From time to time, market participants need to consider whether a “comprehensive surveillance sharing agreement” is in effect between a U.S. securities exchange and a non-U.S. securities exchange. This article seeks to help demystify what these are, why they can be important and how they can be found.
When These Agreements Come Into Play
There are a number of contexts in which these agreements are relevant to the SEC’s rules, or to relevant stock exchange rules. For example, the SEC relies on these agreements in evaluating exchange rule changes to allow trading in new derivative products that are based on foreign securities or indexes, such as in the case of listed options on an ADR. In such a case, the SEC will want to know that there is a surveillance agreement in effect between the applicable U.S. exchange and the primary non-U.S. exchange for the securities that underlie the ADRs. Under Section 19(b) of the Exchange Act, U.S. exchanges are required to submit proposed rules and rule changes to the SEC for approval, including rules that would allow trading in new derivative products that would not be covered by existing listing standards. In order to approve a proposed rule, the SEC must find that, among other things, the rule is consistent with Section 6 of the.
Exchange Act, which requires an exchange to have the capacity to enforce compliance with its rules and the securities laws, and to enact rules designed to prevent fraud and manipulation. In making this finding regarding a request for approval of U.S. derivative products based on non-U.S. securities or indexes, one factor that the SEC evaluates is whether the U.S. exchange sponsoring the product has entered into surveillance agreements with the relevant foreign markets.
The issue also arises when an issuer of a structured note attempts to determine whether it can issue a stock-linked note that is linked to a particular non-U.S. equity security, under the “Morgan Stanley letter.” In addition to the “S-3/F-3 primary eligibility” test under the Morgan Stanley letter, the letter also provides for the possibility of linking to common equity securities where those securities would be eligible for listing on a national securities exchange under that exchange’s rules. The provisions of the relevant rules, such as NYSE Rule 703.21(C)(b)(i), require that the exchange have a comprehensive surveillance sharing agreement with the principal non-U.S. exchange for that security.
What Is a Comprehensive Surveillance Agreement?
A surveillance agreement provides that a non-U.S. entity will be able to produce and share relevant information about market trading activity, clearing activity and customer identity, without being materially impeded by the non-U.S. entity’s rules, or secrecy or blocking laws. The SEC has identified the key criteria of such an agreement as the inclusion of provisions as to each of these types of information, and that the party to the agreement has the ability to obtain and produce this information. The SEC must determine that, based on the agreement and any other relevant information provided by the non-U.S. party, existing rules, laws, or practices would not impede the U.S. entity from obtaining the relevant information.
Does Such an Agreement Exist?
Absence of a List. Unfortunately, there is no single source of publicly available information that can be used to determine whether an appropriate agreement exists between the relevant U.S. securities exchange on the one hand, and the non- U.S. securities exchange on the other hand. These are privately negotiated agreements, and cannot be found on any public database. Accordingly, a phone call to the legal department of the relevant U.S. securities exchange may be needed to determine whether the agreement exists.
The ISG. However, since 1994, the SEC has taken the position that a non-U.S. exchange’s affiliate membership in the Intermarket Surveillance Group (ISG) will serve to denote the existence of a comprehensive surveillance agreement. The SEC has had the opportunity to review the documentation and agreements used by the ISG to accept affiliate members, and determined that process to be sufficient.
The ISG was established in the 1980s, and includes an international group of exchanges, market centers and market regulators that perform market surveillance in their respective jurisdictions. The ISG coordinates and develops programs and procedures to identify possible fraudulent and manipulative activities across markets, and shares necessary information among members. In the U.S., the ISG’s membership includes, for example, the NYSE and Nasdaq. A list of the ISG’s non-U.S. members is available on its website (https://www.isgportal.org/isgPortal/public/members.htm), and includes a variety of securities exchanges in the Americas, Asia and Europe on which a variety of U.S.-traded common equity securities have their primary listings. Accordingly, the website can be a useful resource for evaluating a proposed instrument, and whether it will satisfy the relevant rules.