| Release No. 34-26217 October 26, 1988
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 Table of Contents
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I. Introduction
Under the Commodity Exchange Act ("CEA"), futures trading on an individual security 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 debt securities of Great Britain, Canada, Japan, Australia, France, and New Zealand (the "six designated sovereign issuers") as "exempted securities" under the Exchange Act solely for purposes of marketing and trading futures on those securities in the U.S. In effect, the designation of those securities as exempted securities removes the CEAs prohibition against marketing and trading futures on those securities in the U.S., 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 Austria, Denmark, Finland, the Netherlands, Switzerland, and West Germany (the "seven newly-designated sovereign issuers") to the list of designated foreign government securities exempted by the Rule. To qualify for the exemption, futures contracts on securities of the newly-designated sovereign issuers 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, Japanese, Australian, French, and New Zealand government securities that meet certain conditions as "exempted securities" under the Exchange Act. The purpose of the Rule is to permit certain exchange-traded futures contracts on the designated foreign government securities to be marketed and traded in the U.S. 5 Under the Rule, government debt securities of the six designated sovereign issuers 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 U.S.; (2) the futures contracts require delivery outside the U.S.; 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 the U.S. 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, Australian, French, and New Zealand government debt.
On September 29, 1988, the London International Financial Futures Exchange, Ltd. ("LIFFE") began trading a Deutschmark-denominated German government bond futures contract (or "Bund" contract). The Commission staff has been informed that U.S. citizens, particularly institutional investors, are interested in trading this new product and has received a request that Rule 3a12-8 be amended accordingly. 10 As the worlds securities markets become increasingly internationalized, the Commission expects to receive additional petitions for exemptive relief. As an alternative to continuing to amend the Rule on a country-by-country basis, the Commission, on August 16, 1988, issued a release ("1988 Proposal Release") proposing to amend the Rule by adding debt securities issued by Austria, Denmark, Finland, the Netherlands, Norway, Sweden, Switzerland, and West Germany to the Rules list of designated foreign government securities. 11
III. Discussion
The Commission received seven comment letters in response to the 1988 Proposal Release, including two from the same commentator. 12 Four of the six commentators endorsed or expressed no objection to adding the eight countries included in the 1988 Proposal Release to the list of countries covered by the Rule. 13 Norway and Sweden, however, objected to the exemption of their sovereign debt securities for purposes of futures trading thereon, citing their respective currency restrictions. 14
The Commission also solicited comment in its 1988 Proposal Release on whether under the 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. 15 The two commentators that addressed this issue argued that U.S. investors should have sufficient access to information in English concerning the relevant futures markets and underlying debt instruments. 16
In addition, the Commission solicited comment on whether there are any legal or policy reasons for determining that debt securities issued by Austria, Denmark, Finland, the Netherlands, Norway, Sweden, Switzerland, or West Germany should not be accorded the same treatment for purposes of futures trading in the U.S. as are debt securities issued by the six designated sovereign issuers. The one commentator that addressed this issue stated that there did not appear to be any valid legal or policy reasons for denying U.S. investors the ability to trade futures on debt issued by Austria, Denmark, Finland, the Netherlands, Norway, Sweden, Switzerland, or West Germany. 17
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 Austria, Denmark, Finland, the Netherlands, Switzerland, and West Germany. The Commission agrees that there are no valid legal or policy reasons for denying U.S. investors the ability to trade futures on debt securities issued by the six newly-designated sovereign issuers 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 the six newly-designated sovereign issuers. 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., 18 and that the contracts be traded on a board of trade) will apply to futures contracts on debt securities issued by the six newly-designated sovereign issuers. 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. 19
The Commission has determined not to add Norway and Sweden to the Rules list of eligible sovereign issuers. As noted above, Norway and Sweden objected to the exemption of their sovereign debt securities for purposes of futures trading thereon. Although the Commission believes that trading of Norwegian and Swedish sovereign debt securities could become active enough to support development of a futures market on such securities, as a matter of international comity the Commission will not add Norwegian and Swedish sovereign debt securities to those exempted by the Rule. 20
IV. Cost/Benefit Analysis
In connection with the 1988 Proposal Release, the Commission noted that there do not appear to be any costs associated with the amendment adopted today. While the Rule is being expanded to exempt the debt of additional countries, the Rule continues to include safeguards designed to protect U.S. investors by preventing unregistered bonds issued by the six newly-designated sovereign issuers from entering the country and by requiring that futures on those bonds be traded on boards of trade. In addition, the amendment imposes no record keeping 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. 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
Pursuant to Section 605(b) of the Regulatory Flexibility Act, 21 the Chairman of the Commission certified in connection with the 1988 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 22 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 futures on the sovereign debt securities of the six newly-designated countries 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 U.S. 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 the six newly-designated sovereign issuers 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 U.S.
