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III. Discussion
Deutsche Börse believes that a foreign exchange that is subject to regulation by its home country securities regulatory authority should be permitted to offer U.S. broker-dealers and other sophisticated U.S. investors a direct link to its trading facilities without submitting to significant substantive regulation in the United States.
The fact that foreign exchanges are not subject to a regulatory regime comparable to that of U.S. national securities exchanges should not continue to bar registered broker-dealers and highly sophisticated U.S. investors from trading directly on foreign exchanges. [ See Section VII.A.2 of the Concept Release.] U.S. investors who have the necessary sophistication and motivation to seek access to a foreign exchange cannot reasonably expect that transactions in the foreign exchange will be subject to a regulatory regime identical to the system maintained under the U.S. securities laws. Limiting direct access to foreign exchanges to registered broker-dealers and certain other "qualified U.S. persons" would further ensure that only market participants sufficiently sophisticated to appreciate the differences across regulatory regimes would have the ability to effect transactions directly on a foreign exchange.
It is also important to note that U.S. investors are currently able to effect transactions on foreign exchanges with the intermediation of a U.S. broker-dealer, albeit less efficiently. Many highly sophisticated U.S. investors therefore already have significant experience with transactions on foreign exchanges and have a strong interest in less costly, direct access to foreign exchanges.
A. Comparison of Various Approaches for Regulating Foreign Exchange Activities in the United States
Deutsche Börse believes that reliance upon a foreign exchange’s home country regulation, in connection with certain additional requirements discussed in this letter, is the most appropriate method of regulating the limited activities of foreign exchanges in the United States. [ See Question 105.] As discussed in greater detail below, reliance on home country regulation allows qualified U.S. persons to make their own judgments as to the efficiency, soundness and fairness of foreign exchanges while respecting international principles of comity, national sovereignty and the Commission’s jurisdictional limitations.
In a similar vein, Deutsche Börse would not be averse to the adoption of a nominal registration requirement for foreign exchanges with limited activities in the United States, provided that such registration would entail minimal U.S. substantive requirements in addition to existing home country regulatory requirements — e.g., basic reporting and notification requirements. As with sole reliance on home country regulation, such an approach would substantially defer to the foreign exchange’s home country securities regulatory authority as to the efficiency, soundness and fairness of the operations of the foreign exchange, yet retain for the Commission some degree of monitoring of the U.S. activities of the foreign exchange. The Commission’s proposal to regulate foreign exchanges (or their access providers) as "securities information processors" ("SIPs") under Section 11A of the Exchange Act, for example, describes one framework by which, if appropriately limited, the Commission could monitor a foreign exchange’s U.S. activities without imposing additional costly and potentially duplicative or contradictory regulatory requirements.
Deutsche Börse does not, however, believe that requiring foreign exchanges to register with the Commission as national securities exchanges would, as practical matter, allow foreign exchanges to provide U.S. members with efficient direct access to their trading facilities. Even with the benefit of any exemptive relief the Commission may choose to grant pursuant to its new authority under Section 36 of the Exchange Act, the procedural burdens and costs of submitting to a second regulatory regime, with different information disclosure standards and recordkeeping and other regulatory requirements, will deter foreign exchanges that contemplate only limited activities in the United States from offering membership to registered broker-dealers and highly sophisticated investors in the United States. [ See Division of Market Regulation, Securities and Exchange Commission, Market 2000: An Examination of Current Equity Market Developments VII-4 (1994) ("(T)he limited presence of a foreign exchange that is adequately regulated abroad may not warrant the full application of rules designed to regulate U.S. exchanges.").]
Moreover, Deutsche Börse does not believe it would be necessary or desirable to impose special registration requirements on a registered broker-dealer or a foreign broker-dealer otherwise exempt from registration pursuant to Rule 15a-6 under the Exchange Act because it provides U.S. investors with access to a foreign exchange through its facilities.
1. Reliance on foreign exchanges’ home country regulation
As noted above, Deutsche Börse believes that reliance upon a foreign exchange’s home country regulation, in connection with certain additional requirements discussed in this letter, is the most appropriate method of regulating the limited activities of foreign exchanges in the United States.
Reliance on home country regulation of foreign exchanges presents many advantages over the other alternatives considered by the Commission in the Concept Release. Home country regulation would ensure that each foreign exchange is regulated by a foreign securities authority with direct access to all of its records and trading facilities. Having a single regulator assume responsibility for supervising a particular exchange relieves exchanges from the threat of duplicative or inconsistent regulatory regimes and enables such exchanges to provide more efficient service to their participants.
