Self-Regulatory Organizations; Chicago Board Options Exchange Incorporated; Order Granting Approval of Proposed Rule Change as Modified by Amendment No. 4 To List and Trade Options on Corporate Debt Securities, 37551-37554 [E7-13275]
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Federal Register / Vol. 72, No. 131 / Tuesday, July 10, 2007 / Notices
rule change operative upon filing with
the Commission.
At any time within 60 days of the
filing of such proposed rule change, the
Commission may summarily abrogate
such rule change if it appears to the
Commission that such action is
necessary or appropriate in the public
interest, for the protection of investors,
or otherwise in furtherance of the
purposes of the Act.16
IV. Solicitation of Comments
Interested persons are invited to
submit written data, views, and
arguments concerning the foregoing,
including whether the proposed rule
change is consistent with the Act.
Comments may be submitted by any of
the following methods:
Electronic Comments
• Use the Commission’s Internet
comment form (https://www.sec.gov/
rules/sro.shtml); or
• Send an e-mail to rulecomments@sec.gov. Please include File
Number SR–BSE–2007–27 on the
subject line.
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Paper Comments
• Send paper comments in triplicate
to Nancy M. Morris, Secretary,
Securities and Exchange Commission,
100 F Street, NE., Washington, DC
20549–1090.
All submissions should refer to File
Number SR–BSE–2007–27. This file
number should be included on the
subject line if e-mail is used. To help the
Commission 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 (https://www.sec.gov/
rules/sro.shtml). Copies of the
submission, all subsequent
amendments, all written statements
with respect to the proposed rule
change that are filed with the
Commission, and all written
communications relating to the
proposed rule change between the
Commission and any person, other than
those that may be withheld from the
public in accordance with the
provisions of 5 U.S.C. 552, will be
available for inspection and copying in
the Commission’s Public Reference
Room, 100 F Street, NE., Washington,
DC 20549, on official business days
16 The effective date of the original proposed rule
is June 26, 2007. The effective date of Amendment
No. 1 is June 27, 2007. For purposes of calculating
the 60-day period within which the Commission
may summarily abrogate the proposed rule change
under Section 19(b)(3)(C) of the Act, the
Commission considers the period to commence on
June 27, 2007, the date on which the BSE submitted
Amendment No. 1. See 15 U.S.C. 78s(b)(3)(C).
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between the hours of 10 a.m. and 3 p.m.
Copies of such filing also will be
available for inspection and copying at
the principal office of BSE. All
comments received will be posted
without change; the Commission does
not edit personal identifying
information from submissions. You
should submit only information that
you wish to make available publicly. All
submissions should refer to File
Number SR–BSE–2007–27 and should
be submitted on or before July 31, 2007.
For the Commission, by the Division of
Market Regulation, pursuant to delegated
authority.17
Florence E. Harmon,
Deputy Secretary.
[FR Doc. E7–13309 Filed 7–9–07; 8:45 am]
BILLING CODE 8010–01–P
SECURITIES AND EXCHANGE
COMMISSION
[Release No. 34–55976; File No. SR–CBOE–
2003–41]
Self-Regulatory Organizations;
Chicago Board Options Exchange
Incorporated; Order Granting Approval
of Proposed Rule Change as Modified
by Amendment No. 4 To List and Trade
Options on Corporate Debt Securities
June 28, 2007.
I. Introduction
On September 22, 2003, the Chicago
Board Options Exchange Incorporated
(‘‘CBOE’’ or ‘‘Exchange’’) filed with the
Securities and Exchange Commission
(‘‘Commission’’ or ‘‘SEC’’), 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 list and trade options on
corporate debt securities (‘‘CDSOs’’). On
March 1, 2003, CBOE filed Amendment
No. 1 to the proposed rule change.
CBOE filed Amendment No. 2 to the
proposed rule change on August 24,
2005. CBOE filed Amendment No. 3 to
the proposed rule change on May 26,
2006. On June 13, 2006, the proposed
rule change, as amended by
Amendment Nos. 1, 2, and 3, was
published in the Federal Register.3
CBOE filed Amendment No. 4 on July
14, 2006.4 The Commission received
one comment letter on the proposal.5
CFR 200.30–3(a)(12).
U.S.C. 78s(b)(1).
2 17 CFR 240.19b–4.
3 See Securities Exchange Act Release No. 53935
(June 2, 2006), 71 FR 34174.
4 In Amendment No. 4, CBOE made minor
technical changes to the proposed rule text.
5 See Letter from Mary C.M. Kuan, Vice President
and Assistant General Counsel, The Bond Market
PO 00000
17 17
37551
On October 31, 2006, CBOE filed a
response to the comment.6 This order
approves the proposed rule change, as
amended.
