a security futures product consistent with the terms of the SEC Order.
Otherwise, the trader would be required to phase out its positions as provided in
Commission rules.
Under Exchange Act Section 15(a)(2) and Section 36 Granting Exemptions From Exchange Act Section
15(a)(1) and Certain Other Requirements,” 74 Fed. Reg. 32200(July 7, 20009).
15 Id. at 85.David A. Stawick
July 8, 2010
Page 9
Question 5
Should an order granting the relief requested in HEF’s Petition require that there
be no solicitation of ECP orders, and/or that ECPs be required to trade only for
their own account?
We believe that requiring that there be no solicitation of ECP orders is
unnecessarily restrictive. As noted in the Petition, futures contracts on a non-narrow
security index should be treated no differently than trading on a foreign board of trade on
any futures contract. The Commission in connection with its orders granting futures
firms relief from registration as FCMs under Commission Rule 30.10 has granted
Limited Marketing Conduct relief. The Commission has reasoned that certain contacts
between a 30.10 firm and customers located in the U.S. who have a high degree of
sophistication and financial resources would not be contrary to the public interest.16
These Orders provide that a firm that has been granted Commission Rule 30.10 relief
may engage in limited marketing to sophisticated U.S. persons as long as the firm does
not establish a fixed location in the U.S. Hard Eight believes that, because the exemptive
relief would only apply to sophisticated traders, this limited marketing approach should
also be applied in the context of the Petition. In this regard, including non-narrow
security indexes within a limited marketing approach is consistent in broad approach with
the SEC’s Order, which provides a conditional exemption from broker-dealer registration
for a foreign broker engaged in limited contacts with eligible traders.17
Limiting trading under the exemptive order to an ECP trading for its own account
also would be unduly restrictive. It should be noted that many ECPs that may wish to
avail themselves of the exemption are not necessarily members of every foreign board of
trade on which a qualifying index may trade. In such a case, the ECP trader would by
necessity be required to trade as a customer through an intermediary. Thus, for example,
Hard Eight, the Petitioner, may very well seek to trade a futures contract on a non-narrow
security index through an FCM. It is in the public interest that U.S. registered FCMs be
permitted to intermediate such transactions.
Moreover, a registered commodity pool
operator or commodity trading advisor should be able to trade such contracts on behalf of
a commodity pool. Investors in commodity pools rely upon the professional expertise of
those who manage such commodity pools and such entities should be able to trade under
the requested exemption.
16 See e.g. “Limited Marketing Activities From a United States Location by Certain Firms and Their
Employees or Other Representatives Exempted Under Commodity Futures Trading Commission
Regulation 30.10,” at: http://www.cftc.gov/LawRegulation/FederalRegister/FinalRules/e8-15606.html.
17 See SEC Order at 32205 permitting associated persons of foreign brokers to engage in unchaperoned
contacts with QIBS during visits to the United States for no more than 30 days in a year.David A. Stawick
July 8, 2010
Page 10
Question 6
As discussed above, HEF’s Petition justifies its request for relief, in part, on the
proposition that: (i) U.S. ECPs currently are able to trade contracts that replicate
futures on foreign security indexes in the unregulated OTC markets; and (ii) it is in
the public interest to enable them to do so in a more regulated and transparent
exchange environment on a foreign board of trade. Yet, legislation currently
pending before the Congress, if eventually enacted, could change this premise to
some degree, as it would significantly enhance the transparency of OTC derivatives
and require that certain swaps (subject to an ‘‘end-user exception’’) be traded on a
contract market or a ‘‘swap execution facility’’ as provided for in that legislation.
What are the implications of the OTC derivatives reform legislation pending in
Congress, if any, on HEF’s Petition?
It is not clear that the OTC derivatives reform legislation may have any effect on
Hard Eight’s Petition. First, it is important to note that the Petition relates only to futures
contracts on foreign security indexes. In this regard, such contracts may be traded
primarily in the OTC market outside of the U.S. The OTC derivatives reform legislation,
in broad brush, requires that OTC transactions that are accepted for clearing by a
Derivatives Clearing Organization (“DCO”) be submitted for clearing, absent an
exemption, and transacted on a contract market or a swaps execution facility. If a DCO
does not offer to accept a particular type of swap for clearing, those provisions do not
apply.
Because these are foreign security indexes, it is not clear that a DCO would offer
to accept such contracts for clearing, or even be expected to offer to accept such OTC
contracts for clearing. This is true particularly if the primary locus of the market is
outside of the U.S. Accordingly, depending upon the regulatory framework adopted
abroad, it may be that the current anomaly continues, that sophisticated traders may be
able to transact in the less regulated OTC environment but are precluded from trading the
same contract on a foreign board of trade in the more protected exchange environment.
However, even if all of the requirements of the OTC derivatives reform
legislation were to apply to these transactions, certain differences will remain between
the exchange-traded and OTC trading environments. For example, the operation of a
swaps execution facility is likely to be subject to fewer core principles than an exchange.
