| Rel. No. 34-24209 March 12, 1987
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 Table of Contents
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I. Introduction
Under the Commodity Exchange Act ("CEA"), futures trading on individual securities is prohibited unless the underlying security is an exempted security under the Securities Act of 1933 ("Securities Act") or the Securities Exchange Act of 1934 ("Exchange Act"). The Securities and Exchange Commission ("SEC"), however, adopted Rule 3a12-8 ("Rule") to designate British, Canadian and Japanese government debt obligations ("designated foreign government securities") that meet certain conditions as exempted securities under the Exchange Act only for purposes of marketing futures on those securities in the United States. In effect, the designation of these securities as "exempted securities" removes the CEAs prohibition against marketing futures on the securities in the United States, so long as the terms of the Rule are satisfied. The SEC is today adopting an amendment to the Rule.
The amendment retains the current list of designated foreign government securities, but removes one of the conditions of the exemption, i.e., the requirement that the futures be traded on or through a board of trade located in the country that issued the designated foreign government security ("the location restriction"). The amendment effectively removes the CEAs prohibition against trading futures on designated securities on U.S. contract markets or marketing in the United States foreign futures traded on contract markets other than those located in the issuing country. To qualify for the exemption, futures contracts on the enumerated securities must comply with all other existing requirements of the Rule.
II. Background
The CEA, as amended by the Futures Trading Act of 1982, 1 prohibits the trading of futures contracts on individual securities unless such securities qualify as exempted securities under Section 3 of the Securities Act or Section 3(a)(12) of the Exchange Act. 2 Foreign government securities are not exempted under either of these sections. Section 3(a)(12) of the Exchange Act, however, provides that the term "exempted securities" includes
such other securities... as the Commission may, by such rules and regulations as it deems consistent with the public interest and the protection of investors, either unconditionally or upon specified terms and conditions or for stated periods, exempt from the operation of any one or more provisions of this title which by their terms do not apply to an "exempted security" or to "exempted securities."
In March 1984, pursuant to this authority, the Commission promulgated Rule 3a12-8. 3 The Rule, as amended, 4 designates British, Canadian and Japanese government securities that meet certain conditions as "exempted securities" under the Exchange Act. The primary purpose of the Rule is to permit certain foreign, exchange-traded futures contracts on the designated securities to be marketed in the United States. Under the Rule, designated foreign government securities are considered exempted securities under the Exchange Act only with respect to futures trading on those securities and provided that: (1) the securities are not registered in the United States; (2) the futures transactions involve contracts that require delivery outside the United States; and (3) the futures contracts are traded on a market located in the country that issued those securities.
At the time the Commission first proposed Rule 3a12-8, several commentators objected to the location restriction, among other matters. 5 For example, the Chicago Board of Trade ("CBT") and the Chicago Mercantile Exchange ("CME") argued that the proposed exemption should allow the Commodity Futures Trading Commission ("CFTC") to designate United States boards of trade as contract markets for futures on the exempted British and Canadian securities. 6 The CBT and CME also contended that to do otherwise would confine futures trading to precisely those markets over which United States government agencies have the least regulatory oversight.
The Commission, nevertheless, adopted the location restriction for several reasons. First, the Commission noted that, if the futures were traded only in the country that issued the underlying security, that country "would have a strong interest in ensuring the integrity of the futures market." 7 Second, the Commission noted that a collateral benefit of the restriction was to "reduce the likelihood that some off-shore futures market might be established or utilized for the purpose of disguised marketing of the underlying securities." 8 Finally, the Commission concluded that because "the prospective exempted securities are, in fact, located within the territories of the issuer-government... a cautious approach is furthered by limiting the Rule to markets and locations presently known." 9 The Commission stated, however, that it might revisit this issue if proposals by U.S. boards of trade to trade futures contracts on foreign government securities were developed.