II. Description of the Proposed Rule
Change
(a) Background
Over-the-counter (‘‘OTC’’)
transactions in corporate debt securities
are publicly reported through the
NASD’s Trade Reporting and
Compliance Engine (‘‘TRACE’’) system.
CBOE believes that the enhanced
transparency created by TRACE has
given rise to an OTC market in CDSOs,
and that an exchange-traded alternative
for such products may provide a useful
risk management and trading vehicle for
member firms and their customers.
CBOE believes that exchange-listed
CDSOs would have three important
advantages over similar options traded
in the OTC market. First, as a result of
greater standardization of contract
terms, exchange-listed contracts should
develop more liquidity. Second,
counterparty credit risk would be
mitigated because the contracts would
be issued and guaranteed by The
Options Clearing Corporation (‘‘OCC’’).
Finally, the quotation and last-sale data
provided by CBOE and its members
would lead to more transparent markets.
CBOE believes that offering CDSOs
would create competition with the OTC
market and expand the universe of
listed products available to interested
market participants.
(b) Listing Standards
The Exchange has proposed CBOE
Rules 5.3.10 and 5.4.14 for the initial
listing and continued maintenance
standards, respectively, for CDSOs. The
Exchange proposes that for initial
listing, a CDSO must satisfy the
following criteria:
• The original public sale of a
corporate debt security on which
options transactions will be effected on
the Exchange shall be at least a
$250,000,000 principal amount.
• Trading volume (in all markets in
which the underlying corporate debt
security is traded) has been at least
$100,000,000 in notional value over the
preceding six months.
• The corporate debt security has a
minimum aggregate par value or ‘‘float’’
of $200,000,000.
1 15
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Association (‘‘TBMA’’), to Nancy M. Morris,
Secretary, Commission, dated August 25, 2006
(‘‘TBMA Letter’’).
6 See Letter from Angelo Evangelou, Assistant
Secretary, CBOE, to Ronesha Butler, Special
Counsel, Commission, dated October 25, 2006
(‘‘Response’’).
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• The corporate debt security has at
least 320 holders.
• The issuer of the corporate debt
security or the issuer’s parent, if the
issuer is a wholly-owned subsidiary, has
at least one class of common or
preferred equity securities registered
under Section 12(b) of the Act.
• The equity securities issued by the
corporate debt security issuer are
‘‘covered securities’’ as defined under
Section 18(b)(1)(A) of the Securities Act
of 1933 (‘‘1933 Act’’).
• The corporate debt security on
which options transactions will be
effected on the Exchange has a credit
rating issued by Moody’s Investors
Service that is Caa or higher and a credit
rating issued by Standard and Poor’s
that is CC or higher.
• The issuer of the corporate debt
security has registered the offer and sale
of such securities under the 1933 Act.
• The transfer agent of the corporate
debt security is registered under Section
17A of the Act.
• The trust indenture for the
corporate debt security is qualified
under the Trust Indenture Act of 1939.
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(c) Settlement
CDSOs will be physically settled,
European-style options that may be
exercised only on the last day of
expiration. Trading in CDSOs ordinarily
will cease on the business day (usually
a Friday) preceding the expiration date
and the trading hours will be 8:30 a.m.
to 3:02 p.m. Chicago time. The
expiration date will be the Saturday
immediately following the third Friday
of the expiration month. CBOE Rule
28.7 provides that there will be up to
five expiration months, none further out
than 15 months, but the Exchange can
list additional options expiration further
out than 15 months where a reasonably
active secondary market exists.
The settlement process for CDSOs
will be the same as the settlement
process for equity options under CBOE
rules, with the exception of the delivery
process.7 Payment of a CDSO’s exercise
price will be accompanied by payment
of accrued interest on the underlying
corporate debt security from, but not
including, the last interest payment date
to, and including, the exercise
settlement date, as specified in OCC
rules. The Exchange will notify OCC of
the accrued interest calculation
methodology that applies to each
7 If the outstanding debt issuance amount of an
underlying corporate debt security is insufficient to
satisfy the delivery requirements under CBOE Rule
11.3, OCC rules provide for special settlement
exercise procedures.
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corporate debt security prior to the
listing of the particular CDSO.
(d) Minimum Price Variation and Strike
Price Intervals
The option premium will be quoted in
points where each point equals $1,000.
The minimum tick will be 0.05 ($50.00).