Moreover, deference to foreign regulatory regimes with regard to the regulation of markets and market participants under their jurisdiction respects cultural differences, national sovereignty concerns and international principles of comity and is consistent with the trend toward globalization of securities markets under increasingly higher regulatory standards.
Reliance on home country regulation has been embraced by a significant number of foreign jurisdictions facing the same concerns regarding the operation of non-national electronic exchanges and other markets within their borders. As the Commission is aware, the European Union (the "EU") has endorsed the principle of home country regulation in its directive on investment services in the securities field (the "Investment Services Directive" or the "ISD"). [ Council Directive 93/22/EEC, 1993 O.J. (L 141) 27 (May 10, 1993).] The EU’s system of mutual recognition and reliance on home country regulation, combined with a requirement that EU members develop certain minimum standards of regulation, eliminates unnecessary layers of regulation while ensuring that markets and market participants are subject to a basic, uniform standard of supervision. [ Under the Investment Services Directive, EU investment firms and banks located in one member state (the "home" state) may obtain an EU-wide "passport" allowing them to establish branches or provide cross-border services in another member state (the "host" state), as well as to access the "regulated markets" of the host state, without registering with the host state’s securities regulatory authorities. The ISD passport thus enables EU investment firms to do business throughout the EU free from host state licensing requirements, but does not exempt firms from the application of host state codes of conduct. A "regulated market" is defined to mean a market for specific financial instruments (which are listed in an annex to the Investment Services Directive) that -- i. is certified by its home country as being in compliance with the home country’s market regulations; ii. functions regularly; iii. is characterized by the fact that regulations issued or approved by the home country’s designated securities regulatory authorities define the conditions for the operation of the market, the conditions for access to the market, and the conditions governing admission to listing promulgated in a prior Council directive (Council Directive 79/279/EEC, 1979 O.J. (L 66) 21 (Mar. 16, 1979), as amended) or the conditions that must be satisfied by a financial instrument before it can effectively be dealt in on the market; and iv. requires compliance with all the reporting and transparency requirements laid down in the Investment Services Directive. Investment Services Directive art. 1(13). Furthermore, EU-designated "regulated markets" that are technologically capable of supporting screen-based trading are permitted, under the terms of the Investment Services Directive, to provide terminals and other "appropriate facilities" to member firms located in other EU member states (commonly referred to in EU parlance as "remote membership") without submitting to regulation by such firms’ "home" member states. See id . art. 15(4).]
We believe that registered broker-dealers and other qualified institutional buyers should be permitted to become members of foreign exchanges that meet the requirements for "qualified foreign exchanges" discussed in Part III.B.1 of this letter. In Deutsche Börse’s view, such "qualified U.S. persons" are able to make their own judgments as to the efficiency, soundness and fairness of foreign exchanges. Each prospective member should have the discretion to determine whether a particular foreign exchange is adequately regulated to meet its needs, in light of the nature of the transactions it wishes to effect thereon. [ Among the key considerations that a qualified U.S. person is likely to take into account in evaluating the efficiency, soundness and fairness of a foreign exchange are the following: Reporting of securities transactions on a regular basis to a governmental authority or self-regulatory body of its home country; Maintenance of an adequate system for exchange of price quotations through common communications media; Use of an organized clearance and settlement system subject to adequate regulation by a governmental authority of its home country; Supervision of insider trading by a governmental authority or self-regulatory body of its home country; and Existence of codes of conduct for members of the foreign exchange and other investment firms in the established by a governmental authority or self-regulatory body of its home country. Some of these features, for example, are used to determine whether a foreign securities exchange or other foreign market should qualify as a "designated offshore securities market" for purposes of Regulation S under the Securities Act. See Rule 902(a)(2) of Regulation S. Other analogous criteria may be found in interpretive letters issued by the Division of Market Regulation deeming a "ready market" to exist for certain securities on principal exchanges in the major money markets outside the United States so that such foreign securities may receive haircuts similar to comparable U.S. securities traded on U.S. markets for purposes of net capital calculations under Exchange Act Rule 15c3-1. See , e.g. , Letter from Nelson S. Kibler to Anthony M. O’Connor, Co-Chairman, International Committee, Securities Industry Association (Dec. 29, 1975).]