On February 13, 1986, the CBT submitted to the Commission a letter in which the CBT stated that it would soon apply to the CFTC for designation as a contract market for trading in futures contracts on yen-denominated Japanese government bonds, pound-denominated British gilt bonds and Canadian dollar-denominated Canadian government bonds. 10 The CBT and Futures Industry Association ("FIA") requested that the Commission amend Rule 3a12-8 to provide that futures contracts on specified foreign government securities may be traded on CFTC-designated markets. 11 In addition, the London International Financial Futures Exchange ("LIFFE") requested that the rule be expanded to permit the marketing to U.S. investors of futures on foreign government debt traded on designated foreign boards of trade outside the country of issuance of the underlying debt. 12 As a result, on July 11, 1986, the Commission issued a release proposing for comment an amendment to Rule 3a12-8 that would remove the condition that the futures be traded on a board of trade located in the country that issued the underlying security ("1986 Proposal Release"). 13
III. Discussion
In response to the 1986 Proposal Release the Commission received one comment letter. In its comment letter, the CFTC endorsed amending the Rule to eliminate the location restriction and addressed three specific issues raised in the 1986 Proposal Release. 14
First, the Commission had requested comment on whether the Rule would be used as a vehicle to distribute unregistered foreign government securities in the U.S. In its comment letter, the CFTC asserted its continuing belief that the requirement that delivery on the futures contracts on foreign government debt occur outside the United States would help to ensure that sales of the futures contracts will not be used as a way to sell in the U.S. the underlying, unregistered debt instruments.
Second, the CFTC stated that it would consider whether trading futures on the designated securities on domestic boards of trade might require a greater level of disclosure about the underlying securities than simply marketing such foreign futures in the U.S.
Finally, the Commission had solicited comment on whether there are any other legal or policy factors relevant to determining whether the domestic trading of futures on specified unregistered securities or the marketing to U.S. investors of foreign futures on such securities traded on boards of trade outside the country of issuance, for delivery outside the U.S., is appropriate and consistent with the purposes of the federal securities laws, the CEA, and the protection of U.S. securities investors and markets. In response, the CFTC maintained that elimination of the location restriction is consistent with both the federal securities laws and the CEA. According to the CFTC, the Rule, as amended, will continue to provide adequate protection to both U.S. securities investors and the securities markets and U.S. futures traders and the futures markets. The CFTC emphasized that its oversight of domestic boards of trade would provide adequate safeguards to U.S. investors, and that CFTC regulations may in fact provide greater protection to U.S. customers trading through domestic boards of trade than to those trading through foreign boards of trade.
After careful consideration, the Commission has concluded that elimination of the location restriction is consistent with the protection of U.S. investors. With the increasing internationalization of the securities markets, more U.S. investors maintain investment positions denominated in foreign currencies, including debt securities of foreign public and private issuers. 15 The increased availability of foreign government futures could serve valuable hedging and other risk-shifting uses for such investors. In this regard, the Commission also believes the amendment will promote competition among boards of trade listing the same or different futures on foreign government debt.
The Commission does not believe that there is a serious risk that foreign government futures will be used to distribute unregistered foreign government securities in the U.S. In this regard, we note that most trading of futures in this country does not result in actual delivery of the underlying commodity through the mechanism of the futures contract. Usually only 2% to 10% of futures positions are held for delivery. 16 As a consequence, the Commission does not expect that significant numbers of foreign government futures investors will hold their positions for delivery. Further, the availability of a U.S. futures market for foreign bonds would not appear to offer a foreign government a realistic means of efficiently raising capital in the U.S.; if purchase and delivery of the underlying securities is necessary, it most likely would occur in the foreign countrys secondary market, not from primary offerings of the government. The Commission thus believes that the other two requirements of the current Rule (i.e., that the underlying securities not be registered in the U.S. and that delivery on the futures contracts occur outside the U.S.) will adequately ensure that futures trading, even domestically, does not disrupt or dilute the registration, disclosure and other requirements of the federal securities laws.