Series with strike prices in, at, and out
of the money initially will be listed (up
to ten per month initially). In addition,
CBOE proposes to limit the strike price
intervals that can be used for CDSOs,
which will be fixed at a percentage of
principal amounts (based on a par quote
basis of $100) as follows:
• 0.5% ($0.50) or greater, provided
that the series to be listed is no more
than 5% above or below the current
market price of a corporate debt security
reported on TRACE during TRACE
system hours or effected on or through
the facilities of a national securities
exchange, as applicable, on the day
prior to the day the series is first listed
for trading;
• 1.0% ($1.00) or greater, provided
that the series to be listed is no more
than 10% above or below the current
market price of a corporate debt security
reported on TRACE during TRACE
system hours or effected on or through
the facilities of a national securities
exchange, as applicable, on the day
prior to the day the series is first listed
for trading; and
• 2.5% ($2.50) or greater, provided
that the series to be listed is greater than
10% above or below the current market
price of a corporate debt security
reported on TRACE during TRACE
system hours or effected on or through
facilities of a national securities
exchange, as applicable, on the day
prior to the day the series is first listed
for trading.
These increments are designed to
allow the Exchange flexibility to list
options with strike increments at
appropriate levels, while diminishing
any potential adverse effect on the
Exchange’s quote capacity thresholds.
CBOE believes that the operational
capacity used to accommodate the
trading of CDSOs on the Exchange will
have a negligible effect on the total
capacity used by the Exchange to trade
its products on a daily basis. The
Exchange has represented that it will
delist a CDSO series for which there is
no open interest.
(e) Position Limits
CBOE proposes to establish tiered
position limits for CDSOs based on a
policy to limit positions in such options
to a quantity that, if exercised, would
not exceed 10% of the total float of the
underlying bond. CBOE believes the
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10% level is sufficient to inhibit market
manipulation or to mitigate other
possible disruptions in the market.
CBOE’s lowest position limit for equity
options is 13,500 contracts, which, if
exercised, would represent
approximately 19.28% of the minimum
float of an equity security eligible to
underlie a CBOE equity option (seven
million shares).8 Moreover, CBOE’s
13,500 equity option contract limit
applies to those options having an
underlying security that does not meet
the requirements for a higher option
contract limit. CBOE believes the 10%
position limit for CDSOs, which is
significantly less than that for equity
options, is sufficiently high to account
for the differences in liquidity between
the equity and debt markets and would
consist of the following tiers:
Float of underlying debt issue
$200,000,000–$499,999,000 ....
500,000,000–749,999,000 ........
750,000,000–999,999,000 ........
1,000,000,000–2,499,999,000 ..
2,500,000,000 and greater .......
Position
limit for
CDSO
(contracts)
200
500
750
1,000
2,500
If a person holds more than 10% of
a particular corporate debt security, the
amount held by such person would not
be included in the ‘‘total float’’ for
purposes of determining the applicable
position (and exercise) limits.9
(f) Margin
The margin (both initial and
maintenance) for writing uncovered
puts or calls will be as follows:
• An option writer will be required to
deposit and maintain 100% of the
current market value of the option plus
10% of the aggregate contract value
minus the amount, if any, by which the
option is out of the money, subject to a
minimum for calls equal to 100% of the
current market value of the option plus
5% of the aggregate contract value for
any options on corporate debt securities
that are rated investment-grade.10
• For options on non-investmentgrade 11 corporate debt securities, the
margin requirement will be 100% of the
8 See
CBOE Rule 4.11 (Position Limits).
example, if a person holds 14% of the total
outstanding issuance of a corporate debt security,
the applicable position (and exercise) limits would
be based only on the remaining 86% of the issuance
that is not held by such person.
10 The definition of an investment-grade
corporate debt security is set forth in CBOE Rule
12.3(a)(15). The definition mirrors the definition set
forth in NASD rules pertaining to TRACE.
11 The definition of a non-investment-grade
corporate debt security is set forth in CBOE Rule
12.3(a)(16). The definition mirrors the definition set
forth in the NASD rules pertaining to TRACE.
9 For
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current market value of the option plus
15% of the aggregate contract value
minus the amount, if any, by which the
option is out of the money, subject to a
minimum for calls equal to 100% of the
current market value of the option plus
10% of the aggregate contract value.
• Writers of options on convertible
corporate debt securities will be
required to deposit and maintain 100%
of the current market value of the option
plus 20% of the aggregate contract value
minus the amount, if any, by which the
option is out of the money, subject to a
minimum for calls equal to 100% of the
current market value of the option plus
10% of the aggregate contract value.
• In the case of puts for each of
investment-grade, non-investmentgrade, and convertible corporate debt
securities, the minimum margin
required will be 100% of the current
market value of the option plus 5%,
10%, and 10%, respectively, of the put
exercise price.