The Commission has previously accorded market participants similar discretion to evaluate the protections offered by foreign securities regulatory regimes. For example, Rule 17f-5 under the Investment Company Act of 1940 grants registered investment funds the discretion to determine whether a foreign custodian is capable of providing reasonable care for the custody of securities. [ Specifically, Investment Company Act Rule 17f-5 permits an investment fund to select a foreign custodian for its foreign assets based on a determination by its board of directors (or its delegate) that fund assets maintained by the foreign custodian will be subject to "reasonable care". The "reasonable care" standard is defined by reference to several enumerated factors relevant to the safekeeping of such assets, including the custodian’s practices, procedures and internal controls, the custodian’s financial strength and the custodian’s general reputation and standing, as well as the fund’s ability to exercise jurisdiction over and be able to enforce judgments against the custodian.] As in the context of the Investment Company Act, Rule 144A qualified institutional buyers — many of whom are themselves regulated entities under U.S. federal and state laws [ For example, insurance companies, investment companies and state and ERISA employee benefit plans may be required to meet specific standards of care with respect to the investment of funds under their management.] — that seek direct access to foreign exchanges for proprietary trading have significant incentives to ensure that foreign exchange access is efficient, sound and fair. To the extent that registered U.S. broker-dealers assume certain duties to their customers when trading on their behalf, such broker-dealers likewise have compelling incentives fully to consider the risks inherent in cross-border trading before recommending transactions on certain foreign exchanges or in certain foreign securities. [ See Exchange Act Sections 10(b), 15(c)(1) and 15(c)(2). ]
2. Registration of foreign exchanges or access providers to foreign exchanges as securities information processors
Deutsche Börse would also not be averse to an approach to monitoring the activities of foreign exchanges in the United States that would require foreign exchanges to register with the Commission as "securities information processors" and to comply with certain minimal substantive requirements respecting their U.S. activities. Deutsche Börse does not, however, believe that a registered U.S. broker-dealer or foreign broker-dealer operating pursuant to an exemption from registration under Rule 15a-6 should be required additionally to register as an "access provider" if it provides U.S. investors with automated access to trading opportunities on a foreign market.
a. Regulation of foreign exchanges as SIPs
Under the Commission’s proposal for regulating foreign exchanges (or their access providers) as SIPs in Section VII.B.3.a of the Concept Release, a foreign exchange such as the FWB or the DTB (or Deutsche Börse, as their administering institution) could either register as a SIP or channel transactions with U.S. counterparties through an independent access provider registered with the Commission. Such a SIP-registered entity would then be required to comply with certain minimal regulatory requirements to afford the Commission some degree of oversight of the U.S. activities of the foreign exchange.
If such a regulatory framework could be structured substantially to imitate a home country regulation reliance regime, Deutsche Börse believes that such an approach would not be objectionable, as long as it were understood that the Commission would not use the registration requirement to impose substantial substantive regulation on the foreign exchanges that would duplicate or contradict its home country regulatory requirements. [ Deutsche Börse would expect that, in adapting the SIP registration model to the registration of foreign exchanges in the United States, the Commission would be able to devise a registration form and procedure that is considerably scaled down from the requirements now imposed on exclusive SIPs in Rule 11Ab2-1 under the Exchange Act and Form SIP promulgated pursuant to this rule.]
Such a regulatory framework might, in Deutsche Börse’s view, require a SIP-registered entity to ensure, among other things, that:
• the foreign exchange to which it provides access is a "bona fide" foreign market;
• the home country securities regulatory authority of the foreign exchange has a memorandum of understanding or similar understanding in place with the Commission for the sharing of information regarding, among other subjects, securities trading and for cooperation in investigations of manipulative or abusive practices involving trading on such foreign exchanges;
• the foreign exchange has an agreement in place with the Commission for the provision of certain reports and other information as described further below; [ See infra Part III.B.1.b.ii.]
• access to direct trading on the foreign exchange is limited to U.S. registered broker-dealers and other sophisticated U.S. institutional investors; and
• the foreign exchange operates primarily as a vehicle for the trading of securities, or derivative instruments based on securities, issued by issuers organized outside the United States.
Deutsche Börse believes that recordkeeping, access, disclosure and antimanipulation requirements in addition to those imposed by the foreign exchange’s home country are likely to be unnecessarily duplicative. In Deutsche Börse’s experience, U.S. broker-dealers and other sophisticated investors already recognize that trading on non-U.S. markets is not subject to the same practices as trading on U.S. markets. It is Deutsche Börse’s view that such sophisticated market participants would be able to make their own judgments as to the sufficiency of the recordkeeping, access, disclosure and antimanipulation requirements of the foreign exchange in determining whether to trade on the foreign exchange through direct membership rather than through a foreign broker-dealer member of the exchange.
