News Story Supplement:
Summary of SEC/CFTC Agreement
- Under the framework, the SEC and the CFTC would jointly regulate the market for single stock futures and narrow-based stock index futures. Products would be free to trade on existing and yet to be established commodities and securities exchanges. Moreover, broker-dealers and futures commission merchants could both trade these products.
- Trading of security futures would not be permitted until one year from enactment. Options on futures could be permitted three years after enactment following the SEC and CFTC jointly determining whether to permit such trading, and jointly studying the framework needed for such options.
- Define "Security Futures" as Securities Under the Securities Laws: The legislative changes proposed under this framework start with a simple premise: single stock futures and narrow-based stock index futures (i.e., security futures) would be statutorily defined as securities. Which indexes are "narrow-based" would be determined by an objective test. From the SEC's perspective, defining these products as securities would trigger the application of key provisions in the securities laws and the regulations thereunder. The proposed legislation then limits the applicability of any provisions that would be duplicative of provisions in the CEA.
- Recognize "Security Futures" as Futures Covered by the CEA: The CEA would be modified to make clear that the CFTC had jurisdiction, but not exclusive jurisdiction, over security futures. The legislation would also limit the application of provisions duplicative of those in the securities laws.
- Require Markets and Intermediaries Trading "Security Futures" to Register: Next, the framework would require markets and intermediaries effecting transactions in these securities to register with the SEC and the CFTC. However, expedited "notice" registration with the SEC would be available to futures markets and intermediaries whose sole securities business consists of these security futures. In addition, such individuals and entities would be exempted from securities law requirements that were duplicative of futures law requirements applicable to such registrants. For example, notice exchange registrants would be exempt from SEC review of exchange fees.
- Similar "notice" registration would be available for securities exchanges and broker-dealers whose only futures business was in security futures. The CEA would be amended to eliminate unnecessary, duplicative regulation of broker-dealers and securities exchanges.
- Exemptions for Floor Brokers and Traders: Certain exchange floor brokers and traders would only have to register with the SEC or CFTC and would not be required to file notice registrations with the other agency.
- While both agencies would have enforcement and examination authority, it would be clear that the CFTC is the lead regulator for futures exchanges and futures commission merchants and that the SEC is the lead regulator for securities broker-dealers and markets. Consultation generally would be required when examinations or enforcement actions were undertaken.
Promote Competition, Market Integrity, and Customer Protection
- The framework incorporates several provisions aimed at promoting competition in and among security futures markets, maintaining market integrity, and protecting customers.
- Linked and Coordinated Clearing: The framework requires linked and coordinated clearing that should encourage listing of the same security future on multiple markets. Implementation of this requirement is delayed until the later of: (i) two years; or (ii) the point in time (as measured by an objective test) when a substantial market exists for such products. This objective test is based on a comparison between the number of shares underlying transactions in single stock futures to the number of shares underlying transactions in equity options.
- Margin: Moreover, margin levels, listing standards, and other key trading practices would be jointly supervised by the SEC and CFTC.
- At the outset, margin levels for security futures products could not be lower than comparable options margin levels, although the levels may be higher than comparable options levels where the futures markets margin systems require it. The SEC and CFTC jointly could issue regulations to establish margin requirements, including the establishment of margin levels and use of collateral for security futures products. If an exchange chose to raise margin levels, such change could be filed pursuant to an expedited rule filing process. Other changes related to margin would be published for comment and reviewed by the SEC.
- Customer Protection: Dual registrants will be subject to the customer protection principles of the futures and securities worlds. A notice registrant's primary regulator and self-regulatory organization will provide initial supervision of its customer protection activities. For example, the National Futures Association and the futures exchanges would be responsible for ensuring compliance with the securities laws applicable to an FCM that is registered with the SEC pursuant to the "notice" registration process. The SEC would have jurisdiction over the NFA by designating the NFA as a special purpose national securities association under section 15A of the Exchange Act. Section 15A would list certain requirements for the NFA in conducting its new role, provide for limited review of NFA rules for security futures, and require that appeals from NFA enforcement actions related to the securities laws be heard by the SEC. In its new role, the NFA would have to promulgate suitability rules.
Tax Treatment and Fees
- Tax Treatment: The bill requires that federal income tax treatment for equity options be equivalent to that for security futures products in order for security futures products to trade beyond a certain date. Absent tax equivalency by January 2003, security futures products could begin trading at such time. However, if equivalent treatment were still not achieved in the subsequent two years (by December 31, 2004), the market in such products would be wound down in an orderly fashion prescribed by the statute until tax parity is achieved. The Secretary of the Treasury will certify whether tax equivalency is achieved.
- Transaction Fees: Section 31 fees would not apply to transactions in security futures products.
Trading of Broad-Based Index Futures
- As noted above, the proposed legislation provides an objective test of whether an index is "narrow-based." The test is based on the number and weighting of the securities in the index rather than a subjective test that requires both the SEC and the CFTC to evaluate such factors as the index's reflection of a substantial segment of the market for all publicly traded equity or debt securities.
- More specifically, an index is generally narrow-based if:
- It has 9 or fewer component securities;
- One security comprises more than 30% of the index's weighting;
- The 5 highest weighted component securities in the aggregate comprise more than 60" of the index's weighting; or
- Any one or combination of securities, in the aggregate, has a dollar value of average daily trading volume of less than $50 million (or in the case of an index with 15 or more component securities, $30 million) and has an aggregate index weight in excess of 25%.
- However, an index that meets one of the above criteria will not be narrow-based, if:
- It has at least 9 component securities;
- No component security comprises more than 30% of the index's weighting; and
- Each component security is registered pursuant to section 12 of the Exchange Act; is one of the 750 securities with the largest market capitalization; and is one of the 675 securities with the largest dollar value of average daily trading volume.
This test is meant to identify indexes that only include significant securities.
- In establishing an objective test for determining whether an index is "narrow-based," the bill eliminates prior SEC authority to veto a CFTC determination that an index is "broad-based." However, if the CFTC determines that an index might be a security surrogate, even if it is not "narrow-based" under the numerical test, the CFTC can designate a future on such an index for regulatory treatment as a security futures product subject to the securities laws and sections of the CEA applicable to such products.