
[Federal Register: January 2, 2009 (Volume 74, Number 1)]
[Notices]               
[Page 133-139]
From the Federal Register Online via GPO Access [wais.access.gpo.gov]
[DOCID:fr02ja09-57]                         

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SECURITIES AND EXCHANGE COMMISSION

[Release No. 34-59165; File No. S7-35-08]

 
Order Pursuant to Section 36 of the Securities Exchange Act of 
1934 Granting Temporary Exemptions From Sections 5 and 6 of the 
Exchange Act for Broker-Dealers and Exchanges Effecting Transactions in 
Credit Default Swaps

December 24, 2008.

I. Background

    In response to the recent turmoil in the financial markets, the 
Securities and Exchange Commission (``Commission'') has taken multiple 
actions to protect investors and ensure the integrity of the nation's 
securities markets.\1\ Today, we are taking further action designed to 
address concerns related to the market in credit default swaps 
(``CDS''). The over-the-counter (``OTC'') market for CDS has been a 
source of concerns to us and other financial regulators. These concerns 
include the systemic risk posed by CDS, highlighted by the possible 
inability of parties to meet their obligations as counterparties and 
the potential resulting adverse effects on

[[Page 134]]

other markets and the financial system.\2\ Recent credit market events 
have demonstrated the seriousness of these risks in a CDS market 
operating without meaningful regulation, transparency,\3\ or central 
counterparties (``CCPs'').\4\ These events have emphasized the need for 
CCPs as mechanisms to help control such risks.\5\ A CCP for CDS could 
be an important step in reducing the counterparty risks inherent in the 
CDS market, and thereby help mitigate potential systemic impacts. In 
November 2008, the President's Working Group on Financial Markets 
stated that the implementation of a CCP for CDS was a top priority \6\ 
and, in furtherance of this recommendation, the Commission, the FRB and 
the Commodity Futures Trading Commission (``CFTC'') signed a Memorandum 
of Understanding \7\ that establishes a framework for consultation and 
information sharing on issues related to CCPs for CDS. Given the 
continued uncertainty in this market, taking action to help foster the 
prompt development of CCPs, including granting conditional exemptions 
from certain provisions of the federal securities laws, is in the 
public interest.
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    \1\ A nonexclusive list of the Commission's actions to stabilize 
financial markets during this credit crisis includes: Adopting a 
package of measures to strengthen investor protections against naked 
short selling, including rules requiring a hard T+3 close-out, 
eliminating the options market maker exception of Regulation SHO, 
and expressly targeting fraud in short selling transactions (See 
Securities Exchange Act Release No. 58572 (September 17, 2008), 73 
FR 54875 (September 23, 2008)); issuing an emergency order to 
enhance protections against naked short selling in the securities of 
primary dealers, Fannie Mae, and Freddie Mac (See Securities 
Exchange Act Release No. 58166 (July 15, 2008), 73 FR 42379 (July 
21, 2008)); taking temporary emergency action to ban short selling 
in financial securities (See Securities Exchange Act Release No. 
58592 (September 18, 2008), 73 FR 55169 (September 24, 2008)); 
approving emergency rulemaking to ensure disclosure of short 
positions by hedge funds and other institutional money managers (See 
Securities Exchange Act Release No. 58591A (September 21, 2008), 73 
FR 55557 (September 25, 2008)); proposing rules to strengthen the 
regulation of credit rating agencies and making the limits and 
purposes of credit ratings clearer to investors (See Securities 
Exchange Act Release No. 57967 (June 16, 2008), 73 FR 36212 (June 
25, 2008); entering into a Memorandum of Understanding with the 
Board of Governors of the Federal Reserve System (``FRB'') to make 
sure key federal financial regulators share information and 
coordinate regulatory activities in important areas of common 
interest (See Memorandum of Understanding Between the U.S. 
Securities and Exchange Commission and the Board of Governors of the 
Federal Reserve System Regarding Coordination and Information 
Sharing in Areas of Common Regulatory and Supervisory Interest (July 
7, 2008), http://www.sec.gov/news/press/2008/2008-134_mou.pdf).
    \2\ In addition to the potential systemic risks that CDS pose to 
financial stability, we are concerned about other potential risks in 
this market, including operational risks, risks relating to 
manipulation and fraud, and regulatory arbitrage risks.
    \3\ See Policy Objectives for the OTC Derivatives Market, The 
President's Working Group on Financial Markets (November 14, 2008), 
http://www.ustreas.gov/press/releases/reports/policyobjectives.pdf 
(``Public reporting of prices, trading volumes and aggregate open 
interest should be required to increase market transparency for 
participants and the public.'').
    \4\ See The Role of Credit Derivatives in the U.S. Economy 
Before the H. Agric. Comm., 110th Cong. (2008) (Statement of Erik 
Sirri, Director of the Division of Trading and Markets, Commission).
    \5\ See id.
    \6\ See Policy Objectives for the OTC Derivatives Market, The 
President's Working Group on Financial Markets (November 14, 2008), 
http://www.ustreas.gov/press/releases/reports/policyobjectives.pdf. 
See also Policy Statement on Financial Market Developments, The 
President's Working Group on Financial Markets (March 13, 2008), 
http://www.treas.gov/press/releases/reports/
pwgpolicystatemktturmoil_03122008.pdf; Progress Update on March 
Policy Statement on Financial Market Developments, The President's 
Working Group on Financial Markets (October 2008), http://
www.treas.gov/press/releases/reports/q4progress%20update.pdf.
    \7\ See Memorandum of Understanding Between the Board of 
Governors of the Federal Reserve System, the U.S. Commodity Futures 
Trading Commission and the U.S. Securities and Exchange Commission 
Regarding Central Counterparties for Credit Default Swaps (November 