Requiring registration of a foreign exchange, even as a SIP — as opposed to relying on home country regulation and cooperative agreements with the Commission — would nevertheless expose foreign exchanges to the possibility that the Commission might increase the substantive regulation applicable to such registered entities over time without sufficient assurances that such additional regulation would not conflict with or duplicate home country regulatory requirements or unduly increase the regulatory burden of the foreign exchange. Deutsche Börse would therefore urge the Commission, if it considers adopting the SIP registration approach, to bear in mind the rigorous regulation to which many foreign securities exchanges are subject and to avoid taking advantage of such a jurisdictional "hook" to subject foreign exchanges to unnecessary regulation.
b. Regulation of broker-dealers as access providers
Deutsche Börse does not believe it is necessary or desirable to require registered broker-dealers or foreign broker-dealers operating in the United States pursuant to an exemption under Rule 15a-6 under the Exchange Act separately to register as access providers simply because they provide U.S. investors with on-line access to a foreign exchange.
(i) Registered broker-dealers
As the Commission notes, registered broker-dealers are already subject to most of the recordkeeping, reporting and antifraud requirements that the Commission proposes to apply to regulated access providers. [ See Concept Release, 62 Fed. Reg. at 30,526 n.241.] U.S. broker-dealers therefore would continue to assume responsibility for compliance with all aspects of U.S. securities laws regardless of whether they were required separately to register as SIPs.
The principal regulatory objective identified by the Commission in proposing regulation of access providers that are already registered with the Commission as broker-dealers is disclosure of additional risks relating to trading on foreign exchanges. [ See id .] Any additional information that the Commission might wish to have foreign exchange access providers disclose could be incorporated into existing rules governing broker-dealer conduct, if necessary, without imposing any additional registration requirement on registered broker-dealers. [ Cf . Exchange Act Rule 17a-23, which was adopted to require disclosure of certain trading information applicable to automated trading systems sponsored by registered broker-dealers.]
(ii) Foreign broker-dealers
Likewise, foreign broker-dealers who provide on-line access to a foreign exchange to U.S. investors should not be required to register with the Commission as broker-dealers or broker-dealer access providers, provided that all transactions executed on the foreign exchange through such on-line access continue to be intermediated by a registered U.S. broker-dealer pursuant to Rule 15a-6 under the Exchange Act. [ See Question 116.] It would be duplicative to require such registration by a foreign broker-dealer in connection with such transactions, given that a U.S. broker-dealer intermediating a transaction between a U.S. counterparty and a foreign broker-dealer is currently required, among other things:
• to ensure compliance with the basic requirements of the U.S. securities laws for the protection of U.S. counterparties, including maintenance of books and records with respect to intermediated transactions; [ A registered U.S. broker-dealer acting as an intermediary in a transaction between a U.S. counterparty and a foreign broker-dealer is responsible for (1) effecting the transaction; (2) issuing all required confirmations and statements; (3) extending or arranging for the extension of any credit to the U.S. counterparty; (4) maintaining required books and records relating to the transactions; (5) complying with the Commission’s net capital rule with respect to the transaction; and (6) receiving, delivering and safeguarding funds and securities in connection with the transaction on behalf of the U.S. counterparty in compliance with the Commission’s customer protection rule. See Exchange Act Rule 15a-6(a)(3)(iii)(A).
Pursuant to no-action relief granted by the Commission earlier this year, clearance and settlement of transactions involving certain foreign securities or U.S. Government securities may occur through the direct transfer of funds and securities between a U.S. investor and a foreign broker-dealer in situations where the foreign broker-dealer is not acting as custodian of the funds or securities of the U.S. investor in certain circumstances. See Cleary, Gottlieb, Steen & Hamilton (Apr. 9, 1997).]
• to determine that the foreign broker-dealer is not subject to any statutory disqualification or substantially equivalent foreign disciplinary action in its home country and has not been the subject of certain civil and criminal proceedings; [ See Exchange Act Rule 15a-6(a)(3)(ii)(B).] and
• to obtain written consent to service of process from the foreign broker-dealer for any civil action brought before the Commission or a self-regulatory organization. [ See Exchange Act Rule 15a-6(a)(3)(iii)(D).]
To the extent that the Commission would deem it useful for additional records to be kept in connection with transactions effected by registered broker-dealers on a foreign exchange, it would be more practicable to incorporate such additional recordkeeping requirements into the current requirements applicable to registered broker-dealers rather than to adopt separate registration requirements for the foreign broker-dealer.
3. Registration as national securities exchanges
Imposing a U.S. exchange registration requirement on foreign securities exchanges with limited activities in the United States may, as the Commission recognizes, [ See Section VII.B.2 of the Concept Release.] represent an impossible burden for most foreign exchanges and their members. [ See Question 107.] Some registration requirements, such as the requirement that national securities exchanges deny membership to broker-dealers and natural persons not associated with registered broker-dealers, [ See Exchange Act Section 6(c)(1).] are entirely inappropriate for application to foreign exchanges and would have to be amended, by exemption or otherwise, if registration is to be required of foreign exchanges. Other requirements, such as the requirement that proposed exchange rules and rule changes be approved by the Commission, [ See Exchange Act Section 19(b) and (c).] would often conflict with the foreign exchange’s home country regulatory requirements. Still others, such as the recordkeeping and reporting requirements applicable to registered exchanges, would impose unnecessarily duplicative and costly demands on foreign exchanges that will hinder their ability to provide efficient access to U.S. market participants.
