
[Federal Register: November 23, 2009 (Volume 74, Number 224)]
[Notices]               
[Page 61116-61117]
From the Federal Register Online via GPO Access [wais.access.gpo.gov]
[DOCID:fr23no09-40]                         


[[Page 61116]]

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COMMODITY FUTURES TRADING COMMISSION

SECURITIES AND EXCHANGE COMMISSION

[Release No. 34-61020]

 
Joint Order To Exclude Indexes Composed of Certain Index Options 
From the Definition of Narrow-Based Security Index Pursuant to Section 
1a(25)(B)(vi) of the Commodity Exchange Act and Section 3(a)(55)(C)(vi) 
of the Securities Exchange Act of 1934

AGENCY: Commodity Futures Trading Commission and Securities and 
Exchange Commission.

ACTION: Joint order.

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SUMMARY: The Commodity Futures Trading Commission (``CFTC'') and the 
Securities and Exchange Commission (``SEC'') (collectively, 
``Commissions'') by joint order under the Commodity Exchange Act 
(``CEA'') and the Securities Exchange Act of 1934 (``Exchange Act'') 
are excluding certain security indexes from the definition of ``narrow-
based security index.'' Specifically, the Commissions are excluding 
from the definition of the term ``narrow-based security index'' certain 
volatility indexes composed of series of index options on broad-based 
security indexes.

DATES: Effective Date: November 17, 2009.

FOR FURTHER INFORMATION CONTACT:
    CFTC: Thomas M. Leahy, Jr., Branch Chief, Market and Product Review 
Section, Division of Market Oversight, telephone: (202) 418-5278 or 
Julian E. Hammar, Assistant General Counsel, telephone: (202) 418-5118, 
Commodity Futures Trading Commission, 1155 21st Street, NW., 
Washington, DC 20581.
    SEC: Richard R. Holley III, Senior Special Counsel, Division of 
Trading and Markets, Securities and Exchange Commission, 100 F Street, 
NE., Washington, DC 20549. Telephone (202) 551-5614.

SUPPLEMENTARY INFORMATION:

I. Background

    Futures contracts on single securities and on narrow-based security 
indexes (collectively, ``security futures'') are jointly regulated by 
the CFTC and the SEC.\1\ To distinguish between security futures on 
narrow-based security indexes, which are jointly regulated by the 
Commissions, and futures contracts on broad-based security indexes, 
which are under the exclusive jurisdiction of the CFTC, the CEA and the 
Exchange Act each includes an objective definition of the term 
``narrow-based security index.'' A futures contract on an index that 
meets the definition of a narrow-based security index is a security 
future. A futures contract on an index that does not meet the 
definition of a narrow-based security index is a futures contract on a 
broad-based security index.\2\
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    \1\ See Section 1a(31) of the CEA and Section 3(a)(55)(A) of the 
Exchange Act, 7 U.S.C. 1a(31) and 15 U.S.C. 78c(a)(55)(A).
    \2\ See 17 CFR 41.1(c).
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    Section 1a(25)(A) of the CEA \3\ and Section 3(a)(55)(B) of the 
Exchange Act \4\ provide that an index is a ``narrow-based security 
index'' if, among other things, it meets one of the following four 
criteria:
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    \3\ 7 U.S.C. 1a(25)(A).
    \4\ 15 U.S.C. 78c(a)(55)(B).
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    (i) The index has nine or fewer component securities;
    (ii) any component security of the index comprises more than 30 
percent of the index's weighting;
    (iii) the five highest weighted component securities of the index 
in the aggregate comprise more than 60 percent of the index's 
weighting; or
    (iv) the lowest weighted component securities comprising, in the 
aggregate, 25 percent of the index's weighting have an aggregate dollar 
value of average daily trading volume of less than $50,000,000 (or in 
the case of an index with 15 or more component securities, 
$30,000,000), except that if there are two or more securities with 
equal weighting that could be included in the calculation of the lowest 
weighted component securities comprising, in the aggregate, 25 percent 
of the index's weighting, such securities shall be ranked from lowest 
to highest dollar value of average daily trading volume and shall be 
included in the calculation based on their ranking starting with the 
lowest ranked security.
    The first three criteria evaluate the composition and weighting of 
the securities in the index. The fourth criterion evaluates the 
liquidity of an index's component securities.
    Section 1a(25)(B)(vi) of the CEA \5\ and Section 3(a)(55)(C)(vi) of 
the Exchange Act \6\ provide that, notwithstanding the above criteria, 
an index is not a narrow-based security index if a contract of sale for 
future delivery on the index is traded on or subject to the rules of a 
board of trade and meets such requirements as are jointly established 
by rule, regulation, or order by the Commissions. Pursuant to that 
authority, the Commissions may jointly exclude an index from the 
definition of the term ``narrow-based security index.''
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    \5\ 7 U.S.C. 1a(25)(B)(vi).
    \6\ 15 U.S.C. 78c(a)(55)(C)(vi).
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    Using this authority, on March 25, 2004, the Commissions issued a 
joint order excluding volatility indexes that satisfy certain 
conditions from the definition of ``narrow-based security index''.\7\
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    \7\ See Securities Exchange Act Release No. 49469 (March 25, 
2004), 69 FR 16900 (March 31, 2004) (``2004 Joint Order''). 
Following the issuance of the 2004 Joint Order, the CBOE Futures 
Exchange, LLC listed for trading futures contacts on the CBOE 
Volatility Index (``VIX'').
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II. Discussion