14, 2008), http://www.treas.gov/press/releases/reports/finalmou.pdf.
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    A CDS is a bilateral contract between two parties, known as 
counterparties. The value of this financial contract is based on 
underlying obligations (``reference obligations'') of a single entity 
(a ``reference entity'') or on a particular security or other debt 
obligation (``reference security''), or an index of several such 
entities, securities, or obligations. The obligation of a seller under 
a CDS to make payments under a CDS contract is triggered by a default 
or other credit event as to such entity or entities or such security or 
securities. Investors may use CDS for a variety of reasons, including 
to offset or insure against risk in their fixed-income portfolios, to 
take positions in bonds or in segments of the debt market as 
represented by an index, or to capitalize on the volatility in credit 
spreads during times of economic uncertainty. In recent years, CDS 
market volumes have rapidly increased.\8\ This growth has coincided 
with a significant rise in the types and number of entities 
participating in the CDS market.\9\
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    \8\ See Semiannual OTC derivatives statistics at end-December 
2007, Bank for International Settlements (``BIS''), http://
www.bis.org/statistics/otcder/dt1920a.pdf.
    \9\ CDS were initially created to meet the demand of banking 
institutions looking to hedge and diversify the credit risk 
attendant with their lending activities. However, financial 
institutions such as insurance companies, pension funds, securities 
firms, and hedge funds have entered the CDS market.
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    The Commission's authority over this OTC market for CDS is limited. 
Specifically, section 3A of the Securities Exchange Act of 1934 
(``Exchange Act'') limits the Commission's authority over swap 
agreements, as defined in section 206A of the Gramm-Leach-Bliley 
Act.\10\ For those CDS that are swap agreements, the exclusion from the 
definition of security in section 3A of the Exchange Act, and related 
provisions, will continue to apply. The Commission's action today does 
not affect these CDS, and this order does not apply to them. For those 
CDS that are not swap agreements (``non-excluded CDS''), the 
Commission's action today provides certain exemptions to exchanges that 
effect transactions in such non-excluded CDS and to brokers and dealers 
that effect transactions in non-excluded CDS on exchanges, and is 
designed to facilitate the development of one or more CDS 
exchanges.\11\
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    \10\ 15 U.S.C. 78c-1. Section 3A excludes both a non-security-
based and a security-based swap agreement from the definition of 
``security'' under Section 3(a)(10) of the Exchange Act, 15 U.S.C. 
78c(a)(10). Section 206A of the Gramm-Leach-Bliley Act defines a 
``swap agreement'' as ``any agreement, contract, or transaction 
between eligible contract participants (as defined in section 1a(12) 
of the Commodity Exchange Act* * *) * * * the material terms of 
which (other than price and quantity) are subject to individual 
negotiation.'' 15 U.S.C. 78c note.
    \11\ The Commission found that credit default options and credit 
default basket options, which are essentially exchange-traded 
equivalents of OTC CDS, proposed by the Chicago Board Options 
Exchange, were securities because they are options based on the 
value of a security or securities, options on an interest in a 
security or securities, or options based on the value of an interest 
in a security or securities. See Securities Exchange Act Release No. 
55871 (June 6, 2007), 72 FR 32372, 32375-77 (June 12, 2007) (File 
No. SR-CBOE-2006-84) (``CBOE CDO Order''); Securities Exchange Act 
Release No. 56275 (August 17, 2007), 72 FR 47297 (August 22, 2008) 
(File No. SR-CBOE-2007-26) (together with the CBOE CDO Order, the 
``CBOE Orders''). The Commission made special note that, ``because 
credit default options will be exchange-traded and not individually 
negotiated, * * * they are not qualifying swap agreements under 
Section 206A of the Gramm-Leach-Bliley Act, * * * and, therefore, 
not excluded from the definition of security by Section 3A of the 
Exchange Act.'' 72 FR at 32376 n. 39. Unlike the options at issue in 
the CBOE Orders, which had fixed payouts in the event of a default 
or other credit event, the CDS that are the subject of the 
Commission's actions today may provide for the delivery of a debt 
security or securities against a specified amount, or a cash payment 
based on the value of a debt security or securities. For those CDS 
that are not qualifying swap agreements, that have payouts tied to 
the delivery of debt securities, or that are based on the value of 
debt securities, there may be arguments in addition to those in the 
CBOE Orders that such CDS are security options.
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    In companion actions today, the Commission is temporarily 
exempting, subject to conditions, LCH.Clearnet Ltd. from the 
requirement to register as a clearing agency under section 17A of the 
Exchange Act solely to perform the functions of a clearing agency for 
non-excluded CDS transactions.\12\ To facilitate the operation of one 
or more CCPs for the CDS market, the Commission has also approved 
interim final temporary rules providing exemptions under the Securities 
Act of 1933 and Exchange Act for non-excluded CDS.
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    \12\ See Securities Exchange Act Release No. 59164 (December 24, 
2008) (File No. S7-34-08).
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    In conjunction with these exemptions, the Commission in this order 
is providing a temporary exemption to any exchange that effects or 
reports transactions in non-excluded CDS and is not otherwise subject 
to the requirements under Sections 5 and 6 of the Exchange Act \13\ 
from the requirement to register as a national securities exchange, and 
to any broker or dealer that effects or reports transactions in non-
excluded CDS on such an exempt exchange.\14\ The