As long as there is any difference in protections offered between the OTC trading
environment and an exchange environment, it is in the public interest to remove
unnecessary obstacles to trading in the more protected and regulated exchange
environment.David A. Stawick
July 8, 2010
Page 11
Question 7
As discussed above, HEF’s Petition proposes that an order granting its request for
relief be conditioned upon all the securities in the index underlying the foreign
futures contract being principally traded on, by, or through an exchange or market
located outside the U.S. . . . What are the implications, if any, of the use of this
standard in an order granting the relief requested in HEF’s Petition in comparison
to the ‘‘primary trading market’’ test that the SEC created for securities of foreign
private issuers in a narrow-based security index as set forth in paragraph (1)(a)(ii)
of the SEC Order? Should an order granting the relief requested in HEF’s Petition
treat securities in an index as being principally traded on, by, or through an
exchange outside the United States if they meet the criteria for securities in a
narrow-based security index contained in paragraph (1)(a)(ii) of the SEC
Order?
It is reasonable that the condition that the securities in the non-narrow index be
traded principally outside of the U.S. be interpreted in harmony with the standard set
forth by the SEC in its Order that the underlying securities be traded on a primary trading
market that is not the U.S. This could be achieved either through interpretation or by the
Commission adopting the language in the SEC Order.
Question 8
As discussed above, the SEC Order generally limits the category of U.S. persons that
may trade foreign security futures to QIBs (who own and invest $100 million or
more). This is a narrower class of investors than ECPs. The group of persons that
satisfy the ECP definition but may not be QIBs includes registered investment
companies, commodity pools, pension plans, corporations and high net worth
individuals. . . . . If the relief requested in HEF’s Petition is granted, an ECP that is
a QIB and trades a foreign futures contract on a foreign security index that moves
from broad to narrow-based can continue to trade that contract as a foreign
security future, provided the contract otherwise meets the requirements of the SEC
Order. An ECP that is not a QIB, however, would have to exit its position in the
foreign futures contract within the applicable grace period or be in violation of the
Exchange Act. Given this difference in legal status, should an order issued by the
Commission granting the relief requested in HEF’s Petition be limited to QIBs?
Hard Eight believes that limiting the requested relief to QIBs would be contrary to
the public interest for a number of reasons. First, futures on non-narrow security indexes
merit consideration on their own terms. In this regard, futures on non-narrow security
indexes do not raise the same regulatory issues raised by futures contracts on narrow
based or single security futures products. Narrow-based indexes might act as a proxy for
a contract on a single security and may therefore raise issues of trading on material non-
public information relating to the underlying. Non-narrow indexes do not raise that issueDavid A. Stawick
July 8, 2010
Page 12
and are also less likely to raise issues of market manipulation. It is therefore unnecessary
to apply the more restrictive eligibility standard of the SEC’s Order to the Petitioned-for
exemption.
Secondly, the ECP definition of section 1a(12) of the Commodity Exchange Act
is well understood in the context of futures regulation.
It would create regulatory
confusion to incorporate into the exemption an eligibility standard—QIB—that is not
found any where else in the futures regulatory framework.
Thirdly, the issue of the transition of a futures contract on a non-narrow security
index to a narrow-based security index is well established in Commission rules.
Commission Rule 41.14, 17 C.F.R. §41.14, has been in effect for almost ten years. This
transition rule appears to have caused little in the way of market disruption. Because the
public is familiar with the application of the transition rules with respect to domestic U.S.
narrow based and non-narrow security indexes, there should be little or no confusion in
extending the concept to foreign security indexes.
Finally, even if the Commission were to adopt the QIB eligibility standard, it
would not necessarily lead to a seamless transition from a broad-based to narrow-based
security index.
Where an index transitions from non-narrow to narrow-based, a QIB,
although eligible to continue trading the futures contract on what is now a narrow-based
security index, might nevertheless have to adjust his or her brokerage arrangements to
comply with the SEC’s Order. Accordingly, the Commission should not adopt the QIB
eligibility standard. Rather it should retain the eligibility category of ECP, a category
which is well-grounded in the Commodity Exchange Act. ECPs are sophisticated traders
and will be able to understand that they may qualify to trade futures contracts on non-
narrow indexes but not on narrow-based indexes.
With respect to access to foreign security futures by U.S. persons, are the conditions
contained in the SEC Order consistent with Section 2(a)(1)(F)(ii) of the CEA?
Should ECPs that are not QIBs be permitted to trade foreign security futures?
What conditions, if any, should be imposed on such trading by ECPs that are QIBs,
and ECPs that are not QIBs? How should an order permitting ECPs to trade
foreign security futures take into account, as mandated by Section 2(a)(1)(E) of the
CEA, ‘‘the nature and size of the markets that the securities underlying the security
futures product reflects?’’
