November 20, 2006
Richard P. Streicher, Esq.
Dear Mr. Streicher:
In your letter dated November 17, 2006, you request on behalf of the Tokyo Stock Exchange, Inc. ("TSE" or "Exchange") and its officers, directors, TSE Representatives and Trading Participants that the Division of Market Regulation ("Division") of the Securities and Exchange Commission ("Commission") confirm that (i) the no-action relief provided to TSE and its officers, directors, TSE Representatives and Trading Participants in the no-action letters issued by the Division to TSE on November 15, 2002 ("2002 No-Action Letter")1 and July 27, 1999 ("1999 No-Action Letter")2 applies with respect to Option Contracts for which Japan Securities Clearing Corporation ("JSCC") acts as clearing agency and (ii) the TSE disclosure document dated November 30, 2005 ("Current Disclosure Document") may be used in place of the disclosure document we reviewed in connection with the 2002 No Action Letter. Capitalized terms used in this letter without definition have the meanings given to them in the 1999 No-Action Letter and the 2002 No-Action Letter (collectively, "Prior No-Action Letters").
In your letter you also request advice on behalf of JSCC and its officers, directors and representatives that the Division will not recommend enforcement action to the Commission against JSCC or any officer, director or representative of JSCC by reason of JSCC not registering as a clearing agency under Section 17A of the Securities Exchange Act of 1934 ("Exchange Act"), if TSE, or any TSE Representative or Trading Participant, undertakes the limited activities contemplated by the Prior No-Action Letters and your current letter to familiarize certain Eligible Broker-Dealers and Eligible Institutions in the United States with TSE and Options traded on the Exchange.
The factual basis and representations for your requests for relief are the same as those set forth in the 1999 No-Action Letter (as modified by the 2002 No-Action Letter) and in the 2002 No-Action Letter, except as indicated in your current letter.
You represent that TSE has implemented and complied with the terms and conditions of relief set forth in the Prior No-Action Letters and that TSE will continue to comply with all the terms and conditions of the Prior No-Action Letters. In addition, you represent that, among other things, TSE has established careful limitations to assure compliance with applicable U.S. securities laws and that TSE and JSCC will continue, as necessary, to establish further limitations to assure continued compliance with such laws. You also represent that TSE will not provide persons located in the U.S. with direct electronic access to the Exchange without express approval from the Commission.
We understand the facts to be as follows:
TSE ceased to act as the clearing agency for any transactions on the Exchange created or closed on or after February 2, 2004. On that date, JSCC became the clearing agency for all such transactions. Because of such change, since February 2, 2004, TSE does not have clearing participants. TSE and a subsidiary and an affiliate of TSE carry out certain clearance and settlement activities on behalf of JSCC, as described below.
In order for a Trading Participant of TSE to clear or settle any transaction executed on the Exchange that clears or settles after February 1, 2004, such Trading Participant must be a clearing participant of JSCC, with appropriate clearing qualification status with JSCC that authorizes it to clear and settle the transaction, or else the Trading Participant must clear and settle the transaction through a firm that has that status. All entities that were clearing participants of TSE on February 1, 2004 became clearing participants of JSCC, which authorized them to clear transactions of the same category for which they had been clearing participants of TSE. JSCC became counterparty to all Option Contracts between its clearing participants created after February 1, 2004 and has replaced TSE as counterparty for all Option Contracts outstanding at the close of business on the last business day before February 2, 2004.
JSCC and Clearance and Settlement of Transactions in Options
JSCC, a Japanese joint stock company incorporated on July 1, 2002, is the first securities clearing organization licensed by the Prime Minister of Japan under the Securities and Exchange Law of Japan ("Japanese Securities and Exchange Law"). JSCC is the central clearing organization that provides cross-market clearance services for all the stock markets in Japan and the TSE derivative markets. JSCC is owned by all the stock exchanges in Japan as follows: TSE, 86.3%; Osaka Securities Exchange Co., Ltd., 9.5%; Jasdaq Securities Exchange, Inc., 3.4%; and other stock exchanges, 0.8%. The principal reason for the establishment of a unified clearing organization was the increasing expectations of securities firms, banks and others for further streamlining of clearance operations in Japan.