Requiring securities exchanges organized and regulated outside of the United States to submit to a second comprehensive exchange regulation regime because they would like to extend membership to registered broker-dealers and highly sophisticated U.S. investors may also be considered an unjustifiable extraterritorial exercise of the Commission’s jurisdiction. Such action could lead foreign countries to impose reciprocal restrictions on U.S. exchanges seeking to attract participation by foreign investment firms and investors and thus ultimately undermine efforts to promote the establishment of an adequately regulated global infrastructure for the international securities market. [ At present, for example, Germany does not require non-German exchanges to become licensed as exchanges by virtue of their having German members and a limited presence in Germany.]
Moreover, many of the additional requirements to which foreign exchanges would be required to submit, if registration were required, would place a significant administrative burden on the Commission with very little, if any, marginal benefit for the Commission that could not be readily obtained through compliance with the specific reporting and other conditions that could be imposed in connection with reliance on home country regulation. For example, if the Commission chose to require foreign exchanges to register as national securities exchanges, it would be faced with numerous questions of how to exempt or adapt existing exchange registration requirements for foreign exchanges, especially when such foreign exchanges contemplate only limited contacts with the United States. Similarly, if the Commission requires foreign exchanges to register as national securities exchanges, qualified U.S. persons that sought to participate directly in such exchanges would become subject to the numerous provisions governing the activities of "members" of national securities exchanges contained in the Exchange Act, thereby necessitating additional exemptive relief for such foreign exchange members. [ See Exchange Act Sections 3(a)(3)(A) and 6(f).]
4. Exemptive relief from the exchange registration requirement
Although exemptive relief may relieve foreign securities exchanges of some of the burdens of submitting to U.S. exchange regulation, the process of obtaining and maintaining an exemption from the exchange registration requirements of the Exchange Act is likely to be prohibitively expensive and time-consuming for a foreign exchange that only contemplates limited activities in the United States.
Established foreign exchanges are unlikely to have the necessary flexibility, from a foreign regulatory perspective, to adapt their exchange rules and operating procedures to comply with any technical requirements that the Commission may require even when, on the whole, such markets provide U.S. investors with effective investor protection mechanisms. Crafting specific exemptions to accommodate individual foreign exchanges that do not meet established criteria, moreover, could expose the Commission, as well as any foreign exchanges to whom such exemptions may be granted, to recurring and costly litigation.
Moreover, even if the Commission were to adopt a "facts and circumstances" approach to granting exemptive relief — under which the Commission would presumably consider the effectiveness, soundness and fairness of each foreign exchange as a whole rather than requiring every foreign exchange to meet certain minimum criteria — foreign exchanges would be required to apply for additional relief each time they adopted new features and trading facilities over time or increased their activities in the United States. Such repeated requests for relief would inordinately limit the flexibility and competitiveness of foreign exchanges and would ultimately discourage foreign exchanges from offering membership to qualified U.S. persons.
For example, the experience of the Arizona Stock Exchange with the limited volume exemption [ See Exchange Act Section 5.] suggests that the degree of Commission involvement that is likely to be imposed on an exchange applying for an exemption from the application of the Exchange Act would be overly burdensome to a foreign exchange contemplating only limited activities in the United States. The past unwillingness of foreign exchanges and other markets to apply for limited volume exemptions under Section 5 of the Exchange Act further indicates that such procedural limitations, even with the Commission’s broader exemptive power with respect to the substantive application of the provisions of the Exchange Act, would likely impose prohibitive costs and excessive delays in providing U.S. investors with access to trading on their facilities. [ The application of the Arizona Stock Exchange (formerly Wunsch Auction Systems, Inc.) was apparently the first limited volume exchange exemption request of any kind processed by the Commission in 54 years. See Wunsch Auction Systems, Inc., Exchange Act Release No. 28,899 (Feb. 20, 1991) (granting a limited volume exemption from registration as an exchange under Section 5), 56 Fed. Reg. 8377, 8378 n.12 (Feb. 28, 1991).]