The Commission finds, in accordance with the Administrative Procedure Act, 23 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.
List of Subjects in 17 C.F.R. Part 240
Reporting and record keeping requirements, Securities.
VII. 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
1. The authority citation for Part 240 continues to read as follows: Authority: Sec. 23, 48 Stat. 901, as amended; 15 U.S.C. §78w. * * * §240.3a12-8 also issued under 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).
2. §240.3a12-8 is amended by removing the word "or" from (a)(1)(v), replacing the period with a semi-colon at (a)(1)(vi), and adding paragraphs (a)(1)(vii) through (xii) as follows:
§240.3a12-8 Exemption for designated foreign government securities for purposes of futures trading.
(a) * * *
(1) * * *
(vii) Austria;
(viii) Denmark;
(ix) Finland;
(x) the Netherlands;
(xi) Switzerland; or
(xii) West Germany.
* * * * *
By the Commission.
1Pub. L. No. 97-444, 96 Stat. 2294, 7 U.S.C. §1 et seq. (1982).
2Section 2(a)(1)(B)(v) of the CEA, 7 U.S.C. §2a(v) (1982), 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. 20708, March 2, 1984, 49 FR 8595 ("Adopting Release"), and 19811, May 25, 1983, 48 FR 24725 ("1983 Proposal Release").
4As originally adopted, the Rule applied only to British and Canadian government securities. See Adopting Release, supra note 3. The Rule was amended in 1986 to include Japanese government securities. See Securities Exchange Act Release No. 23423, July 11, 1986, 51 FR 25996. In 1987, the Rule was amended to include debt securities issued by Australia, France, and New Zealand. See Securities Exchange Act Release No. 25072, October 29, 1987, 52 FR 42277.
5As discussed above, without this designation the trading of futures on these securities in the U.S. 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 securities has been 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, Japanese, Australian, French, and New Zealand government debt securities, the Commission noted that there did not appear to be any legal or regulatory reason for treating them differently from British sovereign debt futures.
9See 1983 Proposal Release, supra note 3, 48 FR at 24726-27.
10See letter from Brooksley Born, Arnold & Porter, to Howard L. Kramer, Assistant Director, Division of Market Regulation, SEC, dated June 3, 1988.
11See Securities Exchange Act Release No. 25998, August 16, 1988, 53 FR 31709. The countries proposed to be added to Rule 3a12-8 in the 1988 Proposal Release are those countries not covered currently by the Rule but which would have qualified pursuant to a generic rating standard amendment proposed by the Commission last year. See Securities Exchange Act Release No. 24428, May 5, 1987, 52 FR 18237. The rating standard amendment would have added to the Rules list of exempted securities all debt instruments issued by a country with outstanding long-term sovereign debt rated in one of the two highest rating categories by at least two nationally recognized statistical rating organizations.
12Letters were received from the following: Jorgen Holmquist, Financial Counselor, Embassy of Sweden, dated September 9, 1988 ("Sweden Letter") and October 18, 1988; Brooksley Born, Arnold & Porter, dated September 13, 1988 (on behalf of LIFFE) ("Arnold & Porter Letter"); Laurids Mikaelson, Minister (Economic Affairs), Embassy of Denmark, dated September 19, 1988; Robert H. Weiss, Vice President and Associate General Counsel, Shearson Lehman Hutton, dated September 19, 1988 ("Shearson Letter"); Arve Thorvik, Counselor of Economic Affairs, Embassy of Norway, dated September 20, 1988 ("Norway Letter"); and Ian M. de Jong, Counselor (Economic), Embassy of the Netherlands, dated September 21, 1988 ("Netherlands Letter"). The second letter from Sweden was submitted in response to a Commission staff request for clarification of the first letter.