Under the Japanese Securities and Exchange Law, the Prime Minister has continuing supervisory authority over all clearing organizations in Japan. The Prime Minister has delegated that authority to the Commissioner of the Financial Services Agency ("FSA").
Pursuant to an agreement between JSCC and TSE, JSCC is responsible for the clearance, settlement and guarantee of all transactions in Option Contracts executed on the Exchange. As to all purchases or sales of Option Contracts, JSCC is interposed on a principal-to-principal basis as the buyer to each Clearing Participant (as defined below) seller of an Option Contract and seller to each Clearing Participant buyer of an Option Contract. As principal, JSCC in effect guarantees such trades to such Clearing Participants. JSCC interposes as counterparty between buying and selling Clearing Participants immediately after an Option Contract trade takes place. There is no contractual link between JSCC and a Non-Clearing Participant (as defined below) or any customer of a Clearing Participant or of a Non-Clearing Participant, except that the customer has the right to claim the return of any of its margin deposited to JSCC through a Clearing Participant in case of the suspension of qualification for trading of its executing Trading Participant or for clearing entrustment of the settling Trading Participant. JSCC has no responsibility for settlements between any intermediary (including a Trading Participant) and its customers, or for the funds or securities of a customer that are held by such intermediary. However, each Trading Participant guarantees the final settlement of its customers' TSE transactions.
Although JSCC is solely responsible to Clearing Participants for calculating margin and other amounts relating to the clearance and settlement of transactions executed at the Exchange, JSCC has entrusted performance of some of these functions to third parties pursuant to various contracts.
JSCC does not currently own a computer clearance or settlement system. Instead, pursuant to an agreement between JSCC and TSE, JSCC makes use of various clearance and other functions of certain of TSE's computer systems. Pursuant to this agreement, JSCC has entrusted TSE with various tasks, including accumulating the trade data, calculating the relevant amounts and generating the necessary documents required for clearance and settlement of Options and other transactions on the Exchange cleared and settled by JSCC, accepting the notice of a transaction that opens or closes an Options position, accepting and assigning an Options exercise notice, and maintaining the TSE computer systems insofar as they are used for such purposes. In accordance with the agreement, TSE has re-entrusted certain of such tasks to Tosho Computer System Co., Ltd. ("TCS"), an affiliate of TSE, pursuant to an agreement between TSE and TCS.
Pursuant to an agreement between JSCC and Japan Securities Settlement & Custody, Inc. ("JSSC") (formerly known as Japan Securities Clearing Corporation), a wholly-owned subsidiary of TSE, JSCC has entrusted JSSC with certain other clearance and settlement tasks, such as the delivery to Clearing Participants of trade detail reports, assignment notices and other reports containing the calculation and tabulation of the settlement amounts to be paid or received by Clearing Participants on a net basis which have been generated by TCS. Stocks underlying exercised Equity Options are delivered by book-entry through JSCC's account at the Japan Securities Depository Center ("JASDEC"), a stock corporation contributed to by securities companies, banks, stock exchanges, and others, which has been designated as a securities depository by the Minister of Justice and the Prime Minister. JASDEC, although fully responsible for the physical safekeeping, delivery and withdrawal of certificated stocks and for book-entry, has entrusted the operational aspect of these physical operations to JSSC pursuant to an agreement between JASDEC and JSSC. Thus, JSSC provides clearance and settlement services to JSCC and custody services to JASDEC. None of TSE (since February 2, 2004), TCS, JSSC or JASDEC becomes counterparty to an Options transaction.
JASDEC is regulated by the Commissioner of the FSA and the Minister of Justice of Japan pursuant to the Law Concerning Central Securities Depository and Book-Entry Transfer of Stock Certificates and Other Securities ("Central Depository Law"). Any delegation by JASDEC to a third party of any part of JASDEC's book-entry business requires the approval of the Commissioner of the FSA. The delegation to JSSC of the activities of JASDEC referred to above was reviewed and approved by the FSA. Although JSSC is not regulated under the Central Depository Law, the FSA may, among other things, directly require any subsidiary of TSE, including JSSC, to submit reports and material with respect to its own business or assets or the business or assets of TSE. Also, JSSC and the other subsidiaries of TSE may be deemed to be subject to regulation indirectly by the FSA by virtue of its ability to regulate TSE.
