
[Federal Register Volume 79, Number 175 (Wednesday, September 10, 2014)]
[Notices]
[Pages 53798-53799]
From the Federal Register Online via the Government Printing Office [www.gpo.gov]
[FR Doc No: 2014-21519]



[[Page 53798]]

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SECURITIES AND EXCHANGE COMMISSION

[Release No. 34-72986; File No. SR-CBOE-2014-017]


Self-Regulatory Organizations; Chicago Board Options Exchange, 
Incorporated; Order Approving a Proposed Rule Change, as Modified by 
Amendment 1, To Amend Its Rules Related to Complex Orders

September 4, 2014.

I. Introduction

    On February 19, 2014, Chicago Board Options Exchange, Incorporated 
(the ``Exchange'' or ``CBOE'') filed with the Securities and Exchange 
Commission (the ``Commission''), pursuant to Section 19(b)(1) of the 
Securities Exchange Act of 1934 (``Act'') \1\ and Rule 19b-4 
thereunder,\2\ a proposed rule change to amend its rules relating to 
complex orders. On March 3, 2014, the Exchange filed Amendment No. 1 to 
the proposed rule change. The proposed rule change, as modified by 
Amendment No. 1 thereto, was published for comment in the Federal 
Register on March 10, 2014.\3\ On April 23, 2014, the Commission 
extended the time period in which to either approve the proposal, 
disapprove the proposal, or to institute proceedings to determine 
whether to approve or disapprove the proposal, to June 6, 2014.\4\ On 
June 5, 2014, the Commission instituted proceedings to determine 
whether to approve or disapprove the proposed rule change.\5\ The 
Commission then received two comment letters on proposal.\6\ This order 
approves the proposed rule change.
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    \1\ 15 U.S.C. 78s(b)(1).
    \2\ 17 CFR 240.19b-4.
    \3\ See Securities Exchange Act Release No. 71648 (March 5, 
2014), 79 FR 13359 (``Notice'').
    \4\ See Securities Exchange Act Release No. 72008, 79 FR 24032 
(April 29, 2014).
    \5\ See Securities Exchange Act Release No. 72329, 79 FR 33627 
(June 11, 2014).
    \6\ See letter to Kevin M. O'Neill, Deputy Secretary, 
Commission, from John Kinahan, Interim-CEO, Group One Trading, L.P., 
dated July, 7, 2014 (``Group One Letter''); and letter to the Office 
of the Secretary, Commission, from Martha Redding, Chief Counsel and 
Assistant Corporate Secretary, NYSE, Inc., dated July 10, 2014 
(``NYSE Letter'').
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II. Description of Proposed Rule Change