13Denmark and the Netherlands stated that they have no objections to the amendment contained in the 1988 Proposal Release. Indeed, the Netherlands applauded such an amendment as contributing to a "further integration of financial markets." Netherlands Letter, supra note 12, at 1. Arnold & Porter commented in support of U.S. trading of LIFFEs German Bund contract by noting that the German debt market is very active in Europe and that there is a large U.S. interest in futures contracts on West German sovereign debt securities. Arnold & Porter also argued that amending the Rule to include sovereign debt securities of additional countries other than West Germany would reduce delays and Commission administrative burdens that could arise if new sovereign debt futures contracts were developed. Arnold & Porter Letter, supra note 12, at 3-7. Finally, Shearson supported the proposed amendment to the Rule, but argued that all sovereign debt should be exempted from purposes of futures trading thereon.
14In particular, Norway cited its policy of limiting "the role of the Norwegian kroner as an international translation and investment currency...." Norway Letter, supra note 12, at 1. Sweden noted that its currency controls prohibiting non-residents from holding Swedish kroner-denominated securities would preclude development of a market for physically-settled futures on such securities and that "in any case it is not in the interest of the Swedish government that such a market develops." Sweden Letter, supra note 12, at 1.
15In 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 U.S. As a result, although those particular issues were not the subject of U.S. futures trading, U.S. investors had relevant disclosure materials concerning the issuers, i.e., the governments of Canada and the United Kingdom. In addition, Australia and New Zealand had government debt issues registered in the U.S. when they were added to the Rules list of eligible issuers. The Japanese and French governments, however, had not registered any securities in the U.S. when they were added to the Rule. Of the new countries that will become eligible under the current amendment, only Austria and Denmark currently have government debt securities registered in the U.S.
16Arnold & Porter Letter, supra note 12, at 5-6; Shearson Letter, supra note 12, at 1. Arnold & Porter stressed the availability of information regarding West German Bund futures contracts traded on LIFFE, the underlying German sovereign debt securities, and the "general credit worthiness of the German government so as to allow U.S. investors knowledgeably to trade futures on Bunds." Arnold & Porter Letter, supra note 12, at 5-6.
17See Shearson Letter, supra note 12, at 1. The Commission also solicited comments on possible procedures or standards pursuant to which it could exempt the debt securities of additional countries without having to so on a country-by-country basis, including the generic rating standard approach proposed originally in May 1987 (see note 11, supra) and a standard based on volume and depth of trading in a sovereign issuers debt. In response, one commentator, Shearson Lehman Hutton, argued that all sovereign debt securities should qualify for the exemption provided by Rule 3a12-8. See Shearson Letter, supra note 12, at 2-3.
18Although the only futures contract likely to be eligible immediately for sale in the U.S. once the amendment is adopted is the physically-settled West German bond futures contract traded on LIFFE, the Commission in the past has stated that cash-settlement would be consistent with the Ruless requirement that delivery occur outside the U.S. See Securities Exchange Act Release No. 25072, October 29, 1987, 52 FR 42277, at 42279 n.19.
19The marketing and trading of foreign futures contracts also is subject to regulation by the CFTC. In particular, Section 4(b) of the CEA authorizes the CFTC to regulate the offer and sale of foreign futures contracts to U.S. residents, while Rule 30.02 (18 CFR §30.02), promulgated under Section 2(a)(1)(A) of the CEA, is intended to prohibit fraud in connection with the domestic 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 became effective on January 4, 1988, but which have not been fully implemented pending CFTC review of petitions for exemption, require, among other things, that the domestic offer and sale of foreign futures be effected through CFTC registrants or through entities subject to a foreign regulatory framework comparable to that governing domestic futures trading. See 52 FR 28980 (August 5, 1987).
20The Commission specifically reserves the right to consider exempting such debt securities under the Rule in the future. In addition, although the amendment approved today should obviate the need to amend Rule 3a12-8 in the near future, the Commission will continue to consider possible procedures or standards pursuant to which it could exempt the debt securities of additional countries other than on a country-by-country basis.
215 U.S.C. §605(b) (1982).
2215 U.S.C. §78w(a)(2) (1982).
2315 U.S.C. §553 (1982).
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