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exemptions in this order are subject to the conditions discussed below.
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    \13\ 15 U.S.C. 78e and 78f.
    \14\ A national securities exchange that effects transactions in 
CDS would continue to be required to comply with all requirements 
under the Exchange Act applicable to such transactions. A national 
securities exchange could form subsidiaries or affiliates that 
operate exchanges exempt under this order. Any subsidiary or 
affiliate of a registered exchange could not integrate, or otherwise 
link, the exempt CDS exchange with the registered exchange, 
including the premises or property of such exchange for effecting or 
reporting a transaction, without being considered a ``facility of 
the exchange.'' See Section 3(a)(2) of the Exchange Act, 15 U.S.C. 
78c(a)(2).
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    The Commission believes that the CDS market would benefit from the 
development of exchanges for non-excluded CDS. As the Commission has 
previously noted when approving a proposed rule change by the Chicago 
Board Options Exchange to list and trade certain CDS contracts, there 
are several benefits to trading such products on exchanges rather than 
over-the-counter.\15\ These benefits include a centralized market, 
standardized contract specifications, transparent quotations, and 
transaction reporting.\16\ Exchange trading would permit real-time 
matching of orders, and enhance transparency of the CDS market by 
promoting dissemination of pre-trade quotations as well as post-trade 
transaction information. Additional pre-trade and post-trade 
transparency would enable exchange subscribers to better assess market 
depth and liquidity and allow regulators to better surveil for 
violations of the securities laws.
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    \15\ See CBOE Orders, supra note 11.
    \16\ Id.
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    Accordingly, the Commission is using its authority under section 36 
of the Exchange Act \17\ to exempt temporarily any exchange that 
effects transactions in non-excluded CDS and is not otherwise subject 
to the requirements under Sections 5 and 6 of the Exchange Act,\18\ and 
the rules and regulations thereunder, from the requirement to register 
as a national securities exchange under section 6 of the Exchange 
Act,\19\ and from the prohibition in section 5 of the Exchange Act \20\ 
against effecting transactions as an exchange unless it is registered 
as a national securities exchange or exempt from registration due to 
the limited volume of its transactions. The Commission finds that such 
action is necessary and appropriate in the public interest and 
consistent with the protection of investors to facilitate the operation 
of one or more CDS exchanges in connection with the establishment of 
one or more CCP that clear and settle non-excluded CDS.\21\ The 
Commission is also temporarily exempting brokers and dealers from the 
section 5 prohibition against effecting or reporting transactions in 
securities otherwise than on a national securities exchange or an 
exchange that is exempt from registration due to its limited volume.
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    \17\ 15 U.S.C. 78mm.
    \18\ 15 U.S.C. 78e and 78f.
    \19\ 15 U.S.C. 78f.
    \20\ 15 U.S.C. 78e.
    \21\ See supra note 12.
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    The conditions to these exemptions will enable to the Commission to 
oversee the development of CDS exchanges, and to take such additional 
action as we may deem necessary to promote the public interest and the 
protection of investors. Moreover, the limited duration of the 
exemptions provided today will enable one or more CDS exchanges to 
become operational while we gain experience with the CDS market and 
evaluate public input, including comments we receive on the temporary 
exemptions granted in today's order.