    Under current CBOE Rule 6.53C(d)(ii), a Trading Permit Holder 
representing a COA-eligible order may request that the Exchange 
initiate a complex order auction (``COA'') for the COA-eligible order 
before such order enters the complex order book (``COB'').\7\ In this 
proposed rule change, the Exchange proposes to require all complex 
orders with three or more legs to be subject to a COA prior to entering 
the COB.\8\ Specifically, the Exchange proposes to amend Rule 
6.53C(d)(ii) to provide that CBOE's Hybrid Trading System \9\ (the 
``System'') will initiate a COA on receipt of: (1) A COA-eligible order 
with two legs and request from the Trading Permit Holder representing 
the order that it initiate a COA; or (2) a complex order with three or 
more legs, regardless of the order's routing parameters (e.g., a 
request to route directly to the COB) or handling instructions (except 
for orders routed for manual handling).\10\ Thus, as proposed, all 
complex orders in Hybrid classes with three or more legs would 
automatically be subject to a COA (other than those routed for manual 
handling) prior to entering the COB where they can leg into the 
market.\11\
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    \7\ Under current CBOE Rule 6.53C(d)(i)(2), the Exchange may 
determine on a class-by-class basis which complex orders are 
eligible for a COA, including by complex order type and origin type. 
The Exchange notes that currently, in all Hybrid classes, customer, 
firm and broker-dealer complex orders are eligible for a COA, and 
all complex order types except for immediate-or-cancel (``IOC'') 
orders are eligible for a COA in all Hybrid classes. See Notice, 
supra note 3, n.8. Additionally, only marketable orders and 
``tweeners'' (limit orders bettering the same side of the derived 
net market) are eligible for a COA. For Hybrid 3.0 classes (i.e. 
SPX), all complex order types (including IOC orders) are eligible 
for a COA, but only customer complex orders are eligible for a COA. 
See id. (citing CBOE Regulatory Circulars RG06-73, RG08-38, and 
RG08-97).
    \8\ The Exchange explains that this proposed change applies to 
Hybrid classes only, and not Hybrid 3.0 classes. See Notice, supra 
note 3, n.7. In this regard, the proposed rule change proposes to 
amend CBOE Rule 6.53C, Interpretation and Policy .10 to indicate 
that complex orders in Hybrid 3.0 classes, regardless of the number 
of legs, will initiate a COA in the same manner they currently do. 
See id.
    \9\ The proposed rule change proposes to amend CBOE Rule 
6.53C(d)(ii) to say that the System, rather than the Exchange, will 
send the RFR message. See id. at n.9. Because the System will 
automatically send the RFR message when the conditions set forth in 
CBOE Rule 6.53C(d)(ii) are met, the Exchange believes using the term 
``System'' in the rule text is appropriate. See id.
    \10\ The Exchange explains that if a complex order with three or 
more legs contains an instruction to route for manual handling, such 
as to PAR, and through such manual handling routes to the COB, the 
proposed rule change would provide that such order will initiate a 
COA prior to entry on the COB, even if the PAR operator requests 
that the order not initiate a COA. See Notice, supra note 3, n.10.
    \11\ The Exchange states that this automatic initiation of a COA 
does not apply to stock-option orders. See id. at n.11.
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    The Exchange proposes to amend CBOE Rule 6.53C(d)(ii) to provide 
that CBOE's System will reject back to a Trading Permit Holder any 
complex order with three or more legs that includes a request pursuant 
to CBOE Rule 6.53C, Interpretation and Policy .04 \12\ that the order 
not initiate a COA.\13\ The Exchange also proposes to amend CBOE Rule 
6.53C(d)(ii), which currently provides that only a Trading Permit 
Holder representing an order may request that the order initiate a COA, 
to also provide that PAR operators handling an order may request that a 
COA-eligible order initiate a COA.\14\
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    \12\ CBOE Rule 6.53C, Interpretation and Policy .04 provides 
that Trading Permit Holders routing complex orders directly to the 
COB may request that the complex orders initiate a COA on a class-
by-class basis and Trading Permit Holders with resting complex 
orders on PAR may request that complex orders initiate a COA on an 
order-by-order basis.
    \13\ See Notice, supra note 3, at 13362.
    \14\ CBOE believes that permitting orders resting on PAR to 
initiate a COA is consistent with other CBOE rules. See id. at n. 15 
and accompanying text (citing to CBOE Rule 6.53C(d), which, 
according to the Exchange, states that complex orders may be subject 
to a COA once on PAR, and CBOE Rule 6.53C, Interpretation and Policy 
.04(a), which, according to the Exchange, states that Trading Permit 
Holders with resting complex orders on PAR may request that complex 
orders initiate a COA).
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    According to the Exchange, this proposed rule change will address 
the concern that market makers may reduce the size of their quotations 
in the leg markets because of the presence of certain complex orders 
that are designed to circumvent the ``Quote Risk Monitor Mechanism'' 
(``QRM'') settings established by market makers.\15\ CBOE describes the 
QRM as a functionality designed to help market makers provide liquidity 
across most series in their appointed classes without being at risk of 
executing the full cumulative size of all their quotes before being 
given adequate opportunity to adjust their quotes.\16\
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    \15\ See Notice, supra note 3, at 13363.
    \16\ See id. at 13361.
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    The QRM, according to CBOE, generally operates by allowing market 
makers to set a variety of parameters, which, if triggered, will cause 
the System to cancel a market maker's quotes in all series in an 
appointed class after executing the order that triggered the 
parameter.\17\ CBOE states that the System performs the QRM parameter 
calculations to determine if the QRM has been triggered after each 
execution against a market maker's quotes.\18\ According to the 
Exchange, when a complex order legs into the regular market (i.e., 
executes against individual quotes for each of the legs in the regular 
market), all of the legs of a complex order are considered as a single 
execution for purposes of the QRM, and

