| Release No. 34-25072 October 29, 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" or "Commission") adopted and later amended Rule 3a12-8 ("Rule") under the Exchange Act to designate British, Canadian and Japanese government debt obligations ("designated foreign government securities") as "exempted securities" under the Exchange Act solely for purposes of marketing and trading futures on those securities in the United States. In effect, the designation of those securities as exempted securities removes the CEAs prohibition against marketing and trading futures on those securities in the United States, so long as the other terms of the Rule are satisfied. The Commission today adopts an amendment to the Rule. The amendment adds the debt securities of Australia, France and New Zealand to the list of designated foreign government securities exempted by the Rule. To qualify for the exemption, futures contracts on securities issued by Australia, France and New Zealand will have to meet all the 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 those securities qualify as exempted securities under Section 3 of the Securities Act or Section 3(a)(12) of the Exchange Act. 2 Because foreign government securities are not exempted securities under either of these sections, the CEA prohibition against trading futures on individual securities prevents the marketing and trading of futures on such foreign government securities in this country. Section 3(a)(12) of the Exchange Act, however, provides that the term "exempted security" 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 Section 3(a)(12) under the Exchange Act, 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 purpose of the Rule is to permit certain foreign, exchange-traded futures contracts on the designated foreign government securities to be marketed and traded in the United States. 5 Under the Rule, British, Canadian and Japanese government debt 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 contracts require delivery outside the United States; and (3) the futures contracts are traded on a board of trade. 6
Rule 3a12-8 was promulgated in response to Congress understanding, in approving the 1982 amendments to the CEA, that neither the SEC nor the Commodity Futures Trading Commission ("CFTC") had intended to bar British government bond futures 7 and that administrative action would be taken to allow the sale of these futures contracts in this country. 8 In promulgating the Rule, the Commission implemented Congress intent without abandoning its longstanding policy of subjecting foreign government securities, for most purposes, to the requirements of the federal securities laws. Accordingly, the conditions set forth in the Rule are designed to ensure that a domestic market in unregistered foreign government securities does not develop and that futures markets in these instruments are not used to avoid the registration and other provisions of the federal securities laws.
At the time the Commission originally proposed Rule 3a12-8, it recognized that, should the securities of additional governments become subject to futures trading, it could become necessary to amend the Rule to include those securities. 9 Subsequently, the Commission amended the Rule to include Japanese government debt. Currently, the Sydney Futures Exchange ("SFE") is trading futures on Australian government bonds, the Marche a Terme dInstruments Financiers ("MATIF") 10 is trading futures on French government bonds and bills and New Zealand government bond futures as being traded on the New Zealand Futures Exchange ("NZFE"). The Commission staff has been informed that United States citizens are interested in trading these new products and has received requests that Rule 3a12-8 be amended to allow such trading. 11 As a result, on May 5, 1987, the Commission issued a release ("1987 Proposal Release") proposing two alternative amendments to the Rule. 12 One amendment would add debt securities issued by Australia, France and New Zealand to the Rules list of designated foreign government securities. The other amendment would add to the Rules list of designated foreign government securities the unregistered debt obligations of any government with long-term, external sovereign debt outstanding which is rated in one of the two highest rating categories of at least two nationally recognized statistical rating organizations.