    The statutory definition of the term ``narrow-based security 
index'' is designed to distinguish among indexes composed of individual 
stocks. As a result, certain aspects of that definition are designed to 
take into account the trading patterns of individual stocks rather than 
those of other types of exchange-traded securities, such as security 
index options. However, the Commissions believe that the definition is 
not limited to indexes on individual stocks. In fact, Section 
1a(25)(B)(vi) of the CEA \8\ and Section 3(a)(55)(C)(vi) of the 
Exchange Act \9\ give the Commissions joint authority to make 
determinations with respect to security indexes that do not meet the 
specific statutory criteria.
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    \8\ 7 U.S.C. 1a(25)(B)(vi).
    \9\ 15 U.S.C. 78c(a)(55)(C)(vi).
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    The Commissions believed, when issuing the 2004 Joint Order 
excluding certain volatility indexes from the definition of ``narrow-
based security index,'' that certain volatility indexes were 
appropriately classified as broad-based because they measure the 
magnitude of changes in the level of an underlying index that is a 
broad-based security index. Further, the Commissions noted that they 
believed that futures contracts on volatility indexes that satisfied 
the conditions set forth in the 2004 Joint Order should not be readily 
susceptible to manipulation. The Commisions believed that those 
conditions reduce the ability to manipulate the price of the futures 
contracts through manipulation of the options comprising the volatility 
index.
    Eurex \10\ has requested that the Commissions exclude the VDAX-
NEW[supreg] volatility index from the definition of ``narrow-based 
security index.'' \11\ According to Eurex, this volatility index

[[Page 61117]]

meets all the conditions set forth in the 2004 Joint Order, except the 
sixth condition, which requires that ``[o]ptions on the Underlying 
Broad-Based Security Index * * * [be] listed and traded on a national 
securities exchange registered under section 6(a) of the Exchange 
Act.'' \12\ The Commissions note that a volatility index based on index 
options traded on a foreign exchange, such as the VDAX-NEW[supreg], 
would be unable to satisfy this condition.
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    \10\ Eurex Deutschland is operated by Eurex Frankfurt AG 
(hereinafter ``Eurex Deutschland'' and ``Eurex Frankfurt AG'' 
together are referred to as ``Eurex'').
    \11\ See Letter from Paul M. Architzel, Alston & Bird, LLP, to 
Nancy Morris, Secretary, SEC, and Eileen Donovan, Acting Secretary, 
CFTC, dated December 18, 2006.
    \12\ See 2004 Joint Order, supra note 7, 69 FR at 16901.
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    In the 2004 Joint Order the Commissions stated, with respect to the 
sixth condition, that:

    Given the novelty of volatility indexes, the Commissions believe 
at this time that it is appropriate to limit the component 
securities to those index options that are listed for trading on a 
national securities exchange where the Commissions know pricing 
information is current, accurate and publicly available.\13\
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    \13\ See id.