This methodology incorporates the
same formula that the Exchange applies
to all other option classes in Chapter 12
of CBOE rules, but with percentages that
consider the specific market factors
pertaining to the debt rating and type of
corporate debt security. For example,
the Exchange requires a deposit of 100%
of the current market value of the option
plus a 20% initial/maintenance margin
and a 10% minimum margin. The
Exchange would apply these initial/
maintenance margin and minimum
margin requirements if a convertible
debt security underlies a CDSO. If an
investment-grade corporate debt
security underlies an option, the
Exchange would impose a 10% initial/
maintenance margin and a 5%
minimum margin on the CDSO position
because an investment-grade corporate
debt security generally experiences
lower price movements and lower
volatility levels than stocks. CBOE
proposes a 15% initial/maintenance
margin and a 5% minimum margin for
CDSOs based on non-investment-grade
corporate debt securities because these
securities exhibit more price movements
than investment-grade corporate debt
securities. The Exchange believes that
these margin levels are consistent with
the Commission’s Net Capital Rule 12 for
the underlying corporate debt securities.
(g) Surveillance
CBOE will implement a surveillance
plan to monitor trading in CDSOs. The
surveillance plan will include, but not
be limited to, monitoring for insider
trading, mini-manipulation,
manipulation, frontrunning, and
12 17
CFR 240.15c3–1.
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capping and pegging. The Exchange will
also monitor the media for rating
downgrades and other corporate actions
to ensure the Exchange’s maintenance
standards are fulfilled, and monitor for
any corporate actions that may
influence the pricing of corporate debt
securities and options thereon.
(h) Information Bulletin
CBOE will issue a circular to its
members before the initiation of trading
in CDSOs that will describe the special
characteristics of CDSOs. This circular
will highlight the exercise methodology
of the series, explain the cash
adjustment procedures, identify the new
symbols for the CDSO series, and
identify the initial expiration months
and strike prices available for trading.
(i) Trading Halts
The Exchange proposes CBOE Rule
28.10 which would allow floor officials
to consider the following factors, in
addition to those set forth in CBOE Rule
6.3, in determining whether to halt
trading in a CDSO:
• Whether TRACE is inoperative; and
• whether the issuer or trustee, as
applicable under the agreements
governing the underlying corporate debt
security, provides notification to
holders of the corporate debt security
that the corporate debt security is to be
redeemed in whole or part.
III. Summary of Comments and CBOE
Response
The Commission received one
comment on the proposal. The
commenter, TBMA, generally supported
the proposed rule change, but suggested
modifying it in certain respects. TBMA
noted that the initial principal amount
for bonds underlying an option is
typically $500 million in the OTC
market, and suggested that CBOE raise
its threshold. CBOE responded that the
$250 million issue threshold gave the
Exchange the flexibility to list options
on smaller issues that CBOE believed
were actively traded.
Furthermore, TBMA believed that the
float and trading volume requirements
may not be sufficiently high. TBMA also
requested additional information on
how the initial and ongoing trading
volume and float would be determined
by the Exchange. CBOE responded that
the float and trading volume
requirements for its CDSOs should not
be significantly higher than for equities.
Setting the listing criteria too high for
CDSOs could prevent the listing of
options on corporate debt securities
where options could be listed on
equities of the same issuer. CBOE also
stated that it will determine the initial
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37553
$200 million float by looking at public
information submitted by investors who
are required to report their holdings.
TBMA claimed that differences exist
between CBOE’s proposed margin
requirements and other self-regulatory
organizations (‘‘SROs’’). Specifically,
TBMA notes the differences in the
definition of ‘‘investment grade’’ and
the range of products eligible for
portfolio margining. CBOE, however,
believed that its proposed margin levels
are appropriate. CBOE asserted that the
definition of investment grade is
consistent with the definition of that
term as used by other SROs, and that
CBOE’s definition is more
comprehensive. With respect to the
range of equity products available for
portfolio margining, CBOE stated that it
supports the inclusion of fixed income
products within the portfolio margining
regime and expects that CDSOs will be
incorporated at a later stage. CBOE
noted that it would consider amending
its margin rules at that time.
TBMA requested information on how
CBOE would exclude 10% holders in
determining the total float amount.
CBOE stated that the Exchange
anticipates using Bloomberg’s ‘‘HDS’’
function to obtain this information in a
timely manner. CBOE added that the
Exchange intends to implement
monitoring procedures to identify
corporate actions on an ongoing basis.
TBMA claimed that the expiration
date of CBOE’s CDSOs differed from the
general practice of OTC options on
corporate bonds, which typically expire
on the 20th of the relevant month.