III. Discussion
Based on the comment letters received and for the additional reasons discussed below, the Commission has determined that Rule 3a12-8 should be amended to include the debt obligations of Australia, France and New Zealand. The Commission received nine comment letters in response to the 1987 Proposal Release. 13 Seven of the commentators responded to the Commissions request in the 1987 Proposal Release for comments on the desirability of adding debt securities issued by Australia, France and New Zealand to the Rules list of designated foreign government securities. Each of these seven letters endorsed amending the Rule to add, at a minimum, Australia, France or New Zealand to the list of countries covered by the Rule. 14 Six commentators responded to the Commissions request for comments on the feasibility of a rating standard. Reaction to the rating standard proposal was mixed. 15
The Commission also solicited comment in its 1987 Proposal Release on whether under either proposal the information available in English regarding newly-eligible futures contracts and underlying sovereign debt would be adequate to permit U.S. investors to make informed investment decisions. While this issue was not addressed specifically by any of the commentators, all of the petitioners that requested that Rule 3a12-8 be expanded to cover the debt securities of Australia, France and New Zealand noted in their petitions that United States investors should have sufficient access to information in English concerning the relevant futures markets and underlying debt instruments. 16
Finally, the Commission solicited comment on whether they are any legal or policy reasons for determining that debt securities issued by Australia, France and New Zealand or any other country that would qualify under the generic rating standard should not be accorded the same treatment for purposes of futures trading in the United States as are British, Canadian and Japanese debt securities. Each of the two commentators that addressed this issue stated that there did not appear to be any valid legal or policy reasons for denying United States investors the ability to trade futures on debt issued by Australia, France or New Zealand. 17 Indeed, three commentators noted that the expansion of Rule 3a12-8 would represent a positive step forward in the trend toward globalization of the worlds securities markets. 18
The Commission agrees that there are no valid legal or policy reasons for denying United States investors the ability to trade futures on debt securities issued by Australia, France and New Zealand and that the availability of these new hedging vehicles will allow investors to take advantage of the growing globalization of the securities markets. Due in large part to this trend toward internationalization, U.S. investors should have ready access to information in English concerning the markets and government securities of Australia, France and New Zealand. It also is important to note that the existing conditions set forth in the Rule (i.e., that the underlying securities not be registered in the U.S., that the futures contracts require delivery outside the U.S., 19 and that the contracts be traded on a board of trade) will apply to futures contracts on debt securities issued by Australia, France and New Zealand. This should ensure that the federal securities laws will not be subverted by the marketing and trading of futures on additional government securities in this country. 20
In light of the comments received and the fact that the Commission has received petitions on behalf of futures exchanges in Australia, France and New Zealand to add debt securities issued by those three countries to the Rules list of designated foreign government securities, the Commission has determined that the best course is to proceed without delay to amend the Rule to include debt securities issued by Australia, France and New Zealand. Due to the varied comment the Commission received with respect to a proposed amendment to the Rule that would incorporate a generic rating standard and thus expand the Rule to cover the debt securities of countries in addition to Australia, France and New Zealand, the Commission is not taking any action on that proposed amendment. The Commission will continue to assess the feasibility of such an amendment or other alternatives in light of the comments received.
IV. Cost/Benefit Analysis
In connection with the 1987 Proposal Release, the Commission noted that there do not appear to be any costs associated with the amendment adopted today. The amendment is designed to protect U.S. investors by preventing unregistered Australian, French and New Zealand government bonds from entering the country and by requiring that futures on those bonds be traded on boards of trade. In addition, the amendment imposes no recordkeeping or compliance burden in itself and merely provides an exemption under the federal securities laws. The principal benefit associated with the amendment is that it will allow U.S. boards of trade and investors to trade a greater range of futures contracts on foreign government debt. The Commission received no comments on the costs and benefits of the amendment to Rule 3a12-8.
V. Regulatory Flexibility Act Certification
The Chairman of the Commission certified in connection with the 1987 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.
VI. Effects on Competition and Other Findings
Section 23(a)(2) of the Exchange Act 21 requires the Commission, in adopting rules under the Exchange Act, to consider the competitive effects of such rules, if any, and to balance any impact against the regulatory benefits gained in terms of furthering the purposes of the Exchange Act. The Commission has considered the amendment to Rule 3a12-8 in light of the standards cited in Section 23(a)(2) and believes that adoption of the amendment will not impose any burden on competition not necessary or appropriate in furtherance of the Exchange Act. As stated above, the amendment is designed to assure the lawful availability in this country of Australian, French and New Zealand government debt futures that otherwise would not be permitted to be marketed under the terms of the CEA. The amendment thus serves to expand the range of financial products available in the United States and enhances competition in financial markets. Insofar as the Rule contains limitations, they are designed to promote the purposes of the Exchange Act by ensuring that futures trading on government securities of Australia, France and New Zealand is consistent with the goals and purposes of the federal securities laws by minimizing the impact of the Rule on securities trading and distribution in the United States.
The Commission finds, in accordance with the Administrative Procedure Act, 22 that the amendment to Rule 3a12-8 is exemptive in nature. Accordingly, the Commission has determined to make the foregoing action effective immediately upon publication in the Federal Register.