The Commission does not believe it is appropriate to limit an amendment to delete the location restriction to trading on domestic boards of trade regulated by the CFTC. If, as has been indicated, the LIFFE seeks to trade a future on Japanese yen bonds, the Commission does not believe that such trading would be any more likely to contribute to the development of an unregistered securities market in the underlying debt securities in this country than trading such futures on, for example, the CBT. Indeed, it could be argued that futures trading on a domestic board of trade is, in fact, more likely to induce U.S. investors to trade the underlying debt securities. Moreover, the marketing of such LIFFE futures in the United States would be subject to the CFTCs antifraud rules. 17
Finally, the Commission agrees with the CFTC that the CFTCs oversight of domestic boards of trade will provide effective safeguards against abuse. With respect to non-U.S., non-issuance countries marketing foreign futures in the U.S. (e.g., LIFFE trading futures on Japanese yen bonds), the Commission also believes that the CFTCs antifraud authority regarding such futures trading will permit the CFTC to address abuses in the futures market itself.
For the above-mentioned reasons, the Commission believes the amendment to the Rule to accommodate the trading on domestic as well as foreign boards of trade of futures on designated foreign government securities is consistent with the purposes of the federal securities laws and Section 2(a)(1)(B)(v) of the CEA. 18
IV. Regulatory Flexibility Act Certification
The Chairman of the Commission certified in connection with the 1986 Proposal Release that the amendment to Rule 3a12-8, if adopted, would not have a significant economic impact on a substantial number of small entities. The Commission received no comments on this certification.
V. Effects on Competition
Section 23(a)(2) of the Act 19 requires the Commission, in amending rules, to consider their potential impact on competition. The Commission believes that elimination of the location restriction will enhance competition by allowing additional markets to offer competing products.
The Commission has determined to make the foregoing action effective 30 days after publication in the Federal Register.
VI. Statutory Basis
The amendment to Rule 3a12-8 is being adopted pursuant to 15 U.S.C. §§ 78a et seq., particularly Sections 3(a)(12), 15 U.S.C. §78c(a)(12) and §23(a), 15 U.S.C. §78w(a).
List of Subjects in 17 CFR Part 240
Reporting and recordkeeping requirements, Securities.
VII. Text of the Adopted Amendment
The Commission is amending Part 240 of Title 17, Chapter II of the Code of Federal Regulations as follows:
Part 240--GENERAL RULES AND REGULATIONS, SECURITIES EXCHANGE ACT OF 1934
1. The authority citation for Part 240 is amended by adding the following citation:
Authority: Sec. 23, 48 Stat. 901, as amended; 15 U.S.C. §78w. * * * §240.3a12-8 also is issued under 15 U.S.C. §78a et seq., particularly secs. 3(a)(12), 15 U.S.C. §78c(a)(12) and 23(a), 15 U.S.C. §78w(a). * * *
2. Section 240.3a12-8 is amended by revising paragraph (a)(2) as follows:
§240.3a12-8 Exemption for designated foreign government securities for purposes of futures trading.
(a) * * *
(2) The term "qualifying foreign futures contracts" shall mean any contracts for the purchase or sale of a designated foreign government security for future delivery, as "future delivery" is defined in 7 U.S.C. 2, provided such contracts require delivery outside the United States, any of its possession or territories, and are traded on or through a board of trade, as defined at 7 U.S.C. 2.
* * * * *
By the Commission.
1 Pub. L. No. 97-444, 96 Stat. 2294, 7 U.S.C. §1 et seq. (1984).
2 Section 2(a)(1)(B)(v) of the CEA, 7 U.S.C. §2a(v), provides that "no person shall offer to enter into, enter into or confirm the execution of any contract of sale (or option on such contract) for future delivery of any security, or interest therein or based on the value thereof, except an exempted security under Section 3 of the Securities Act... or Section (3)(a)(12) of the... Exchange Act...."
3 See Securities Exchange Act Release Nos. 20708 ("1984 Adoption Release"), March 2, 1984, 49 FR 8595, and 19811 ("1983 Proposal Release"), May 25, 1983, 48 Fr 24725.
4 The Rule recently was amended to include Japanese government securities. See Securities Exchange Act Release No. 23423, July 11, 1986, 51 FR 25996. As originally adopted, the Rule applied only to British and Canadian government securities. See 1984 Adoption Release, note 3, supra. In addition, the Commission has received petitions to add the securities of Australia, France and New Zealand to the list of designated government securities. See letters from Philip McBride Johnson, Skadden, Arps, Slate, Meagher & Flom, to Richard Ketchum, Director, Division of Market Regulation, SEC, dated August 20, 1986 (Australia) and October 1, 1986 (New Zealand); letter from Eugene W. Boehringer, Managing Director, First Boston Corporation, to Richard G. Ketchum, Director, Division of Market Regulation, SEC, dated October 1, 1986 (France). The Commission anticipates publishing for comment appropriate proposed rule amendments regarding these requests in the near future.