TBMA believed that this difference
could affect how CBOE’s options were
used to hedge OTC options. CBOE
stated that final trading on third Fridays
allows settlement on Saturdays and
allows dovetailing of processing of
equity and bond options. CBOE noted
that, while the 20th of the month may
be the standard settlement date for
credit index derivatives, it is not clear
that this settlement date has been
adopted for the less active market for
CDSOs. CBOE added that it would
nevertheless consider amending its rule
to adopt this standard at a later time.
TBMA suggested that CBOE work
with the OCC to revise the Options
Disclosure Document (‘‘ODD’’) to
accommodate CDSOs, and that the ODD
be made available for review and
comment before approval of the
proposal. In order to accommodate the
listing and trading of CDSOs, CBOE
expects that the OCC would amend its
By-Laws and Rules to reflect CDSOs,
which would be subject to public
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comment.13 In addition, the Exchange
believes that the OCC would seek to
revise the ODD to incorporate CDSOs.14
Further, CBOE clarified that the
Exchange is working with OCC to
develop procedures to address actions
including full and partial redemptions,
conversions to equities, bankruptcies,
conversion to new series, and other
actions. According to CBOE, the OCC
intends to use a major data vendor to
determine the market value of the
underlying corporate debt securities of
CDSOs. The data vendor will view
TRACE and several other price reporting
services to derive a composite price for
each underlying security on a daily
basis.
IV. Discussion and Commission’s
Findings
After careful review, the Commission
finds that the proposed rule change, as
amended, is consistent with the
requirements of the Act and the rules
and regulations thereunder applicable to
a national securities exchange.15 In
particular, the Commission believes that
the proposed rule change is consistent
with Section 6(b)(5) of the Act,16 which
requires that the rules of an 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 for a free and
open market and a national market
system, and, in general, to protect
investors and the public interest.
The Commission believes that the
listing rules proposed by CBOE for
CDSOs are reasonable and consistent
with the Act. The Commission notes
that, for a CDSO to be listed, the
underlying corporate debt security
must, among other things, have
substantial trading volume, initial
principal amount, and outstanding float;
the issuer of the corporate debt security
must have at least one class of equity
security registered under Section 12(b)
of the Act; and such equity securities
must satisfy the requirements for
options trading on CBOE. These
requirements are reasonably designed to
facilitate investors’ access to
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13 Telephone
conversation between Jennifer L.
Klebes, Senior Attorney, CBOE and Marc McKayle,
Special Counsel, Division of Market Regulation,
Commission, on June 28, 2007.
14 See also Exchange Act Rule 9b–1(b)(2)(i) which
requires the relevant option market to file material
changes to the ODD with the Commission, if the
ODD without such changes would become
inaccurate, incomplete, or misleading.
15 In approving this proposed rule change, the
Commission notes that it has considered the
proposed rule’s impact on efficiency, competition,
and capital formation. See 15 U.S.C. 78c(f).
16 15 U.S.C. 78s(b)(5).
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information that may be necessary to
price a CDSO appropriately.
The Commission believes that the
proposed position limits and margin
rules for CDSOs are reasonable and
consistent with the Act. The proposed
position limits reasonably balance the
promotion of a free and open market for
these securities with minimization of
incentives for market manipulation and
insider trading. The proposed margin
rules are reasonably designed to deter a
member or its customer from assuming
an imprudent position in CDSOs.
In support of the proposed rule
change, the Exchange has made the
following representations:
1. The Exchange has sufficient
operational capacity to accommodate
the listing and trading of CDSOs.
2. The Exchange’s surveillance
procedures are adequate to properly
monitor the trading of the CDSOs.
3. The Exchange will inform its
members in an Information Circular of
the special characteristics and risks
associated with trading the CDSOs.
4. The Exchange will delist CDSO
series for which there is no open
interest.
This approval order is conditioned on
the Exchange’s adherence to these
representations.
V. Conclusion
It is therefore ordered, pursuant to
Section 19(b)(2) of the Act,17 that the
proposed rule change (SR–CBOE–2003–
41), as modified by Amendment No. 4,
be, and hereby is, approved.
For the Commission, by the Division of
Market Regulation, pursuant to delegated
authority.18
Florence E. Harmon,
Deputy Secretary.
[FR Doc. E7–13275 Filed 7–9–07; 8:45 am]
BILLING CODE 8010–01–P
SECURITIES AND EXCHANGE
COMMISSION
[Release No. 34–56000; File No. SR–CBOE–
2007–73]
Self-Regulatory Organizations;
Chicago Board Options Exchange,
Incorporated; Notice of Filing of
Proposed Rule Change To Assess, on
a Retroactive Basis, Certain CBOE and
CBSX Market Data Fees
July 2, 2007.
Pursuant to Section 19(b)(1) of the
Securities Exchange Act of 1934
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17 15
18 17
U.S.C. 78s(b)(2).
CFR 200.30–3(a)(12).
