CFTC Staff Issues Advisory on Trading of Foreign Security Futures, but Availability Remains Limited
On June 8, 2010, the Commodity Futures Trading Commission’s (“CFTC”) Division of Clearing and Intermediary Oversight (“DCIO”) issued an Advisory regarding the extent to which certain sophisticated customers located in the United States may transact in foreign security futures products (“FSFP”). The Securities and Exchange Commission (“SEC”) issued an Order on this subject about a year ago, on June 30, 2009, as described in a previous K&L Gates Alert.
The SEC’s Order permits only qualified institutional buyers (“QIBs”) and non-U.S. persons to trade FSFPs through registered securities brokers or dealers or banks. (A QIB is defined in Rule 144A under the Securities Act of 1933, 17 C.F.R. §230.144A, and generally requires that the en-tity, acting for its own account or the accounts of other QIBs, in the aggregate owns and invests on a discretionary basis at least $100 million in securities of issuers that are not affiliated with the entity.) The registered securities brokers or dealers covered by the SEC Order include “No-tice Broker-Dealers,” which are futures commission merchants (“FCMs”) or introducing brokers that register with the SEC as a broker or dealer pursuant to Section 15(b)(11) of the Securities Exchange Act of 1934 (“Exchange Act”), and whose only securities-related activity involves se-curity futures. In addition, a foreign broker or dealer could effect transactions pursuant to the SEC Order if it is exempt from U.S. broker-dealer registration by Rule 15a-6 under the Exchange Act or alternative exemptions from the registration requirements under Exchange Act Section 15(a)(1) that the SEC also issued on June 30, 2009.
The limited relief provided by the SEC Order leaves numerous persons that qualify as “eligible contract participants” (“ECP”) under the Commodity Exchange Act (“CEA”), but do not satisfy the $100 million QIB investment threshold, unable to lawfully trade FSFPs. These persons may have real needs for risk management based upon exposures in foreign financial markets or to the economic conditions in other countries, or may want to gain some exposure to those markets as part of the asset allocation in their investment portfolio.
The new DCIO Advisory does not expand the availability of trading in FSFPs for U.S. investors. The DCIO Advisory notes that, although the CEA permits ECPs to trade FSFPs to the same ex-tent that they may trade foreign securities, there is no parallel provision in the Exchange Act. The Exchange Act also requires, in Section 6(h)(1), that security futures products be listed for trading on national securities exchanges or national securities associations. When Congress lifted the ban on trading security futures products in the United States as part of the Commodity Futures Modernization Act of 2000 (“CFMA”), joint jurisdiction over such products was given to the CFTC and SEC. Generally, Congress adopted parallel amendments to the CEA and the Exchange Act regarding security futures products, but it failed to do so with respect to FSFPs, creating considerable confusion. Thus, until further action by Congress or the SEC, the avail-ability of trading in FSFPs by U.S. investors will remain quite limited.
The previous K&L Gates Alert on this topic suggested that a possible workaround for an ECP that was not also a QIB would be to find another ECP willing to enter into an off-exchange de-rivative transaction that would mirror the return of FSFPs. As also noted in that Alert, such a strategy would need to be reconsidered if statutory and regulatory changes affecting derivatives were adopted. Although the final details of these changes are not yet known, it is clear that ma-jor changes are coming to the derivatives area that could result in restrictions on the ability to enter into, and the availability of dealers willing to offer, off-exchange transactions that would mirror the return of FSFPs.
The impending financial regulatory reform legislation, as well as the Joint Report of the SEC and the CFTC on Harmonization of Regulation issued last October, calls for greater coordination by the two agencies across a wide range of subjects. Implementation of the new regulatory authori-ties will require a huge commitment of resources and expertise. Hopefully, the DCIO Advisory is not the final word on the ability of U.S. investors to trade FSFPs, and both the CFTC and the SEC will keep the issue of access to FSFPs on their crowded agendas, so that ECPs will be able to realize the access to FSFPs permitted under the CEA when the CFMA was passed almost ten years ago.
