Congress, in a surprise move, has imposed a registration provision on non-U.S. futures markets (“foreign boards of trade”) with direct market access from the United States. As expected, the U.S. financial reform legislation (“Dodd-Frank Act” or the “Act”) applies new regulatory requirements to contracts traded on foreign boards of trade (FBOT) that are directly linked to contracts traded in U.S. markets.1 However, the final version of the bill as enacted into law also includes the requirement that all FBOTs that provide for direct market access from the United States register with the Commodity Futures Trading Commission (CFTC).2 The full extent and impact of this requirement on FBOTs can only be assessed following promulgation of implementing rules by the CFTC.
New Registration Requirements for Foreign Boards of Trade
The final version of the Dodd-Frank Act provides that the CFTC may adopt regulations requiring FBOTs that provide members located in the United States direct market access3 to its electronic trading and order matching systems to register with the CFTC. The registration provision of the Dodd-Frank Act is general in nature and merely provides that the CFTC must take into consideration:
- whether any FBOT is “subject to comparable, comprehensive supervision and regulation by the appropriate governmental authorities” in its home country; and
- whether there are any previous CFTC findings that subject the FBOT to “comparable comprehensive supervision and regulation by the appropriate government authorities” in its home country.4
Current CFTC Practice: Request for No-Action Relief and CFTC Scope of Review
Presently, U.S. members or participants of an FBOT are granted direct market access to FBOTs through a no-action process.5 Generally, FBOTs request no-action relief to permit:
- members situated in the United States to trade for their own accounts through the trading system;
- members registered with the CFTC as futures commission merchants (FCMs) or who are exempt from registration to submit orders and trade for U.S. customers through the trading system;6 and
- members who are registered as FCMs or who are exempt from registration to accept orders from U.S. customers through automated order routing systems for submission to the trading system.7
- The grant of no-action relief generally includes a number of conditions, including the requirement that the FBOT report its volume on a quarterly basis and that the FBOT’s home regulator affirm on an annual basis that the FBOT remains in good standing.8 To date, approximately 20 FBOTs have been granted no-action by the CFTC.9
Changes Under Dodd-Frank
The registration provision of Dodd-Frank will likely result in transforming the current no-action process into a formal CFTC registration procedure. Although the Act leaves it within the CFTC’s discretion whether to adopt FBOT registration requirements, it is unlikely that the CFTC will continue to use a no-action process in light of the explicit grant of authority to affirmatively register FBOTs.
The issue therefore, is two-fold—whether the procedures and the substance of any new registration requirement will establish a higher barrier to entry for FBOTs than the current no-action process. Presently, in making a determination whether to grant no-action relief, the CFTC considers whether the foreign exchange is a bona fide FBOT. In making that determination, the CFTC considers whether the FBOT possesses the attributes of an established, organized exchange; adheres to appropriate rules prohibiting abusive trading practices; has been authorized by a regulatory process that examines customer and market protections; and is subject to continued oversight by a regulator that has power to intervene in the market and share information with the CFTC.10 The uncertainty facing FBOTs is whether the CFTC will interpret its current practice as meeting the legislative intent of the new registration provision.
Effect for FBOTs with Existing No-Actions
The effect of the new registration provision may be tempered for FBOTs that have already been granted no-action relief. Congress has provided that in connection with the registration of FBOTs, the CFTC must consider an FBOT’s past demonstration of the comparability of its home regulatory framework. Based upon this provision, it is reasonable to assume that FBOTs that have already been granted no-action relief will be grandfathered into registered status or, at a minimum, that the registration procedures for such FBOTs will be highly streamlined.
Regulation of Linked Contracts
Separate from the new registration process, special requirements will apply with respect to the contacts of an FBOT with direct market access to the United States that are linked to contacts traded on a U.S. market. Section 738(a) of the Act prohibits the CFTC from permitting an FBOT to provide customers in the United States direct market access to a linked contract11 unless the FBOT meets the following requirements:
- the FBOT must make publicly available the daily trading information relating to the linked contract that is comparable to the daily trading information published by the U.S. registered entity; and
- either the FBOT or its home regulator:
- adopts position limits12 for the linked contract that are comparable to those which apply to the U.S. contract;
- has the authority to require or direct market participants to limit, reduce or liquidate any position of the FBOT (or its home regulator);13
- agrees to promptly notify the CFTC of specified changes or events;14 and
- provides information to the CFTC for inclusion in the CFTC’s Commitment of Traders Reports.15
Aggregate Position Limits
In addition to the new registration provision, the Dodd-Frank Act, for the first time, will include, under an aggregate speculative position limit, contracts traded on an FBOT with direct market access that are economically linked to contracts traded on a U.S. market. Section 737(a) of the Dodd-Frank Act requires that the CFTC set aggregate speculative position limits on exempt and agricultural commodities in economically linked futures contracts, swaps, over-the-counter derivatives and contracts traded on a FBOT with direct market access.16 The CFTC must establish such limits for exempt commodities within 180 days, and for agricultural commodities, within 270 days, of enactment.17 Also noteworthy for FBOTs and their continued ability to offer direct market access to their U.S. members, Section 719 of the Dodd-Frank Reform Act requires the CFTC to conduct a study of the aggregate position limits with respect to the movement of transactions from exchanges in the United States to trading venues outside the United States.18 In addition, the Dodd-Frank Act requires the chairman of the CFTC to prepare and submit to Congress biennial reports on the “growth or decline of the derivatives markets in the United States and abroad, which shall include assessments of the causes of any such growth or decline, the effectiveness of regulatory regimes in managing systemic risk, a comparison of the costs of compliance at the time of the report for market participants subject to regulation by the United States with the costs of compliance in December 2008 for the market participants, and the quality of the available data.”19
The Dodd-Frank Act provides for a number of new requirements that will apply to FBOTs that offer direct market access to their U.S. members. These include a new registration procedure and the imposition of speculative position limits for contracts linked to those trading on a U.S. market. The full extent of the scope and effect of these requirements cannot be fully assessed until the CFTC adopts implementing rules. For this reason, FBOTs should closely monitor the CFTC’s regulatory process during the coming months.