[[Page 53799]]

not as a series of individual transactions, because each leg of the 
complex order is contingent on the other leg.\19\ Thus, the System 
performs the QRM parameter calculations after the entire complex order 
executes against interest in the regular market. In contrast, if the 
legs of the complex order had been submitted to the regular market 
separately and without any complex order contingency, the System would 
perform the QRM parameter calculations after each leg executed against 
interest in the regular market. According to the Exchange, this 
differential treatment may result in market makers exceeding their risk 
parameters by a greater number of contracts when complex orders leg 
into the regular market.\20\
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    \17\ See id. at 13360-61. CBOE states that the System performs 
the parameter calculations after an execution against a market maker 
quote occurs in order to assure that all quotations are firm for 
their full size. See id. at 13361.
    \18\ See id.
    \19\ See id.
    \20\ See id.
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    The Exchange believes that the potential risk to market makers of 
complex orders legging into the regular market limits the amount of 
liquidity that market makers are willing to provide in the regular 
market.\21\ In particular, according to the Exchange, market makers may 
reduce the size of their quotations in the regular market because of 
the presence of these complex orders that are designed to circumvent 
QRM and risk the execution of the cumulative size of market makers' 
quotations across multiple series without market makers' being aware of 
these complex orders or having an opportunity to adjust their 
quotes.\22\ Accordingly, the Exchange believes that reducing market 
maker risk in the regular market by requiring complex orders in Hybrid 
classes with three or more legs to be subject to a COA--which will 
allow market makers to react accordingly, including adjusting their 
quotes to avoid the circumvention of their QRM parameter settings--will 
benefit investors by encouraging market makers to provide additional 
liquidity in the regular market and enhance competition in those 
classes.\23\ According to the Exchange, this potential benefit to 
investors far exceeds any ``perceived detriment'' to requiring certain 
complex orders to be subject to a COA prior to potential interaction 
with the leg markets.\24\ The Exchange notes that complex orders with 
three or more legs will still have opportunities for execution through 
a COA, in the COB or in the leg markets if they do not execute at the 
end of the COA.\25\
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    \21\ See Notice, supra note 3, at 13362.
    \22\ See id.
    \23\ See id.
    \24\ See id.
    \25\ See id.
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    In the Notice, the Exchange states that it will announce the 
implementation date of the proposed rule change in a Regulatory 
Circular to be published no later than 90 days following the effective 
date of this proposed rule change.\26\ The Exchange also states that 
the implementation date will be no later than 180 days following the 
effective date of this proposed rule change.\27\
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    \26\ See Notice, supra note 3, at 13363.
    \27\ See id.
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III. Summary of Comment Letters

    As noted above, the Commission received two comments, both 
expressing support for the proposed rule change.\28\ One commenter 
stated that it believes CBOE's proposal is a reasonable response to the 
problem of complex orders circumventing market makers QRM 
parameters.\29\ The other commenter stated that it believes that the 
proposal will allow market makers to better rely on the Exchange's QRM 
to remove quotes when a market makers risk tolerance is exceed, which, 
according to the commenter, will allow market makers to provide 
quotations with large sizes and tight spreads.\30\
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    \28\ See supra note 6.
    \29\ See NYSE Letter, supra note 6, at 2.
    \30\ See Group One Letter, supra note 6, at 2.
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IV. Discussion and Commission Findings

    After careful review, the Commission finds that the proposed rule 
change is consistent with the requirements of the Act and the rules and 
regulations thereunder applicable to a national securities 
exchange.\31\ In particular, the Commission finds that the proposed 
rule change is consistent with Section 6(b)(5) of the Act,\32\ which 
requires, among other things, that the rules of a national securities 
exchange be designed to prevent fraudulent and manipulative acts and 
practices, to promote just and equitable principles of trade, to remove 
impediments to and perfect the mechanism of a free and open market and 
a national market system, and, in general, to protect investors and the 
public interest. The Commission notes that participating in a COA will 
provide complex orders with three or more legs an opportunity for price 
improvement through the auction mechanism. The Commission also notes 
that both commenters expressed support for the proposal.
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    \31\ In approving this proposal, the Commission has considered 
the proposed rule's impact on efficiency, competition, and capital 
formation. See 15 U.S.C. 78c(f).
    \32\ 15 U.S.C. 78f(b)(5).
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V. Conclusion

    It is therefore ordered, pursuant to Section 19(b)(2) of the 
Act,\33\ that the proposed rule change (SR-CBOE-2014-017) is approved.
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    \33\ 15 U.S.C. 78s(b)(2).

    For the Commission, by the Division of Trading and Markets, 
pursuant to delegated authority.\34\
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    \34\ 17 CFR 200.30-3(a)(12).
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Kevin M. O'Neill,
Deputy Secretary.
[FR Doc. 2014-21519 Filed 9-9-14; 8:45 am]
BILLING CODE 8011-01-P