II. Discussion

    Section 5 of the Exchange Act states that ``[i]t shall be unlawful 
for any broker, dealer, or exchange, directly or indirectly, to make 
use of the mails or any means or instrumentality of interstate commerce 
for the purpose of using any facility of an exchange * * * to effect 
any transaction in a security, or to report any such transactions, 
unless such exchange (1) is registered as a national securities 
exchange under section 6 of [the Exchange Act], or (2) is exempted from 
such registration * * * by reason of the limited volume of transactions 
effected on such exchange* * *.'' \22\ Section 6 of the Exchange Act 
sets forth a procedure whereby an exchange \23\ may register as a 
national securities exchange.\24\
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    \22\ 15 U.S.C. 78e.
    \23\ Section 3(a)(1) of the Exchange Act, 15 U.S.C. 78c(a)(1), 
defines ``exchange.'' Rule 3b-16 under the Exchange Act, 17 CFR 
240.3b-16, defines certain terms used in the statutory definition of 
exchange. See Securities Exchange Act Release No. 40760 (December 8, 
1998), 63 FR 70844 (December 22, 1998) (``Regulation ATS Adopting 
Release'') (adopting Rule 3b-16 in addition to Regulation ATS).
    \24\ 15 U.S.C. 78f. Section 6 of the Exchange Act also sets 
forth various requirements to which a national securities exchange 
is subject.
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    Section 36 of the Exchange Act provides that the Commission, ``by 
rule, regulation, or order, may conditionally or unconditionally exempt 
any person, security, or transaction, or any class or classes of 
persons, securities, or transactions, from any provision or provisions 
of [the Exchange Act] or of any rule or regulation thereunder, to the 
extent that such exemption is necessary or appropriate in the public 
interest, and is consistent with the protection of investors.'' To 
facilitate the establishment of one or more exchanges for non-excluded 
CDS, the Commission is exercising its authority under section 36 of the 
Exchange Act to temporarily exempt any exchange, broker or dealer that 
effects transactions in non-excluded CDS from the prohibition in 
Section 5 of the Exchange Act and (in the case of exchanges) the 
requirements in Section 6 of the Exchange Act and the rules and 
regulations thereunder. These temporary exemptions are subject to 
certain conditions, discussed further below. These conditions on 
exchanges generally mirror those applicable to alternative trading 
systems, which are securities trading systems that the Commission 
previously exempted from exchange registration.\25\
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    \25\ See Regulation ATS, 17 CFR 242.300 et seq. In 1998, the 
Commission exercised its exemptive authority under Section 36 of the 
Exchange Act and its general authority under Section 11A of the 
Exchange Act, 15 U.S.C. 78k-1, to establish a regulatory framework 
for ``alternative trading systems,'' which perform many of the same 
functions as exchanges. Under this framework, an entity that, like 
an exchange, matches the orders in securities of multiple buyers and 
sellers according to established, non-discretionary methods is 
exempt from the definition of ``exchange'' if it instead registers 
as a broker-dealer and complies with Regulation ATS. Regulation ATS 
is designed, among other things, ``to adopt a regulatory framework 
that addresses [the Commission's] concerns without jeopardizing the 
commercial viability of these markets.'' Regulation ATS Adopting 
Release, supra note 23, 63 FR at 70846.
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    This temporary exemption is designed to allow brokers, dealers, and 
exchanges to effect transactions in non-excluded CDS on exchanges, 
subject to certain conditions. The Commission believes the exemption, 
together with the conditions, is necessary in the public interest and 
consistent with the protection of investors. In addition, the 
Commission believes that these conditions will not impede the ability 
of brokers, dealers, and exchanges to compete in the market for CDS. 
The limited term of this exemption will provide the Commission with 
adequate time to evaluate the application of this exemption to non-
excluded CDS exchanges, and whether such conditions should be modified. 
In particular, the Commission will be considering whether Regulation 
ATS, with or without modifications, could apply to systems that match 
orders in non-excluded CDS of multiple buyers and sellers.
    This temporary exemption is available only to exchanges that effect 
transactions in non-excluded CDS. To the extent that an exchange is 
otherwise subject to the requirements of section 5 of the Exchange Act, 
it must register with the Commission as a national securities exchange 
under Section 6 of the Exchange Act and the rules and regulations 
thereunder or comply with the terms of another exemption. Similarly, a 
broker or dealer is temporarily exempt from the prohibition in Section 
5 only to the extent that it effects transactions in non-