Frm 00051
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(‘‘Act’’) 1 and Rule 19b–4 thereunder,2
notice is hereby given that on June 28,
2007, the Chicago Board Options
Exchange, Incorporated (‘‘CBOE’’ or
‘‘Exchange’’) filed with the Securities
and Exchange Commission
(‘‘Commission’’) the proposed rule
change as described in Items I, II, and
III below, which Items have been
substantially prepared by the Exchange.
The Commission is publishing this
notice to solicit comments on the
proposed rule change from interested
persons.
I. Self-Regulatory Organization’s
Statement of the Terms of Substance of
the Proposed Rule Change
The Exchange proposes to amend its
Fees Schedule to assess, retroactive to
April 1, 2007, fees relating to CBOE and
CBOE Stock Exchange (‘‘CBSX’’) market
data that were implemented on June 1,
2007. The text of the proposed rule
change is available at CBOE, the
Commission’s Public Reference Room,
and www.cboe.org/legal.
II. Self-Regulatory Organization’s
Statement of the Purpose of, and
Statutory Basis for, the Proposed Rule
Change
In its filing with the Commission,
CBOE included statements concerning
the purpose of and basis for the
proposed rule change and discussed any
comments it received on the proposed
rule change. The text of these statements
may be examined at the places specified
in Item IV below. The Exchange has
prepared summaries, set forth in
Sections A, B, and C below, of the most
significant aspects of such statements.
A. Self-Regulatory Organization’s
Statement of the Purpose of, and
Statutory Basis for, the Proposed Rule
Change
1. Purpose
On June 1, 2007, the Exchange
implemented new fees relating to
TickerXpress (‘‘TX’’), which is an
Exchange service that supplies market
data to Exchange market-makers trading
on the Hybrid Trading System.3
Specifically, the Exchange increased the
monthly fee for enhanced TX market
data from $200 per month to $300 per
month and adopted a fee of $100 per TX
user per month for use of TX software
for the use and display of market data.
The Exchange proposes to assess these
fees for the period April 1, 2007 through
1 15
U.S.C. 78s(b)(1).
CFR 240.19b–4.
3 See Securities Exchange Act Release No. 55882
(June 8, 2007), 72 FR 32931 (June 14, 2007) (File
No. SR–CBOE–2007–54).
2 17
E:\FR\FM\10JYN1.SGM
10JYN1
]]>Agencies
[Federal Register Volume 72, Number 131 (Tuesday, July 10, 2007)]
[Notices]
[Pages 37551-37554]
From the Federal Register Online via the Government Printing Office [www.gpo.gov]
[FR Doc No: E7-13275]
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SECURITIES AND EXCHANGE COMMISSION
[Release No. 34-55976; File No. SR-CBOE-2003-41]
Self-Regulatory Organizations; Chicago Board Options Exchange
Incorporated; Order Granting Approval of Proposed Rule Change as
Modified by Amendment No. 4 To List and Trade Options on Corporate Debt
Securities
June 28, 2007.
I. Introduction
On September 22, 2003, the Chicago Board Options Exchange
Incorporated (``CBOE'' or ``Exchange'') filed with the Securities and
Exchange Commission (``Commission'' or ``SEC''), 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 list and trade options
on corporate debt securities (``CDSOs''). On March 1, 2003, CBOE filed
Amendment No. 1 to the proposed rule change. CBOE filed Amendment No. 2
to the proposed rule change on August 24, 2005. CBOE filed Amendment
No. 3 to the proposed rule change on May 26, 2006. On June 13, 2006,
the proposed rule change, as amended by Amendment Nos. 1, 2, and 3, was
published in the Federal Register.\3\ CBOE filed Amendment No. 4 on
July 14, 2006.\4\ The Commission received one comment letter on the
proposal.\5\ On October 31, 2006, CBOE filed a response to the
comment.\6\ This order approves the proposed rule change, as amended.
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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. 53935 (June 2,
2006), 71 FR 34174.
\4\ In Amendment No. 4, CBOE made minor technical changes to the
proposed rule text.
\5\ See Letter from Mary C.M. Kuan, Vice President and Assistant
General Counsel, The Bond Market Association (``TBMA''), to Nancy M.
Morris, Secretary, Commission, dated August 25, 2006 (``TBMA
Letter'').
\6 \ See Letter from Angelo Evangelou, Assistant Secretary,
CBOE, to Ronesha Butler, Special Counsel, Commission, dated October
25, 2006 (``Response'').
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II. Description of the Proposed Rule Change
(a) Background
Over-the-counter (``OTC'') transactions in corporate debt
securities are publicly reported through the NASD's Trade Reporting and
Compliance Engine (``TRACE'') system. CBOE believes that the enhanced
transparency created by TRACE has given rise to an OTC market in CDSOs,
and that an exchange-traded alternative for such products may provide a
useful risk management and trading vehicle for member firms and their
customers.