In addition to the clearance and settlement of, and becoming counterparty for, all transactions in Options, JSCC acts as the central clearing house and clears, settles and becomes counterparty for all transactions: (i) in all other TSE futures and options derivative instruments and cash market products traded at the Exchange and (ii) in all cash market products traded at all other stock exchanges in Japan. Clearing Participants that also trade in such other products at the Exchange or other securities markets in Japan also may have clearing qualification status with JSCC that authorizes them to clear and settle their transactions in such products through JSCC.
Equity Options and Index Options are not fungible or interchangeable with options that are traded on any other market. Thus, any Equity Option or Index Option position opened on TSE can be closed only on TSE or exercised only by a Trading Participant giving an exercise notice to the Exchange. There is no cross-settlement with respect to Option Contracts between the Exchange's markets and any other securities market, except (i) because all shares of stock of domestic issuers in Japan deliverable and receivable among participants in JSCC, whether as a result of a transaction on the Exchange or another stock exchange in Japan, is on a settlement date net balance basis by issue, any shares deliverable and receivable upon exercise of an Equity Option are included in calculating such net balance and (ii) because all funds payable and receivable for the purchase and sale of stock and convertible bonds among participants in JSCC, whether as the result of a transaction on the Exchange or another stock exchange in Japan, is on a settlement date net balance basis, any funds payable and receivable in connection with such exercise are included in calculating such net balance.
An eligible entity, as described below, including a Trading Participant that is an eligible entity, may, with the approval of JSCC, acquire clearing qualification status with JSCC and become a clearing participant ("Clearing Participant") for one or more categories of clearing. A Trading Participant that is not a Clearing Participant with respect to a particular category ("Non-Clearing Participant") must settle its transactions covered by that category through its designated clearing participant.
Entities that are eligible to become Clearing Participants include Japanese securities companies, foreign securities companies that have one or more branches in Japan and are registered with the Prime Minister under the Japanese Law Concerning Foreign Securities Firms, registered financial institutions prescribed by the Japanese Securities and Exchange Law, and securities finance companies. Although, under the Japanese Securities and Exchange Law, foreign securities companies without branches in Japan that are "approved" by the Prime Minister under the Japanese Law Concerning Foreign Securities Firms are eligible to become trading participants of stock exchanges, they cannot become trading participants at this time, because none of the stock exchanges have adopted rules permitting them to do so.
Clearing Participants may be qualified in one or more of the following categories of Clearing Participant and thereby become authorized to perform the functions indicated for such category or categories: "Cash Transaction Clearing Participant" qualified to clear and settle transactions in securities and transactions carried out by exercise of Equity Options; "Bond Futures Clearing Participant" qualified to clear and settle transactions in government bond futures contracts and option contracts thereon; "Stock Index Futures Clearing Participant" qualified to clear and settle transactions in stock index futures and Index Option Contracts; and "Equity Options Clearing Participant" qualified to clear and settle transactions in Equity Options.
An eligible entity may be qualified as a Clearing Participant upon application to and approval by JSCC. Before granting such approval, JSCC must be satisfied that the applicant maintains adequate administrative and operational capabilities for settlement and meets all the financial criteria for a Clearing Participant.
JSCC has established comprehensive margining and risk management procedures designed to ensure that adequate margin is held to ensure settlement of Options transactions and to cover losses resulting from defaults by Clearing Participants. In addition, JSCC and TSE have created certain default reserves applicable to Clearing Participants' Option Contracts. JSCC's procedures are designed so that for every outstanding Option for which there is a buyer, there is a writer of an Option of the same series who has undertaken to perform the writer's obligations in the event that an exercise is assigned to such writer.