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excluded CDS on an exchange or reports such transactions on an 
exchange.
    The Commission believes that this order will facilitate the 
establishment of one or more exchanges that effect transactions in non-
excluded CDS. For this reason and the reasons discussed above,\26\ the 
Commission believes that these exemptions are necessary or appropriate 
in the public interest and consistent with the protection of investors.
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    \26\ See supra notes 15-16 and accompanying text.
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    As noted, the conditions under which CDS exchanges must operate to 
qualify for the exemption from exchange registration being granted 
today are modeled on requirements applicable to alternative trading 
systems. Like an alternative trading system, a CDS exchange must keep 
records about its operations, its subscribers, and their orders.\27\ A 
CDS exchange also must provide the Commission with trading information 
on a quarterly basis \28\ and establish procedures to ensure the 
confidential treatment of trading information.\29\ Likewise, a CDS 
exchange must permit the Commission to examine its premises, systems, 
and records and must cooperate with the examination of its 
subscribers.\30\ These requirements are designed to allow the 
Commission to monitor market developments, to ascertain how new 
entrants are affecting the national market system, and to promote 
compliance with the federal securities laws generally. The Commission 
believes that temporarily exempting exchanges that effect transactions 
in non-excluded CDS from exchange registration, subject to these 
conditions, is necessary or appropriate in the public interest and is 
consistent with the protection of investors.
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    \27\ Compare 17 CFR 242.301(b)(8), 242.302, and 242.303.
    \28\ Compare 17 CFR 242.301(b)(9).
    \29\ Compare 17 CFR 242.301(b)(10).
    \30\ Compare 17 CFR 242.301(b)(7).
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A. Exemption From Sections 5 and 6 of the Exchange Act for Exchanges

1. No Self-Regulatory Authority
    To be exempt under this order, the exchange must not: (a) Set rules 
governing the conduct of subscribers other than the conduct of such 
subscribers trading on such exchange; or (b) discipline subscribers 
under the Exchange Act other than by exclusion from trading. That is, 
an exempted exchange may not exercise self-regulatory authority over 
its subscribers. The Commission intends this condition to be the same 
requirement as applies to alternative trading systems under Regulation 
ATS. As described in the Regulation ATS Adopting Release, self-
regulatory authority would include, for example, any restrictions on 
subscribers' activities outside of the exchange or imposing as a 
condition of participation any requirement for which the exchange would 
examine subscribers for compliance. The requirement in Regulation ATS 
and this condition are based on the Commission's belief that a 
organization, association, or group of persons that could exercise 
self-regulatory authority over its subscribers should be registered as 
a self-regulatory organization (``SRO'') and subject to the full 
responsibilities and supervision that registration entails. The 
Commission continues to believe that rules governing exchange 
subscriber conduct may be imposed and enforced only by SROs because of 
the potential that they may be applied for anti-competitive purposes. 
However, as we noted in connection with adopting Regulation ATS, the 
Commission does not intend this condition to preclude a trading system 
from applying credit standards to its subscribers or requiring 
subscribers to provide financial information relevant to their activity 
on the system.\31\
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    \31\ See Regulation ATS Adopting Release, supra note 23, 63 FR 
at 70859.
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2. Recordkeeping
    In addition, to be exempt under this order, an exchange must 
maintain an audit trail of orders that it receives and transactions 
that it effects. These records are critical to the Commission's ability 
to oversee the CDS market, detect and deter illicit market activity, 
and take action as necessary to address manipulation and fraud, 
including insider trading. These recordkeeping and record preservation 
requirements are comparable to those required under Regulation ATS and 
tailored to apply to non-excluded CDS.\32\ Specifically, an exchange 
must make and keep the following records for a period of not less than 
three years, the first two years in an easily accessible place:
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    \32\ See 17 CFR 242.301(b)(8), 242.302, and 242.303.
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     A record of subscribers in the exchange (identifying any 
affiliations between the exchange and subscribers in the exchange, 
including common directors, officers, or owners);
     Daily summaries of trading, including: (a) Information 
identifying CDS in which transactions are effected; and (b) transaction 
volume, expressed in terms of number of trades and total U.S. dollar 
notional value;
     Time-sequenced records of order information, including: 
(a) Identity of the party entering an order; (b) identification of non-
excluded CDS contract (including the reference entity, security, or 
index, and notional value); (c) date and time that order was received; 
(d) price (whether expressed as credit spread, rate, strike, or 
coupon); (e) whether the order is to buy or sell and any order 
conditions; (f) any subsequent modification or cancellation of the 
order; (g) date and time the order was executed, the size (e.g., 
notional value amount) executed, and the price; and (h) identity of the 
parties to the transaction.\33\
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    \33\ These information items, with one exception, must be 
recorded and kept current by alternative trading systems pursuant to 
Regulation ATS. See 17 CFR 242.301(b)(8) and 242.302(c). Alternative 
trading systems are not required by Regulation ATS to keep records 
of the identity of the party entering an order. The Commission 
believes, however, that such information could be important to its 
ability to enforce the securities laws and is, therefore, to be kept 
as a condition to this exemption. Alternative trading systems must 
be registered with the Commission as a broker-dealer, and are 
therefore subject to additional Commission recordkeeping rules. See 
17 CFR 242.301(b)(1). An exchange that avails itself of this 
exemption, however, may not otherwise be subject to requirements 
under the Exchange Act.
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    In addition, as a condition of this exemption, an exchange must 
preserve the following records:
     For a period of not less than three years, the first two 
years in an easily accessible place, all notices provided by such 
exchange to subscribers generally, whether written or communicated 
through automated means, including, but not limited to, notices 
addressing hours of system operations, system malfunctions, changes to 
system procedures, maintenance of hardware and software, instructions 
pertaining to access to the market and denials of, or limitations on, 
access to the exchange; and
     During the life of the enterprise and of any successor 
enterprise, the exchange's organizational documents and copies of 
reports filed with the Commission pursuant to this exemption.