CBOE believes that exchange-listed CDSOs would have three important
advantages over similar options traded in the OTC market. First, as a
result of greater standardization of contract terms, exchange-listed
contracts should develop more liquidity. Second, counterparty credit
risk would be mitigated because the contracts would be issued and
guaranteed by The Options Clearing Corporation (``OCC''). Finally, the
quotation and last-sale data provided by CBOE and its members would
lead to more transparent markets. CBOE believes that offering CDSOs
would create competition with the OTC market and expand the universe of
listed products available to interested market participants.
(b) Listing Standards
The Exchange has proposed CBOE Rules 5.3.10 and 5.4.14 for the
initial listing and continued maintenance standards, respectively, for
CDSOs. The Exchange proposes that for initial listing, a CDSO must
satisfy the following criteria:
The original public sale of a corporate debt security on
which options transactions will be effected on the Exchange shall be at
least a $250,000,000 principal amount.
Trading volume (in all markets in which the underlying
corporate debt security is traded) has been at least $100,000,000 in
notional value over the preceding six months.
The corporate debt security has a minimum aggregate par
value or ``float'' of $200,000,000.
[[Page 37552]]
The corporate debt security has at least 320 holders.
The issuer of the corporate debt security or the issuer's
parent, if the issuer is a wholly-owned subsidiary, has at least one
class of common or preferred equity securities registered under Section
12(b) of the Act.
The equity securities issued by the corporate debt
security issuer are ``covered securities'' as defined under Section
18(b)(1)(A) of the Securities Act of 1933 (``1933 Act'').
The corporate debt security on which options transactions
will be effected on the Exchange has a credit rating issued by Moody's
Investors Service that is Caa or higher and a credit rating issued by
Standard and Poor's that is CC or higher.
The issuer of the corporate debt security has registered
the offer and sale of such securities under the 1933 Act.
The transfer agent of the corporate debt security is
registered under Section 17A of the Act.
The trust indenture for the corporate debt security is
qualified under the Trust Indenture Act of 1939.
(c) Settlement
CDSOs will be physically settled, European-style options that may
be exercised only on the last day of expiration. Trading in CDSOs
ordinarily will cease on the business day (usually a Friday) preceding
the expiration date and the trading hours will be 8:30 a.m. to 3:02
p.m. Chicago time. The expiration date will be the Saturday immediately
following the third Friday of the expiration month. CBOE Rule 28.7
provides that there will be up to five expiration months, none further
out than 15 months, but the Exchange can list additional options
expiration further out than 15 months where a reasonably active
secondary market exists.
The settlement process for CDSOs will be the same as the settlement
process for equity options under CBOE rules, with the exception of the
delivery process.\7\ Payment of a CDSO's exercise price will be
accompanied by payment of accrued interest on the underlying corporate
debt security from, but not including, the last interest payment date
to, and including, the exercise settlement date, as specified in OCC
rules. The Exchange will notify OCC of the accrued interest calculation
methodology that applies to each corporate debt security prior to the
listing of the particular CDSO.
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\7\ If the outstanding debt issuance amount of an underlying
corporate debt security is insufficient to satisfy the delivery
requirements under CBOE Rule 11.3, OCC rules provide for special
settlement exercise procedures.
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(d) Minimum Price Variation and Strike Price Intervals
The option premium will be quoted in points where each point equals
$1,000. The minimum tick will be 0.05 ($50.00). Series with strike
prices in, at, and out of the money initially will be listed (up to ten
per month initially). In addition, CBOE proposes to limit the strike
price intervals that can be used for CDSOs, which will be fixed at a
percentage of principal amounts (based on a par quote basis of $100) as
follows:
0.5% ($0.50) or greater, provided that the series to be
listed is no more than 5% above or below the current market price of a
corporate debt security reported on TRACE during TRACE system hours or
effected on or through the facilities of a national securities
exchange, as applicable, on the day prior to the day the series is
first listed for trading;
1.0% ($1.00) or greater, provided that the series to be
listed is no more than 10% above or below the current market price of a
corporate debt security reported on TRACE during TRACE system hours or
effected on or through the facilities of a national securities
exchange, as applicable, on the day prior to the day the series is
first listed for trading; and
2.5% ($2.50) or greater, provided that the series to be
listed is greater than 10% above or below the current market price of a
corporate debt security reported on TRACE during TRACE system hours or
effected on or through facilities of a national securities exchange, as
applicable, on the day prior to the day the series is first listed for
trading.