B. Proposed Conditions for Reliance Upon a Scheme of Home Country Regulation or Minimal U.S. Regulatory Supervision
Deutsche Börse believes that a foreign securities exchange should be regarded as a "qualified foreign exchange" and be permitted to extend membership to qualified U.S. persons in reliance upon its home country regulation — either based on a cooperative agreement with the Commission or, alternatively, pursuant to a minimal U.S. regulatory framework applicable to such foreign exchanges, as described in Parts III.A.1 and III.A.2 of this letter, respectively — if the foreign exchange represents to the Commission that it meets certain basic conditions relating to its structure and operations and complies with certain reporting and other requirements.
1. Conditions for "Qualified Foreign Exchanges"
a. Conditions relating to the structure and operations of the foreign exchange
To be considered a "qualified foreign exchange", we believe that a foreign exchange should represent to the Commission that it meets the following conditions relating to its organization and membership. [ See Question 106.]
i. Organization and primary operation outside the United States. The foreign exchange should be able to represent to the Commission that it is organized and primarily operated outside the United States and that a foreign securities authority is responsible for comprehensively overseeing its global operations and activities. In this regard, the foreign exchange should be required to represent that it: [ See Question 118.]
• is incorporated under the laws of its home country and maintains its headquarters in its home country;
• is regulated by its home country securities regulatory authority;
• operates primarily as a vehicle for the trading of securities, or derivative instruments based on securities, issued by issuers organized outside the United States; and
• draws its primary membership from a generally recognized community of brokers, dealers, banks or other professional intermediaries outside the United States with an established operating history outside the United States.
ii. Limited physical presence in the United States. To avoid becoming subject to the exchange registration requirement, the foreign exchange should be required to represent to the Commission that it maintains no more than a limited physical presence in the United States. In general, we believe that the provision of limited facilities in the United States to facilitate direct access to trading on foreign exchanges by members who are qualified U.S. persons should not require a foreign exchange to register as a national securities exchange if the foreign exchange or its home country securities regulatory authority adequately supervises the extraterritorial activities of the foreign exchange.
For example, we believe that the "limited presence" of telecommunications devices maintained by a foreign exchange in the United States, such as user terminals and network access devices and communications servers, should not require the foreign exchange to register as a national securities exchange. [ See Question 120. The establishment and maintenance of a representative office of a foreign exchange in the United States should similarly not give rise to a determination that the foreign exchange has established a sufficiently significant presence in the United States to be required to register as a national securities exchange. Such offices would typically engage in promotional activities and other activities ancillary to the limited operation of a foreign exchange in the United States. The Division has previously extended no-action relief to one foreign exchange permitting it to maintain a representative office in the United States without registering as a national securities exchange. See London International Financial Futures Exchange (May 1, 1992).] The use of exchange-owned or exchange-leased equipment is a salutary measure designed to ensure that trade execution instructions and confirmations, as well as transaction and quotation information, are disseminated across the exchange network accurately, securely and reliably. Unlike markets that permit any user potentially to access its trading facilities on-line through the Internet or though unsecured telecommunications lines, the use of proprietary equipment minimizes the risk that either members or non-members might undermine the integrity of the trading system and the foreign exchange.
Other regulatory regimes have appreciated the difference between the presence of trading terminals in a country and the presence of an actual market subject to the jurisdiction of that country’s regulatory regime. The Investment Services Directive, for example, provides that an EU "regulated market" that operates "without any requirement for a physical presence" should be allowed to provide "appropriate facilities" within the territories of other EU member states, without itself registering as a market in such other member states, in order to enable their investment firms to become "remote members" of or have access to such regulated market. [ See Investment Services Directive art. 15(4); supra note 11 .]
The presence of foreign exchange equipment in the United States, however, might be subject to limited monitoring by the Commission. To this end, the Commission might therefore require foreign exchanges that do provide terminals in the United States to provide the Commission with periodic reports covering the location of such terminals, the persons who are authorized to trade in the foreign exchange using such terminals, and the location of any network devices used to connect terminals to the foreign exchange.
iii. No evasion of the U.S. exchange registration requirement. The foreign exchange should be required to represent to the Commission that it has not been organized outside the United States for the purpose of "evading" the U.S. exchange registration requirements. For example, a foreign exchange that meets the criteria outlined above and yet a majority of whose membership consists of U.S. persons or whose executive bodies are determined to be "controlled" by U.S. persons, should, in Deutsche Börse’s view, not be considered a "qualified foreign exchange" and should be required to register with the Commission as a national securities exchange. [ See Question 119.] The fact that U.S. persons may become members of a foreign exchange and participate in decisions regarding trading, rules, practices or procedures on equal terms as non-U.S. members, of course, should not in itself cause a foreign exchange to become subject to the exchange registration requirement.