5 See letter from Thomas R. Donovan, President, Chicago Board of Trade, to George A. Fitzsimmons, Secretary, SEC, dated July 5, 1983, and letter from Thomas Eric Kilcollin, Vice President of Research and Chief Economist, Chicago Mercantile Exchange, to George A. Fitzsimmons, Secretary, SEC, dated July 26, 1983, located in File No. S7-975.
6 Id.
7 1983 Proposal Release, note 3, supra, 48 FR at 24727. The CFTC noted, however, that presumably "any country would have a strong interest in assuring the integrity of its futures markets, even if that country does not produce the commodity or issue the debt obligation." Letter from Kenneth M. Raisler, General Counsel, CFTC, to Richard G. Ketchum, Associate Director, Division of Market Regulation, SEC, at 4, dated August 1, 1983.
8 1984 Adoption Release, note 3, supra, 49 FR at 8597 n.15. Similarly, the Commission noted that with respect to domestic boards of trade trading futures on foreign government debt securities, such trading would raise "discrete concerns regarding the expansion of cash trading that might develop if there were present here substantial markets in the overlying futures."
9 Id., 49 FR at 8597 (footnote omitted).
10 See No-action Request for Domestic Trading of Futures on Japanese Government Bonds, British Gilt Bonds, or Canadian Government Bonds, or Petition to Amend Rule 3a12-8, dated February 3, 1986 ("Petition"). Available in File No. S7-4-86.
11 See Petition, note 10, supra, and letter from John M. Damgard, President, FIA, to John Wheeler, Secretary, SEC, dated February 26, 1986.
12 See letter from Brooksley Born, Arnold & Porter, counsel for LIFFE, to Brandon Becker, Assistant Director, Division of Market Regulation, SEC, dated June 20, 1986. LIFFE also indicated that it is actively considering developing a future contract on the Japanese yen bond.
13 See Securities Exchange Act Release No. 23422 (July 11, 1986), 51 FR 26018. Under the proposal, subsection (a)(2) of Rule 3a12-8 would be amended to remove the location restriction. The Rule would retain the current list of designated foreign government securities, as well as the requirements that the underlying securities be unregistered and that the delivery on the futures contracts occur outside the United States.
14 Letter from Kenneth M. Raisler, General Counsel, CFTC, to Richard G. Ketchum, Director, Division of Market Regulation, SEC, dated September 8, 1986 ("CFTC Comment Letter").
15 See Securities Exchange Act Release No. 21958, April 18, 1985, 50 FR 16302. As evidence of this growing internationalization, futures on U.S. Treasury bonds are now being traded on the Sydney Futures Exchange and LIFFE.
16 The figure for debt futures is at or below 2%. See CBT, Statistical Futures Yearbook (1985); CME, International Monetary Market Yearbook (1985).
17 CFTC Comment Letter, note 14, supra, at 4. The CFTC cited Section 4(b) of the CEA, which authorizes the CFTC to regulate the offer and sale of foreign futures contracts to U.S. residents. Rule 30.02, 17 CFR 30.02, promulgated under Section 2(a)(1)(A) of the CEA, is intended to prohibit fraud in connection with the offer and sale of futures contracts executed on a foreign exchange. In addition, the CFTC recently proposed a series of regulations governing the domestic offer and sale of futures and options contracts traded on foreign boards of trade. The proposed rules, if adopted, would, among other things, require that the domestic offer and sale of foreign futures be effected through CFTC registrants, or comparably regulated entities, under a regulatory framework similar to that governing domestic futures contracts. See 51 FR 12104 (April 8, 1986).
18 As noted above, the CEA prohibits the sale of futures on individual securities, other than exempted securities.
19 15 U.S.C. §78w(a)(2) (1984).
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