    In response to Eurex's request, the Commissions believe that 
certain volatility indexes should be excluded from the definition of 
``narrow-based security index'' if the index options used to calculate 
the magnitude of change in the level of the underlying broad-based 
security index are listed for trading on an exchange and pricing 
information for the underlying broad-based security index, and options 
on such index, is computed and disseminated in real-time though major 
market data vendors. For purposes of this Order, the Commissions would 
consider such pricing information to be current, accurate, and publicly 
available.
    The Commissions believe that, when pricing information for the 
index underlying a volatility index and for the index options that 
compose the volatility index is current, accurate, and publicly 
available, it would minimize the ability to manipulate the index 
options used to calculate the volatility index. As a result, futures 
contracts on such a volatility index would not be readily susceptible 
to manipulation.
    Therefore, the Commissions believe that an alternative to the sixth 
condition in the 2004 Joint Order, which requires that the component 
securities of a volatility index (i.e., options on the underlying 
broad-based index) be listed for trading on a national securities 
exchange registered pursuant to Exchange Act Section 6(a), would be 
appropriate in certain circumstances. The Commissions believe that it 
is appropriate to permit the component securities of a volatility index 
to be listed for trading on any exchange, provided that pricing 
information for the underlying broad-based security index, and the 
options on such index that compose the volatility index, is current, 
accurate, and publicly available. Specifically, the new sixth condition 
would require such pricing information to be computed and disseminated 
in real-time through major market data vendors.
    In addition to the alternative sixth condition discussed above, a 
volatility index would have to satisfy the other conditions in the 2004 
Joint Order, which are set forth below.\14\ The Commissions also 
reaffirm the rationale for those conditions stated in the 2004 Joint 
Order.
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    \14\ The Commissions note that nothing in this joint order 
should be construed as repealing or otherwise revoking the 2004 
Joint Order.
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    Accordingly,
    It is ordered, pursuant to Section 1a(25)(B)(vi) of the CEA and 
Section 3(a)(55)(C)(vi) of the Exchange Act, that an index is not a 
narrow-based security index and is therefore a broad-based security 
index, if:
    (1) The index measures the magnitude of changes in the level of an 
underlying broad-based security index that is not a narrow-based 
security index as that term is defined in Section 1a(25) of the CEA and 
Section 3(a)(55) of the Exchange Act over a defined period of time, 
which magnitude is calculated using the prices of options on the 
underlying broad-based security index and represents (a) an annualized 
standard deviation of percent changes in the level of the underlying 
broad-based security index, (b) an annualized variance of percent 
changes in the level of the underlying broad-based security index, or 
(c) on a non-annualized basis, either the standard deviation or the 
variance of percent changes in the level of the underlying broad-based 
security index;
    (2) The volatility index has more than nine component securities, 
all of which are options on the underlying broad-based security index;
    (3) No component security of the volatility index comprises more 
than 30% of the volatility index's weighting;
    (4) The five highest weighted component securities of the 
volatility index in the aggregate do not comprise more than 60% of the 
volatility index's weighting;
    (5) The average daily trading volume of the lowest weighted 
component securities in the underlying broad-based security index upon 
which the volatility index is calculated (those comprising, in the 
aggregate, 25% of the underlying broad-based security index's 
weighting) has a dollar value of more than $50,000,000 (or $30,000,000 
in the case of an underlying broad-based security index with 15 or more 
component securities), except if there are two or more securities with 
equal weighting that could be included in the calculation of the lowest 
weighted component securities comprising, in the aggregate, 25% of the 
underlying broad-based security index's weighting, such securities 
shall be ranked from lowest to highest dollar value of average daily 
trading volume and shall be included in the calculation based on their 
ranking starting with the lowest ranked security;
    (6) The index options used to calculate the magnitude of change in 
the level of the underlying broad-based security index are listed for 
trading on an exchange and pricing information for the underlying 
broad-based security index, and options on such index, is computed and 
disseminated in real-time through major market data vendors; and
    (7) The aggregate average daily trading volume in options on the 
underlying broad-based security index is at least 10,000 contracts 
calculated as of the preceding 6 full calendar months.

    By the Commodity Futures Trading Commission.

    Dated: November 17, 2009.
David A. Stawick,
Secretary.

    By the Securities and Exchange Commission.

    Dated: November 17, 2009.
Elizabeth M. Murphy,
Secretary.
[FR Doc. E9-28101 Filed 11-20-09; 8:45 am]

BILLING CODE 6351-01-P