b. Conditions respecting reporting and other requirements
To offer membership to prospective U.S. members, we believe that a "qualified foreign exchange" should comply with the following additional reporting and other requirements for the protection of U.S. investors. [ See Question 106.]
i. Memorandum of understanding between the Commission and foreign securities authorities. The foreign exchange’s home country securities regulatory authority should have a memorandum of understanding or a similar understanding in place with the Commission for the sharing of information regarding securities trading and for cooperation in investigations of manipulative or abusive practices involving trading on such foreign exchanges. Having such an understanding in place with a foreign exchange’s home country securities regulatory authority would give the Commission the right to seek assistance from such authority in connection with any Commission investigation involving a potential violation of U.S. securities laws on such foreign exchange. [ See Questions 122-123. The Commission may wish to consider periodically publishing a list of all foreign securities authorities with which it has an adequate understanding in place for these purposes.]
ii. Agreement between the Commission and the foreign exchange. The foreign exchange should be required to enter into a satisfactory agreement with the Commission that requires the foreign exchange to:
• provide quarterly reports to the Commission regarding the volume of trading involving U.S. members as compared to overall trading volume on the foreign exchange;
• provide the Commission with all information received from U.S. members in its possession regarding the location of U.S. member terminals and to update such information upon reasonable request;
• provide notice, upon request, of any material changes to the securities laws and regulations of its home country affecting the operations of the foreign exchange; and
• provide notice of any material changes to the constitution, rules or operating procedures of the foreign exchange.
Such an agreement between the foreign exchange and the Commission would enable the Commission to obtain information relevant to a Commission investigation involving a potential violation of U.S. securities laws. [ See Question 130. To help prospective U.S. members determine whether a foreign exchange is in compliance with such reporting and notification requirements, the Commission may wish to consider periodically publishing a list of all foreign exchanges with which the Commission has an adequate agreement in place for these purposes.]
Requiring the foreign exchange to submit certain periodic reports to the Commission — such as quarterly reports regarding the volume of trading involving U.S. members trading through terminals located in the United States or disclosing the location of U.S. member terminals — would provide the Commission with sufficient information regarding the U.S. activities of a foreign exchange, on the basis of which it could solicit additional information from the home country securities regulatory authority of the foreign exchange, if necessary, to investigate unusual trading activity involving U.S. members.
Moreover, requiring the foreign exchange to notify the Commission, upon request, of any material changes in the securities laws or regulations under which it is supervised that would affect the operations of the foreign exchange, as well as any material changes in its constitution, rules or operating procedures, would ensure that the Commission and U.S. members are apprised of any material developments affecting the foreign exchange or its U.S. activities.
We do not believe that it would be desirable to require disclosure of information regarding the differences between trading on a foreign exchange and U.S. markets by virtue of permitting direct membership by U.S. broker-dealers and other sophisticated institutional investors in the foreign exchange. [ See Questions 132-134.] The "qualified U.S. persons" that we have suggested should be permitted to become members of foreign exchanges are sufficiently sophisticated to appreciate the differences between U.S. and foreign exchange operations and would have significant incentives to perform the requisite diligence in the membership application process to obtain any information that they believe may be relevant to trading activities in which they would propose to engage on a foreign exchange. This due diligence exercise should enable these "qualified U.S. persons" to obtain even more information about such differences than would be readily available if these persons were limited to trading indirectly on the foreign exchange through foreign broker-dealer members.
2. "Qualified U.S. Persons"
In light of the significant variety of foreign securities regulatory regimes, direct membership in qualified foreign exchanges should be limited to U.S. registered broker-dealers and U.S. investors who possess the necessary sophistication to trade in unregistered foreign securities as well as to appreciate the differences between U.S. and foreign exchange regulatory regimes. [ See Questions 124-125.]
It would be appropriate, in our view, to limit the universe of permissible members in qualified foreign exchanges to registered broker-dealers and other U.S. persons that qualify as Rule 144A "qualified institutional buyers". As the Commission has noted, entities that meet the criteria of Rule 144A (as well as "major institutional investors" as defined in Rule 15a-6 under the Exchange Act) are more likely to have prior experience in foreign markets that would provide insight into the reliability of those markets and their participants. [ See Securities Act Release No. 6806 (Oct. 25, 1988), 53 Fed. Reg. 44,016, 44,028 (Nov.1, 1988) (proposing changes to the method of determining the holding period for restricted securities under Rules 144 and 145).] In addition, trading in unregistered securities on foreign exchanges by "qualified institutional buyers" would be significantly less likely to result in any inadvertent violations of the Securities Act.