An exchange exempt pursuant to this order may comply with these 
recordkeeping and record preservation requirements through use of a 
service bureau, depository, or other recordkeeping service that 
maintains and preserves these records on behalf of the exchange. An 
agreement with a service bureau, depository, or other recordkeeping 
service will not relieve the exchange from the responsibility to 
prepare and maintain the specified records.

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    The Commission believes that the types of records an exchange would 
be required to make and keep pursuant to this condition are records an 
exchange would keep in the normal course of its business and, 
therefore, that this condition is not unduly burdensome.
3. Regulatory Reporting
    An exchange that relies on this order must, within five days of 
commencing operation, submit a notice to the Commission \34\ that 
includes the following information:
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    \34\ Any such notice should be sent to: Secretary, Securities 
and Exchange Commission, 100 F Street, NE., Washington, DC 20549, 
and be noted as regarding ``CDS Exchange Exemption from 
Registration.''
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    1. Full legal name of the exchange;
    2. A description of the exchange's ownership structure;
    3. Contact person and contact information;
    4. A general description of the CDS contracts that trade on the 
exchange; and
    5. A description of how the exchange operates.

This information is essential for the Commission to understand 
developments in the CDS market. Any subsequent action regarding this 
exemption--for example, whether it should be modified, extended, or 
allowed to expire--is predicated on understanding which market 
participants are relying on it. In the future, different regulatory 
frameworks may be appropriate for different market participants. These 
notices will enable the Commission to commence a dialog with the 
relevant market participants.
    In addition, an exchange that relies on this exemption must report 
the following information to the Commission within 30 days of the end 
of each quarter:
    1. The total dollar volume of transactions executed during the 
quarter, broken down by reference entity, security, or index;
    2. The total unit volume and/or notional amount executed during the 
quarter, broken down by reference entity, security, or index; and
    3. A list of all subscribers that effected transactions on the 
exchange during the quarter.

Reporting of this information will assist the Commission in carrying 
out its responsibility to supervise and regulate the securities 
markets. This information is similar to that which an alternative 
trading system must provide quarterly.\35\
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    \35\ See 17 CFR 242.301(b)(9)(i); Form ATS-R, 17 CFR 249.638. 
The Commission notes that an alternative trading system is not 
required to report to the Commission its transaction volume by 
security; only aggregate volumes must be reported to the Commission. 
Reports in most equity securities and many debt securities traded on 
an ATS are required to be reported to an SRO on a transaction-by-
transaction basis. This is the not the case for CDS. For this 
reason, the Commission is conditioning this exemption on an exchange 
providing quarterly information to the Commission on trading volume 
broken down by reference entity, security, or index. The Commission 
believes it is appropriate to require this more specific information 
from CDS exchanges to better understand the development of the 
exchange-traded market in non-excluded CDS.
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4. Confidentiality of Trading Information
    An exchange relying on this order also must establish adequate 
safeguards and procedures to protect subscribers' confidential trading 
information. Such safeguards and procedures shall include: (a) Limiting 
access to the confidential trading information of subscribers to those 
employees of the exchange who are operating the system or responsible 
for its compliance with this exemption or any other applicable rules; 
and (b) implementing standards controlling employees of the exchange 
trading for their own accounts. The exchange must adopt and implement 
adequate oversight procedures to ensure that the safeguards and 
procedures established pursuant to this condition are followed. This 
condition, which closely tracks a requirement applicable to alternative 
trading systems,\36\ is designed to prevent the misuse of subscriber 
trading information that is available to the exchange. This should 
strengthen confidence in the exchange, promoting participation.
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    \36\ See 17 CFR 242.301(b)(10).
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5. Commission Jurisdiction
    Finally, an exchange that relies on this order must provide access 
to the Commission to conduct on-site inspections of its facilities 
(including automated systems and systems environment), records, and 
personnel related to exchange activities. The exchange must cooperate 
with the Commission in connection with the investigation of any 
exchange subscribers. This requirement is similar to one in Regulation 
ATS that applies to alternative trading systems.\37\
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    \37\ See 17 CFR 242.301(b)(7).
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    Recent market events have clearly demonstrated the importance of 
the CDS market and its potential to impact other markets, including the 
equity securities markets. It is therefore imperative that the 
Commission have examination authority over any exchange that effects 
transactions in non-excluded CDS, with regard to its compliance with 
the conditions of the exemption provided under this order as well as 
enforcement of the antifraud provisions of the securities laws, 
including the prohibitions on insider trading. Particularly because the 
CDS market is so large and involves many market participants that are 
not directly subject to the Commission's authority, cooperation by the 
CDS exchange with the Commission in any investigation or enforcement 
action is crucial.