VII. 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 Subject in 17 CFR Part 240
Reporting and recordkeeping requirements, Securities.
VIII. Text of the Adopted Amendment
The Commission is amending Part 240 of Chapter II, Title 17 of the Code of Federal Regulations as follows:
Part 240--GENERAL RULES AND REGULATIONS, SECURITIES EXCHANGE ACT OF 1934
The authority citation for Part 240 is amended by adding the following citation:
Authority: Sec. 23, 48 Stat. 901, as amended; 5 U.S.C §78w. * * * §240.3a12-8 also 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).
§240.3a12-8 is amended by removing the word "or" from (a)(1)(ii), adding a semi-colon to (a)(1)(iii), and adding paragraphs (a)(1)(iv) through (vi) as follows:
§240.3a12-8 Exemption for designated foreign government securities for purposes of futures trading
(a) * * *
(1) * * *
(iv) Australia;
(v) France; or
(vi) New Zealand.
* * * * *
By the Commission.
1Pub. L. No. 97-444, 96 Stat. 2294, 7 U.S.C. §1 et seq.
2Section 2(a)(1)(B)(v) of the CEA, 7 U.S.C. §2a(v) (1984), 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...."
3See Securities Exchange Act Release Nos. 20728, March 2, 1984, 49 FR 8595 ("Adopting Release"), and 19811, May 25, 1983, 48 FR 24725 ("1983 Proposal Release").
4The Rule was amended last year to include Japanese government securities. 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 Adopting Release, supra note 3.
5As discussed above, without this designation the trading of futures on these securities in the United States would be prohibited by Section 2(a)(1)(B)(v) of the CEA.
6A requirement that the board of trade be located in the country that issued the underlying debt security recently was eliminated. See Securities Exchange Act Release No. 24209, March 12, 1987, 52 FR 8875.
7See 1983 Proposal Release, supra note 3, 48 FR at 24725 citing 128 Cong. Rec. H7492 (daily ed. September 23, 1982) (statements of Representatives Daschle and Wirth).
8In extending the exemption to futures on Canadian government bonds and bills and then to futures on Japanese yen bonds, the Commission noted that there did not appear to be any legal or regulatory reason for treating them differently from British gilt futures.
9See 1983 Proposal Release, supra note 3, 48 FR at 24726-27.
10The MATIF is a financial futures exchange established in Paris in February 1986.
11See letters from Philip McBride Johnson, Skadden, Arps, Slate, Meagher & Flom, to Richard G. Ketchum, Director, Division of Market Regulation, SEC, dated August 20, 1986 (Australia) ("Petition I"), October 1, 1986 (New Zealand) ("Petition II"), and February 26, 1987 (France) ("Petition III"); and 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) ("Petition IV").
12See Securities Exchange Act Release No. 24428, May 5, 1987, 52 FR 18237.
13Letters were received from the following: Neil H. Sherman, First Vice President and Associate General Counsel, Shearson Lehman Brothers, dated June 4, 1987 ("Shearson Letter"); Stephen R. Greene, Vice President, First Boston, dated June 12, 1987 ("First Boston Letter"); J.A. Fraser, Minister (Economic), Embassy of Australia, dated June 15, 1987; Thomas R. Donovan, President, Chicago Board of Trade ("CBT"), dated June 15, 1987; Erkki Liikanen, Minister of Finance, and Kalevi Pykala, Acting Cabinet Counsellor, Ministry of Finance, finland, dated June 15, 1987 ("Finland Letter"); Jorgen Wagner-Knudsen, General Manager, Morgan & Cie, dated June 15, 1987; Ross Tanner, Counsellor (Economic), New Zealand Embassy, dated June 1987 ("New Zealand Letter"); Kurt D. Steele, Senior Vice President and General Counsel, Standard & Poors Crop. ("S&P"), dated June 15, 1987 ("S&P Letter"); and Mats Ringborg, Embassy of Sweden, undated ("Sweden Letter"). The Sweden Letter addressed only the trading of futures on Swedish government securities.
