VIA E-MAIL TO email@example.com
September 3, 2002
Jonathan G. Katz
Re: File No. S7-29-02 - Exemption for Standardized Options From Provisions of the Securities Act of 1933 and From the Registration Requirements of the Securities Exchange Act of 1934
Ladies and Gentlemen:
On behalf of our client, the Canadian Derivative Clearing Corporation ("CDCC"), we are pleased to comment on the proposal by the Securities and Exchange Commission (the "Commission") to exempt certain standardized options from all provisions of the Securities Act of 1933, as amended (the "Securities Act"), other than the Section 17 antifraud provision and the registration requirements of the Securities Exchange Act of 1934, as amended (the "Exchange Act").1 We take particular interest in the following questions posed by the Commission in the Release:
We concur with the Commission that Securities Act and Exchange Act registrations of standardized options issued by registered clearing agencies and traded on a registered national securities exchange or on an automated quotation system of a registered national securities association (the "Covered Securities") provide little useful information to investors and that the costs of registration borne by market participants outweigh the benefits to investors. However, we believe that the informational and efficiency analysis applied to the Covered Securities, in certain cases, applies with equal force to other classes of standardized options. Therefore, we respectfully request that the Commission consider broadening the class of standardized options eligible for the registration exemptions discussed in the Release (the "Exemptions"). Specifically, we propose that the Exemptions be revised to include standardized options (i) issued by a foreign clearing agency and traded on a foreign exchange, both of which are subject to the oversight of a foreign regulatory authority acceptable to the Commission and covered by an information-sharing arrangement with the Commission concerning regulatory and enforcement matters and (ii) covered by an options disclosure document ("ODD") that meets the requirements of Exchange Act Rule 9b-1 and has been approved by the Commission.
Overview of CDCC
CDCC was incorporated under the laws of Canada in 1974.2 While CDCC is not registered under Exchange Act Section 17A as a clearing agency, it performs substantially the same function in Canada that the Options Clearing Corporation (the "OCC") performs in the United States. The OCC is deemed to be the issuer of standardized options listed on a registered national securities exchange or on an automated quotation system of a registered national securities association ("OCC Options")3 and clears and settles OCC Options. Likewise, CDCC issues all standardized put and call options listed for trading on the Bourse de Montreal Inc. ("CDCC Options") and acts as the clearing facility through which settlement of CDCC Options transactions is made.4 The Bourse is CDCC's sole shareholder. The securities underlying CDCC Options are (i) the equity securities of Canadian issuers, (ii) Canadian government bonds or (iii) Canadian equity indices. CDCC Options are not listed or traded in the United States, although certain of the underlying securities are cross-listed on one or more registered national securities exchanges.
Like the OCC, CDCC registers, as issuer, CDCC Options for sale in the United States on Form S-20. However, unlike OCC Options, CDCC Options are not subject to Exchange Act registration because CDCC Options are not listed for trading on a registered national securities exchange.5 Pursuant to the requirements of Exchange Act Rule 9b-1, CDCC has prepared an ODD. A registered broker-dealer must provide a customer with a copy of CDCC's ODD before it can approve the customer for CDCC Options trading or accept purchase or sell orders for CDCC Options from the customer. The Commission approved the latest version of CDCC's ODD on May 22, 20016
CDCC's settlement and clearing operations are also similar to those of the OCC. Both the CDCC and the OCC effect payment and delivery on behalf of their clearing members. Like the OCC, CDCC has back-up systems based on financial requirements imposed upon clearing members, margin and clearing deposits designed to ensure that the obligations of clearing members are fulfilled.
In the Release, the Commission discusses its reasons for proposing the Exemptions. We concur with the Commission's view that Securities Act and Exchange Act registrations provide scant useful information to investors in the Covered Securities. However, we also believe that the rationale offered by the Commission in support of applying the Exemptions to the Covered Securities can be applied equally to CDCC Options and possibly to certain other options issued by foreign clearing agencies and traded on foreign exchanges.
Because the issuer of standardized options is fundamentally different than a conventional issuer Securities Act and Exchange Act registrations do not provide relevant information to investors.
The Commission notes in the Release that a registered clearing agency in its role as an issuer of standardized options has a fundamentally different relationship to the securities it issues than a conventional issuer has to its securities. Noting that "the purchaser of standardized options does not invest in the clearing agency that registers transactions in standardized options" and the investment risk of standardized options "is determined by the market performance of the underlying security rather than the performance of the clearing agency registrant", the Commission concludes that "information about the registrant's business, its officers and directors, and its financial statements is less relevant to investors in standardized options."7 Indeed, these same observations underlie the Commission's decision in 1982 to create the ODD and to make the ODD the primary disclosure document for trading in standardized options.
CDCC's role and operations are substantially similar to those of the OCC.