C. Addressing the Differences Between U.S. and Foreign Listed Company Disclosure Standards
Deutsche Börse is sensitive to the Commission’s concern that the availability of membership in, and direct access to, foreign exchanges by non-U.S. broker-dealers and other sophisticated institutional investors could result in increased U.S. investor holdings of foreign securities whose issuers are exempt from the reporting requirements of the Exchange Act. In Deutsche Börse’s view, however, the Commission should not eliminate the exemption from the Exchange Act’s reporting requirements currently available to foreign issuers under Rule 12g3-2(b) under the Exchange Act without simultaneously relaxing U.S. disclosure requirements (and particularly, the requirement that financial statements be prepared in accordance with U.S. generally accepted accounting principles) that would apply to foreign issuers that wish to register offerings of securities in the United States under the Securities Act. [ See Question 138.]
The principle of deference to home country regulation embodied in Rule 12g3-2(b) was designed to strike a balance between the Commission’s goal of maximizing disclosure by foreign issuers whose securities trade in the U.S. secondary market and the jurisdictional and practical limitations on regulating foreign issuers when U.S. investors affirmatively seek to trade in their securities. [ See 2 Louis Loss & Joel Seligman, Securities Regulation 776-785 (3d ed. 1990).] Rule 12g3-2(b) allows an unlimited number of U.S. persons to hold unregistered foreign securities that are not listed on a national securities exchange or quoted on Nasdaq, provided that the issuer of such securities provides the Commission with any materials required to be made public under the laws of its home country, filed with any stock exchange or distributed to its securities holders. Rule 12g3-2(b) thus ensures that U.S. investors trading in unregistered foreign securities have access to, at a minimum, all the information that has been disclosed to foreign securityholders.
Deutsche Börse recognizes that the opportunity for more efficient trading in foreign securities by U.S. persons through direct access to, or membership in, foreign exchanges may, in combination with the safe harbors provided by Rule 144A and Regulation S under the Securities Act, ultimately result in an increase in U.S. holdings of unregistered foreign securities. Deutsche Börse believes, however, that U.S. registered broker-dealers and other sophisticated U.S. institutional investors who wish to trade foreign securities through direct membership in a foreign exchange would reasonably expect that they would be entering into such transactions on the basis of the home country disclosure that is available to all other members of the exchange. It would, obviously, be impracticable to require that all issuers who have listed shares on the foreign exchange be required to submit to U.S. disclosure standards solely by reason of allowing direct membership in the foreign exchange by U.S. registered broker-dealers and other sophisticated institutional investors. [ See Edward F. Greene et al., Hegemony or Deference: U.S. Disclosure Requirements in the International Capital Markets , in Symposium on the Regulation of Capital Markets , 50 Bus. Law. 413 (1995). ]
Repealing or otherwise narrowing the scope of Rule 12g3-2(b) without reconsidering the appropriate level of disclosure to be required of foreign issuers would also unfairly disadvantage the significant number of foreign issuers whose securities are currently held by U.S. investors in reliance upon the Rule. [ As of January 23, 1997, approximately 1,170 foreign private issuers have submitted Rule 12g3-2(b) filings to the Commission. See Exchange Act Release No. 38,235 (Feb. 4, 1997), 62 Fed. Reg. 6018 (Feb. 10, 1997). ]
Over the long term, Deutsche Börse would encourage the Commission to permit foreign issuers to register offerings of securities in the United States based on disclosure meeting internationally accepted standards, or alternatively, on the basis of home country disclosure satisfying certain basic U.S. disclosure standards. [ We do not believe that companies required to report periodic information to the Commission pursuant to Section 12 of the Exchange Act are likely to experience any significant negative consequences if foreign securities are offered in the United States on the basis of a relaxed disclosure standard, given the already substantial number of securities issued by non-U.S. issuers in the United States in secondary trading pursuant to Rule 144A, Regulation D and Regulation S. See Question 142.] Identifying minimum standards of compliance — such as basic accounting disclosures, consolidated financial documentation and minimum frequency of reporting — would encourage foreign countries to continue to improve their home country disclosure regimes. Such efforts may also lead to an eventual international harmonization of accounting standards. [ We note in this regard that a Working Party of the International Organization of Securities Commissions ("IOSCO"), with the participation of the SEC staff, has made substantial progress in developing a set of disclosure standards for use by companies in connection with cross-border public offerings and listings ( i.e. , directed to one or more countries other than the issuer’s home country) of equity shares. See Working Party No. 1, IOSCO, International Disclosure Standards for Cross-Border Offerings and Initial Listings by Foreign Issuers (draft dated July 2, 1997). The standards are generally intended to be used for prospectuses, offering documents, initial listing particulars and registration statements.]
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