Revised Disclosure Document
In connection with the foregoing, you have submitted with your request the Current Disclosure Document. The Current Disclosure Document, among other things (i) changes the clearing body for transactions in Options from TSE to JSCC, (ii) changes the TOPIX Index from a capitalization weighted stock price index, the base value and current values of which are calculated generally taking into account all outstanding shares of the component stocks, to a free-float adjusted market capitalization weighted stock price index, the base and current values of which are calculated generally taking into account only those shares of the component stocks that are deemed to be available for purchase by investors in the market, and (iii) adds a limitation of liability of TSE in the event of an error in the calculation of the TOPIX Index.
Update of Written Representations Required from Eligible Broker-Dealers and Eligible Institutions
As required by the Prior No-Action Letters, the Exchange has a rule that requires Trading Participants to obtain various written representations from Eligible Broker-Dealers and Eligible Institutions, including a representation with respect to margin as specified in item (5) under "Transactions with U.S. Customers" in the 1999 No-Action Letter. In order to reflect that Eligible Broker-Dealers and Eligible Institutions understand the situation as to margin subsequent to JSCC becoming the clearing agency for transactions in Options, such representation with respect to margin shall read, in effect, as follows:
"it [the Eligible Broker-Dealer or Eligible Institution] will cause any disposition of any TSE Equity Option or TSE Index Option that it has purchased or written to be effected only on the TSE and to be settled by Japan Securities Clearing Corporation ("JSCC") in Tokyo, and it understands that any required payments for premium, settlement, exercise or closing of any TSE Equity Option or TSE Index Option in respect of which it has a contract with a Trading Participant must be made in Japan and in Japanese yen. It also understands that, if in relation to an any TSE Equity Option or TSE Index Option, it has a contract with a Trading Participant as a writer of such Option,
The Division confirms that the no-action relief provided to TSE and its officers, directors, TSE Representatives and Trading Participants in the Prior No Action Letters applies with respect to Option Contracts for which JSCC acts as clearing agency, subject to all the terms and conditions of the Prior No-Action Letters.
The Division has also reviewed the Current Disclosure Document. Based on our review of that document, and on the facts and representations set forth above, the Division advises that it will not recommend that the Commission take enforcement action against a TSE Representative, a Trading Participant, or an Eligible Broker-Dealer pursuant to Rule 9b-1(d) under the Exchange Act, if the TSE Representative, Trading Participant, or Eligible Broker-Dealer furnishes the Current Disclosure Document to an Eligible Broker Dealer or Eligible Institution before the Eligible Broker-Dealer or Eligible Institution effects a transaction in the Option Contracts, subject to the following conditions:
Finally, based on the facts and representations set forth above, and subject to all the terms and conditions of the Prior No-Action Letters, the Division will not recommend enforcement action to the Commission against JSCC or any officer, director or representative of JSCC by reason of JSCC not registering as a clearing agency under Section 17A of the Exchange Act, if TSE, or any TSE Representative or Trading Participant, undertakes the limited activities contemplated by the Prior No-Action Letters and your current letter to familiarize certain Eligible Broker-Dealers and Eligible Institutions in the U.S. with TSE and Options traded on the Exchange.
These positions of the Division concern enforcement action only and do not represent conclusions on the applicability of statutory or regulatory provisions of the federal securities laws. The Division has taken these positions based, in part, on the fact that the Commission, along with the Commodity Futures Trading Commission, has entered into a Statement of Intent with the FSA that provides a framework for mutual assistance in investigating regulatory matters,3 and that foreign broker-dealers, including Trading Participants, electing to deal with U.S. institutional investors pursuant to Rule 15a-6(a)(3) under the Exchange Act are required to provide directly to the Commission, upon request, information, documents, testimony, and assistance in taking the evidence of persons that relate to transactions pursuant to Rule 15a-6(a)(3) under the Exchange Act. Moreover, these positions are based on the understanding that under Japanese law only members licensed or registered by the competent Japanese authorities may have direct access to the Exchange, which is licensed as a stock exchange and subject to regulation by the Minister of Finance and the FSA. Finally, these positions are based on your representation that TSE will not provide persons located in the U.S. with direct electronic access to the Exchange without express approval from the Commission.
The positions of the Division in this letter are based on the representations that you have made. Any different facts or conditions might require a different response, and these positions are subject to modification or revocation if the facts and representations set forth above are altered.
Elizabeth K. King
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