As discussed above, CDCC performs the same "issuer" role in Canada that the OCC performs as a registered clearing agency. The Commission has previously acknowledged the parallels between the OCC and CDCC, and between OCC Options and CDCC Options.8 Although CDCC is considered the issuer of CDCC Options it does not receive any proceeds from the sale of CDCC Options.9 Just as with OCC Options, the performance and risk associated with investment in CDCC Options depends upon the performance of the underlying security. The information contained in CDCC's Form S-20 prospectus is no more relevant to an investor in CDCC Options than OCC's Form S-20 prospectus is to investors in OCC Options.
CDCC's ODD is the primary disclosure document for CDCC Options.
Moreover, as intended by the Commission's 1982 overhaul of options regulation, the ODD has supplanted the Form S-20 prospectus as the primary disclosure document for standardized options. In recent years CDCC has not received a single request for a copy of it Form S-20 prospectus from an investor in CDCC Options. In contrast, CDCC's ODD is furnished to every U.S. purchaser or seller of CDCC Options in accordance with the delivery requirements contained in Exchange Act Rule 9b-1. CDCC's ODD contains relevant information about the performance characteristics of CDCC Options designed to enable the reader to evaluate the risks of trading in CDCC Options. It also contains relevant information about the CDCC's and the Bourse's roles in the market for CDCC Options. The information contained in CDCC's Form S-20 prospectus is either duplicative of information contained in the ODD or of minimal relevance to a potential purchaser or seller of CDCC Options. CDCC's ODD must be approved for use and distribution by the Commission pursuant to Exchange Act Rule 9b-1.10 Since revisions of CDCC's ODD must be reviewed and approved by the Commission, the Commission would retain significant regulatory oversight over the primary disclosure document associated with CDCC Options even if the proposal were revised to extend the Exemptions to CDCC Options.
Because of the similarities in the functions performed by the OCC and CDCC, and because the Commission has reviewed and approved CDCC's ODD, we feel that a revision of the Commission's proposal to make the Exemptions available to CDCC Options is consistent with the shift in focus from the Form S-20 prospects to the ODD as the appropriate disclosure document for standardized options. In this regard we feel that it would be appropriate for the Commission to also consider extending the Exemptions to an issuer of standardized options that has an ODD approved for use and distribution by the Commission.
Registered clearing agencies are self-regulatory organizations subject to Commission oversight.
In the Release, the Commission cites the status of registered clearing agencies (the issuer of the Covered Securities) as self-regulatory organizations subject to Commission oversight as support for its view that the Exemptions will not cause detrimental effects to investors in the Covered Securities. While the CDCC is not a registered clearing agency under Exchange Act 17A, it is subject to comparable regulation by Canadian regulatory authorities and, pursuant to such regulatory oversight, maintains comprehensive risk management systems analogous to those employed by the OCC. Furthermore, as discussed above, CDCC is subject to Commission oversight as an issuer of standardized options to the extent that its ODD must be reviewed and approved for use by the Commission.
CDCC is subject to significant oversight by Canadian regulatory authorities.
As a clearing agency and issuer of CDCC Options, CDCC is regulated by provincial securities commissions in Canada pursuant to the securities acts of the Canadian provinces. CDCC is subject to regulation by these Canadian authorities analogous to that applied to the OCC by the Commission as a registered clearing agency. We also note that all CDCC Options are traded on the Bourse, a Canadian securities exchange that is a Canadian SRO and is subject to oversight by Canadian securities regulators. The Commission has recognized the quality of the regulation of Canadian securities markets by Canadian authorities in many contexts. We note that the Commission has entered into Memoranda of Understanding regarding cooperation in investigations and enforcement matters with the Canadian provincial securities commissions.
CDCC maintains a risk management program similar to the OCC's program.
As a clearing agency subject to oversight by provincial securities regulatory authorities, CDCC employs comprehensive risk management tools. A CDCC clearing member must be a member of a Canadian securities exchange or a Canadian Schedule I Bank and subject to oversight by a provincial securities regulator. CDCC requires its clearing members to maintain minimum net capital requirements set by Canadian SROs or the Canadian Federal Bank Act. In addition, clearing members must maintain with the CDCC margin for aggregate positions in CDCC Options. CDCC also maintains a clearing fund that protects CDCC against the failure by a clearing member to discharge its obligations in respect of CDCC Options. Each clearing member contributes to the clearing fund. Finally, CDCC introduced "Enhanced Capital Monitoring", a credit-based component to its risk management system, in October 2000. Through Enhanced Credit Monitoring, CDCC can consider a clearing member's ability to respond to sudden increases in its margin and clearing fund requirements.
Recently, CDCC has undertaken a review with a nationally recognized statistical ratings organization (a "NRSRO") to assess its credit-worthiness. While the review is not yet completed, it is anticipated that CDCC's rating will reflect the robust liquidity and risk management techniques employed by CDCC.