B. Exemption From Section 5 of the Exchange Act for Brokers and Dealers

    Absent an exemption, section 5 of the Exchange Act \38\ would 
prohibit brokers and dealers from effecting transactions in non-
excluded CDS on an exchange that is not a national securities exchange 
because of that exchange's reliance on this order. The Commission finds 
that temporarily exempting brokers and dealers that effect transactions 
in non-excluded CDS on such an exchange from this restriction in 
section 5 is necessary and appropriate in the public interest and is 
consistent with the protection of investors because it will facilitate 
brokers' and dealers' use of CDS exchanges, which for the reasons noted 
above the Commission believes would be beneficial. Without also 
exempting brokers and dealers from this section 5 requirement, the 
Commission's temporary exemption of CDS exchanges would be ineffective, 
because brokers and dealers would not be permitted to effect 
transactions on those exchanges.
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    \38\ 15 U.S.C. 78e.
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    Section 5 of the Exchange Act recognizes that there are situations 
where brokers and dealers should be permitted to trade on an exchange 
that is not registered as a national securities exchange. Section 5 
provides in relevant part that brokers and dealers may effect 
transactions on an exchange that the Commission, by reason of the 
limited volume of transactions effected on such exchange, has exempted 
from registration under Section 6. Brokers and dealers are also 
permitted to effect transactions on alternative trading systems, which 
are exempted from the definition of ``exchange'' and thus do not fall 
within the restriction of Section 5. For the reasons noted above, the 
Commission finds that it is consistent with the public interest and the 
protection of investors to grant a temporary exemption from section 5 
of the Exchange Act to any broker or dealer that effects transactions 
in non-excluded CDS, or reports such transactions, on an exchange that 
is exempted pursuant to this order.

[[Page 138]]

C. Solicitation of Comments

    The Commission intends to monitor closely the development of the 
CDS market and intends to determine to what extent, if any, additional 
regulatory action may be necessary. For example, as circumstances 
warrant, certain conditions could be added, altered, or eliminated. 
Moreover, because this exemption is temporary, the Commission will in 
the future consider whether it should be extended or allowed to expire. 
The Commission believes it would be prudent to solicit public comment 
on its action today, and what action it should take with respect to the 
CDS market in the future. The Commission is soliciting public comment 
on all aspects of this exemption, including:
    1. Whether the length of this temporary exemption (until September 
25, 2009) is appropriate. If not, what should the appropriate duration 
be?
    2. Whether the conditions to the exemption are appropriate. Why or 
why not? Should other conditions apply? Are any of the present 
conditions to the exemption provided in this order unnecessary? If so, 
please specify and explain why such conditions are not needed.
    3. Whether exchanges relying on this exemption should ultimately be 
required to register under the Exchange Act. Why or why not?
    4. Whether exchanges for non-excluded CDS can reasonably comply 
with Regulation ATS. Why or why not? If not, what aspects or conditions 
of Regulation ATS are problematic?

Comments may be submitted by any of the following methods:

Electronic Comments

     Use the Commission's Internet comment form (http://
www.sec.gov/rules/other.shtml);
     Send an e-mail to rule-comments@sec.gov. Please include 
File Number S7-35-08 on the subject line; or
     Use the Federal eRulemaking Portal (http://
www.regulations.gov/). Follow the instructions for submitting comments.

Paper Comments

     Send paper comments in triplicate to Secretary, Securities 
and Exchange Commission, 100 F Street, NE., Washington, DC 20549-1090.