14Australia and Morgan & Cie only addressed, and were in favor of adding, Australian and French debt securities respectively to those exempted by the Rule. Finland favored the adoption of a rating standard over the addition of Australia, France and New Zealand, because the rating standard would exempt the securities of a greater number of countries, while New Zealand, citing problems that could arise if a countrys debt rating were to fall below the two highest rating categories, favored the specific addition of Australia, France and New Zealand. The CBT urged the Commission to amend the Rule to specifically include debt issued by all the countries that would qualify under the proposed rating standard, while Shearson suggested that the Commission adopt both amendments, so as to avoid the possibility that the government securities of Australia, France of New Zealand later would become "disqualified" under the rating standard. Finally, First Boston favored the rating standard over the specific addition of Australia, France and New Zealand, but suggested that the Commission consider exempting all sovereign debt for purposes of futures trading.
15In addition to the CBT, Finland, First Boston, New Zealand, and Shearson comments described at note 14, supra, S&P also addressed the rating standard proposal. While the commentators for the most part favored the addition of debt securities of as many countries as possible to the Rules list of designated foreign government securities, they raised concerns as to the practicability of a rating standard. In general, these concerns related to the proper functioning of the Rule in the event that a government issuers rating were to fall below the two highest rating categories and the validity of relying on rating standards as a measure of the depth and liquidity of the secondary market for the government issuers securities.
16See Petition I, supra note 11, at 6; Petition II, supra note 11, at 6; Petition III, supra note 11, at 7; Petition IV, supra note 11, at 2.
In adopting Rule 3a12-8 the Commission decided not to require, as a condition to the exemption, that such information be available. See Adopting Release, supra note 3, 49 FR 8597-98. At the time Rule 3a12-8 was adopted both the United Kingdom and Canada had government debt issues registered in the united States. As a result, although those particular issues were not the subject of futures trading, United States investors had relevant disclosure materials concerning the issuers, i.e., the governments of Canada and the United Kingdom. The Japanese government, however, had not registered any securities in the United States when it was added to the Rules list of eligible issuers. Of the new countries that would become eligible under the current proposal, only New Zealand currently has government debt securities registered in the U.S.
17See First Boston Letter, supra note 13, at 3; Shearson Letter, supra note 13, at 2.
18See Finland Letter, supra note 13, at 1; First Boston Letter, supra note 13, at 1; New Zealand Letter, supra note 13, at 1.
19The Commission notes that the Australian government bond futures traded on the SFE and the New Zealand government bond futures traded on the NZFE are settled by the delivery of cash, rather than by delivery of the underlying sovereign debt securities. Petition I, supra note 11, at 2; Petition II, supra note 11, at 2. The proposed domestic trading and marketing of these contracts, which would be the first cash-settled futures to qualify for the exemption afforded by Rule 3a12-8, raises the issue of whether a cash-settled product would satisfy the Rules delivery requirement. The CFTC also has raised this issue, and suggested that cash settlement would be consistent with the Rule. See letters from Virginia F. Crisman, Deputy General Counsel, CFTC, to David Underhill, Attorney, Division of Market Regulation, SEC, dated April 13 and April 16, 1987. The Commission agrees that cash settlement would be consistent with the Rules requirement that delivery occur outside the U.S. In originally adopting the Rule, the Commission stated that requiring delivery of the underlying, unregistered securities outside the U.S. was designed to "inhibit the development of domestic trading in these unregistered securities". See Adopting Release, supra note 3, 49 FR at 8598. This concern does not arise in connection with cash settlement, as there is no security required to be delivered. Accordingly, the Commission will not be object to the domestic trading and marketing of foreign futures that are cash-settled (whether cash settlement occurs abroad or in the U.S.), assuming the futures satisfy all the Rules other requirements.
20The marketing and trading of foreign futures contracts also is subject to regulation by the CFTC. In particular, Section 4b of the CEA authorizes the CFTC to regulate the offer and sale of foreign futures contracts to U.S. residents, while 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 foreign exchanges. In addition, the CFTC recently adopted a series of regulations governing the domestic offer and sale of futures and options contracts traded on foreign boards of trade. The rules, which become effective on January 4, 1988, require, among other things, that the domestic offer and sale of foreign futures be effected through CFTC registrants or comparably regulated entities under a regulatory framework similar to the governing domestic futures contracts. See 52 FR 28980 (August 5, 1987).
2115 U.S.C. §78w(a)(2) (1982).
2215 U.S.C. §553 (1982).
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