Even though CDCC is not a registered clearing agency it is subject to Commission oversight.
As discussed above, through its review and approval authority with respect to the ODD, the Commission has significant regulatory oversight over CDCC even though CDCC is not a registered clearing agency. Since an approved ODD is a precondition for the trading of a standardized option in the U.S., the Commission exercises substantial influence over CDCC's structure and operations.
Canadian securities markets, in general, and the CDCC as a Canadian clearing agency, in particular, are subject to substantial regulatory oversight by Canadian regulatory authorities. The recognized quality of Canadian securities regulation and the fact that the Commission is a party to coordination and information-sharing agreements with Canadian securities regulatory authorities provide the Commission with comfort that CDCC, as the issuer of CDCC Options, is subject to an acceptable level of regulatory scrutiny. CDCC's sophisticated risk management systems and the high level of its credit-worthiness as rated by a NRSRO also indicate the quality of CDCC as an issuer of standardized option. We respectfully suggest that the Commission should consider making the Exemption available to issuers of standardized options regulated by foreign regulatory authorities acceptable to the Commission.
CDCC commends the Commission for reducing the regulatory burden with respect to Securities Act and Exchange Act registrations for standardized options. While we agree with the Commission's analysis regarding the utility of registration requirements for the Covered Securities, we believe that the Commission's observations also apply to other standardized options and respectfully request that the Commission consider expanding the application of the Exemptions. Specifically, we propose that the Commission consider broadening the Exemptions to cover standardized options (i) issued by a foreign clearing agency and traded on a foreign exchange, both of which are subject to the oversight of a foreign regulatory authority acceptable to the Commission and covered by an information-sharing arrangement with the Commission concerning regulatory and enforcement matters and (ii) covered by an approved ODD.
If you have any questions, please contact me at (416) 367-7377.
Yours very truly,
/s/ D. Grant Vingoe
D. Grant Vingoe
cc: Michel Favreau (President, Canadian Derivatives Clearing Corporation)
1 Release Nos. 33-8114; 34-46264 (July 25, 2002) (the "Release").
2 CDCC was formerly known as Trans Canada Options Inc. The name of the corporation was changed in January 1996.
3 We know of no securities other than OCC Options that presently meet the definition of Covered Security discussed above.
4 Previously, options cleared and settled by CDCC were purchased and sold in transactions on the Bourse de Montreal Inc. (the "Bourse"), the Toronto Stock Exchange (the "TSE"), the Toronto Futures Exchange (the "TFE") and the Vancouver Stock Exchange (the "VSE"). Under a Memorandum of Agreement dated March 15, 1999 between the Alberta Stock Exchange ("ASE"), the Bourse, the TSE and the VSE it was agreed that the ASE and the VSE would combine to create a single junior equities market, all senior equities would be transferred to the TSE, and the Bourse would handle all exchange-traded derivative products, including any type of option contracts. Under this agreement, derivative products traded on the TFE were transferred to the Bourse and the TFE ceased all trading in such products effective December 21, 1999.
5 Although CDCC Options are not subject to Exchange Act registration, CDCC on a monthly basis discloses on Form 8-K current information about newly listed and newly delisted CDCC Options. In each of these filings on Form 8-K, CDCC also provides a complete list of all classes of options currently listed for trading on the Bourse. The information disclosed in CDCC's filings on Form 8-K is substantially similar to that disclosed by the OCC on amendments to Form 8-A pursuant to the requirements of the Exchange Act.
6 Exchange Act Release No. 34-44333 (May 22, 2001). The Commission approved the use and distribution of earlier versions of CDCC's ODD in Exchange Act Release No. 34-21365 (October 2, 1984), Exchange Act Release No. 34-22349 (August 21, 1985), Exchange Act Release No. 34-24480 (May 19, 1987), Exchange Act Release No. 34-29033 (April 1, 1991) and Exchange Act Release No. 34-37569 (August 14, 1996).
7 Release Nos. 33-8114; 34-46264 (July 25, 2002)
8 See Exchange Act Release 34-32106 (April 5, 1993). In granting exemptive relief from Exchange Act Rules 15g-2 through 15g-6 and Exchange Act Rule 15g-6 to CDCC Options, the Commission stated:
The Commission notes that in order for [CDCC]-issued options to be traded, the underlying common stock must meet substantial eligibility criteria with respect to public float, minimum trade price, and market capitalization. [CDCC] options are traded on securities exchanges with real-time last sale reporting of these transactions.
The Commission believes that suitability concerns are adequately addressed by Commission and SRO options disclosure and suitability requirements. Moreover, the Canadian provincial authorities are parties to a memorandum of understanding with the Commission that calls for the mutual exchange of information concerning regulatory and enforcement matters.
9 CDCC does receive a Cdn$0.17 clearing fee per CDCC Options transaction cleared from its clearing members.
10 See note 6 supra.