All submissions should refer to File Number S7-35-08. This file number 
should be included on the subject line if e-mail is used. To help us 
process and review your comments more efficiently, please use only one 
method. The Commission will post all comments on the Commission's 
Internet Web site (http://www.sec.gov/rules/other.shtml). Comments are 
also available for public inspection and copying in the Commission's 
Public Reference Room, 100 F Street, NE., Washington, DC 20549, on 
official business days between the hours of 10 a.m. and 3 p.m. All 
comments received will be posted without change; we do not edit 
personal identifying information from submissions. You should submit 
only information that you wish to make available publicly.

III. Conclusion

    It is hereby ordered pursuant to section 36 of the Exchange Act 
that until September 25, 2009, an exchange is exempt from the 
requirements of sections 5 and 6 of the Exchange Act \39\ and the rules 
and regulations thereunder to the extent that such exchange effects or 
reports transactions in non-excluded CDS and is not otherwise required 
to register as a national securities exchange, subject to the following 
conditions:
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    \39\ 15 U.S.C. 78e and 78f.
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    (1) The exchange must not: (a) Set rules governing the conduct of 
subscribers other than the conduct of such subscribers trading on such 
exchange; or (b) discipline subscribers other than by exclusion from 
trading;
    (2) The exchange must make and keep for a period of not less than 
three years, the first two years in an easily accessible place, the 
following records:
     A record of subscribers in the exchange (identifying any 
affiliations between the exchange and subscribers in the exchange, 
including common directors, officers, or owners);
     Daily summaries of trading, including (a) information 
identifying CDS in which transactions are effected; and (b) transaction 
volume, expressed in terms of number of trades and total U.S. dollar 
notional value;
     Time-sequenced records of order information, including: 
(a) Identity of the party entering an order; (b) identification of non-
excluded CDS contract (including the reference entity, security, or 
index, and notional value); (c) date and time that order was received; 
(d) price (whether expressed as credit spread, rate, strike, or 
coupon); (e) whether the order is to buy or sell and any order 
conditions; (f) any subsequent modification or cancellation of the 
order; (g) date and time the order was executed, the size (e.g., 
notional value amount) executed, and the price; and (h) identity of the 
parties to the transaction;
    (3) The exchange must preserve the following records:
     For a period of not less than three years, the first two 
years in an easily accessible place, all notices provided by such 
exchange to subscribers generally, whether written or communicated 
through automated means, including, but not limited to, notices 
addressing hours of system operations, system malfunctions, changes to 
system procedures, maintenance of hardware and software, instructions 
pertaining to access to the market and denials of, or limitations on, 
access to the exchange; and
     During the life of the enterprise and of any successor 
enterprise, the exchange's organizational documents and copies of 
reports filed with the Commission pursuant to this exemption;
    (4) An exchange must, within five days of commencing operation, 
submit a notice to the Commission that includes the following 
information:
     Full legal name of the exchange;
     A description of the exchange's ownership structure;
     Contact person and contact information;
     A general description of what CDS contracts trade on the 
exchange; and
     A description of how the exchange operates;
    (5) An exchange must report the following information to the 
Commission within 30 days of the end of each quarter:
     The total dollar volume of transactions executed during 
the quarter, broken down by reference entity, security, or index;
     The total unit volume and/or notional amount executed 
during the quarter, broken down by reference entity, security, or 
index; and
     A list of all subscribers that effected transactions on 
the exchange during the quarter;
    (6) The exchange must establish adequate safeguards and procedures 
to protect subscribers' confidential trading information. Such 
safeguards and procedures shall include: (a) Limiting access to the 
confidential trading information of subscribers to those employees of 
the exchange who are operating the system or responsible for its 
compliance with this exemption or any other applicable rules; and (b) 
implementing standards controlling employees of the exchange trading 
for their own accounts. The exchange must adopt and implement adequate 
oversight procedures to ensure that the safeguards and procedures 
established pursuant to this condition are followed; and

[[Page 139]]

    (7) The exchange must provide access to the Commission to conduct 
on-site inspections of its facilities (including automated systems and 
systems environment), records, and personnel related to exchange 
activities. The exchange must cooperate with the Commission in 
connection with the investigation of any exchange subscribers.
    It is further ordered pursuant to section 36 of the Exchange Act 
that until September 25, 2009, a broker or dealer that effects 
transactions in non-excluded CDS, or reports such transactions, on an 
exchange that is exempted pursuant to this order is exempt from section 
5 of the Exchange Act.

    By the Commission.
Florence E. Harmon,
Acting Secretary.
 [FR Doc. E8-31190 Filed 12-31-08; 8:45 am]

BILLING CODE 8011-01-P