Hard Eight appreciates that the Commission has raised these issues. Hard Eight
believes that after the Commission adopts the requested exemption, further
harmonization between the requirements of the two Commissions would benefit traders
and be in the public interest. However, a first step is for the Commission to grant the
Petition and to proceed with an exemption for non-narrow contracts.David A. Stawick
July 8, 2010
Page 13
Question 9
Lying at the core of the complex interplay between HEF’s Petition on the one hand,
and the CEA and the federal securities laws on the other hand, is the application of
the statutory definition of a ‘‘narrow-based security index’’ to foreign security
indexes. To the extent that a foreign security index falls squarely on the broad-based
side of the line, distinctions between ECPs that are QIBs and those that are not, and
the prospect of an ECP that is relying on the relief requested by HEF violating the
securities laws, may be of less concern. Congress has recognized that ‘‘[t]he detailed
statutory test of a narrow-based security index was tailored to fit the U.S. equity
markets, which are by far the largest, deepest and most liquid securities markets in
the world.’’ In the CFMA in 2000, Congress directed that the CFTC and the SEC,
within one year, jointly adopt rules or regulations that set forth requirements for
broad based foreign security indexes traded on a foreign board of trade. And
shortly thereafter, the CFTC and SEC promised to consider amending the rules
regarding security index futures trading on or subject to the rules of a foreign board
of trade. Should the CFTC and the SEC establish criteria to exclude appropriate
foreign security indexes from the definition of a ‘‘narrow-based security index?’’ If
so, on what basis? How should it be determined whether a foreign security index is
appropriately treated as a broad-based security index so that foreign futures on
such an index would trade subject to the exclusive jurisdiction of the CFTC, or as a
narrow based security index so that foreign futures on such an index would trade as
foreign security futures? The Commission encourages commenters to submit any
quantitative data and analysis to support any proposed distinctions between broad
and narrow based foreign security indexes.
Hard Eight urges the Commission as a first step to act on its Petition using the
statutory test differentiating narrow and non-narrow indexes.
Although Congress
recognized that a more nuanced test might be appropriate in the context of non-U.S.
markets, Hard Eight does not believe that the Commission should delay acting on its
Petition while the Commissions consider jointly amending their rules on this issue.
Question 10
Is the exemption requested in HEF’s Petition consistent with the requirements for
relief set forth in Section 4(c) of the CEA?
• Would granting the exemption requested in HEF’s Petition be consistent with the
public interest and purposes of the CEA?
As explained in Hard Eight’s Petition, the requested relief would remove barriers
to ECPs entering into futures contracts on non-narrow security index futures on foreign
boards of trade. As explained in the Petition, this will provide ECPs with the choice to be
able to carry out such transactions in a more, rather than less, regulated environment.
Under the relief, ECPs would be able to access non-narrow security futures productsDavid A. Stawick
July 8, 2010
Page 14
under the conditions which apply to all other commodities under the Act. Thus, the relief
sought is clearly in the public interest.
Moreover, the relief sought would not have a material adverse effect on the
Commission or any contract market in carrying out its regulatory or self-regulatory
duties. The main effect would be to permit trading of futures on foreign non-narrow
security indexes on par with all other commodities traded on a foreign board of trade.
Thus, there is no adverse effect from the requested relief. If anything, the requested relief
will place more transactions within an exchange-traded framework, one of the
fundamental goals and objectives of the Act.
• Would granting the relief requested in HEF’s Petition have any material adverse
effects upon derivatives clearing organizations, exchanges, or other Commission
registrants from a competitive or other perspective?
Granting Hard Eight’s Petition would not have a material adverse effect on any
DCO, contract market or other Commission registrant. The security indexes in question
are composed of indexes that are traded on foreign boards of trade and granting the
requested relief would not hamper a U.S. market from seeking to list a similar contract if
it so chose. Accordingly, there is no adverse competitive or self-regulatory effect upon
U.S. futures exchanges or derivatives clearing organizations arising from the requested
relief.
However, it is clear that a significant competitive disadvantage to U.S. trading
firms currently exists and will persist until Hard Eight’s Petition is granted. Trading
firms operate in a global environment. Commission policies that limit access by U.S.
trading firms to futures contracts on non-narrow foreign security indexes disadvantages
them in their competition with international trading firms which face no similar
restrictions. This impediment to U.S. firms’ competitiveness acts as an incentive to move
operations outside of the U.S. In light of the fact that these firms are among the most
sophisticated and innovative traders in the world, this is clearly contrary to the public
intererst. Until Hard Eight’s Petition is granted, U.S. trading firms will continue to
operate under a significant competitive disadvantage.
* * * * *
Hard Eight appreciates the Commission publishing for public comment its
Petition for Rulemaking. Hard Eight believes that its Petition addresses a significant
competitive disadvantage faced by U.S. ECPs without compromising the regulatoryDavid A. Stawick
July 8, 2010
Page 15
protections that benefit participants on regulated futures markets. Hard Eight believes
that the exemption in its Petition, by making it possible for ECPs to execute futures
contracts on non-narrow foreign security indexes in a cleared, exchange environment,
will promote market integrity, enhance transparency, reduce possible systemic risk and
encourage competition.
Respectfully submitted,
Paul M. Architzel
cc:
Francis Wisniewski
Chairman Gensler
Commissioner Dunn
Commissioner Chilton
Commissioner Sommers
Commissioner O'Malia
Daniel Berkovitz, General Counsel
Julian Hammar, OGC
Edwin Yoshimura, OGC
Richard Shilts, Director DMO
Thomas Leahy, DMO
LEGAL02/31997703v1