These increments are designed to allow the Exchange flexibility to
list options with strike increments at appropriate levels, while
diminishing any potential adverse effect on the Exchange's quote
capacity thresholds. CBOE believes that the operational capacity used
to accommodate the trading of CDSOs on the Exchange will have a
negligible effect on the total capacity used by the Exchange to trade
its products on a daily basis. The Exchange has represented that it
will delist a CDSO series for which there is no open interest.
(e) Position Limits
CBOE proposes to establish tiered position limits for CDSOs based
on a policy to limit positions in such options to a quantity that, if
exercised, would not exceed 10% of the total float of the underlying
bond. CBOE believes the 10% level is sufficient to inhibit market
manipulation or to mitigate other possible disruptions in the market.
CBOE's lowest position limit for equity options is 13,500 contracts,
which, if exercised, would represent approximately 19.28% of the
minimum float of an equity security eligible to underlie a CBOE equity
option (seven million shares).\8\ Moreover, CBOE's 13,500 equity option
contract limit applies to those options having an underlying security
that does not meet the requirements for a higher option contract limit.
CBOE believes the 10% position limit for CDSOs, which is significantly
less than that for equity options, is sufficiently high to account for
the differences in liquidity between the equity and debt markets and
would consist of the following tiers:
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\8\ See CBOE Rule 4.11 (Position Limits).
------------------------------------------------------------------------
Position
limit for
Float of underlying debt issue CDSO
(contracts)
------------------------------------------------------------------------
$200,000,000-$499,999,000.................................. 200
500,000,000-749,999,000.................................... 500
750,000,000-999,999,000.................................... 750
1,000,000,000-2,499,999,000................................ 1,000
2,500,000,000 and greater.................................. 2,500
------------------------------------------------------------------------
If a person holds more than 10% of a particular corporate debt
security, the amount held by such person would not be included in the
``total float'' for purposes of determining the applicable position
(and exercise) limits.\9\
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\9\ For example, if a person holds 14% of the total outstanding
issuance of a corporate debt security, the applicable position (and
exercise) limits would be based only on the remaining 86% of the
issuance that is not held by such person.
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(f) Margin
The margin (both initial and maintenance) for writing uncovered
puts or calls will be as follows:
An option writer will be required to deposit and maintain
100% of the current market value of the option plus 10% of the
aggregate contract value minus the amount, if any, by which the option
is out of the money, subject to a minimum for calls equal to 100% of
the current market value of the option plus 5% of the aggregate
contract value for any options on corporate debt securities that are
rated investment-grade.\10\
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\10\ The definition of an investment-grade corporate debt
security is set forth in CBOE Rule 12.3(a)(15). The definition
mirrors the definition set forth in NASD rules pertaining to TRACE.
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For options on non-investment-grade \11\ corporate debt
securities, the margin requirement will be 100% of the
[[Page 37553]]
current market value of the option plus 15% of the aggregate contract
value minus the amount, if any, by which the option is out of the
money, subject to a minimum for calls equal to 100% of the current
market value of the option plus 10% of the aggregate contract value.
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\11\ The definition of a non-investment-grade corporate debt
security is set forth in CBOE Rule 12.3(a)(16). The definition
mirrors the definition set forth in the NASD rules pertaining to
TRACE.
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Writers of options on convertible corporate debt
securities will be required to deposit and maintain 100% of the current
market value of the option plus 20% of the aggregate contract value
minus the amount, if any, by which the option is out of the money,
subject to a minimum for calls equal to 100% of the current market
value of the option plus 10% of the aggregate contract value.
In the case of puts for each of investment-grade, non-
investment-grade, and convertible corporate debt securities, the
minimum margin required will be 100% of the current market value of the
option plus 5%, 10%, and 10%, respectively, of the put exercise price.
This methodology incorporates the same formula that the Exchange
applies to all other option classes in Chapter 12 of CBOE rules, but
with percentages that consider the specific market factors pertaining
to the debt rating and type of corporate debt security. For example,
the Exchange requires a deposit of 100% of the current market value of
the option plus a 20% initial/maintenance margin and a 10% minimum
margin. The Exchange would apply these initial/maintenance margin and
minimum margin requirements if a convertible debt security underlies a
CDSO. If an investment-grade corporate debt security underlies an
option, the Exchange would impose a 10% initial/maintenance margin and
a 5% minimum margin on the CDSO position because an investment-grade
corporate debt security generally experiences lower price movements and
lower volatility levels than stocks. CBOE proposes a 15% initial/
maintenance margin and a 5% minimum margin for CDSOs based on non-
investment-grade corporate debt securities because these securities
exhibit more price movements than investment-grade corporate debt
securities. The Exchange believes that these margin levels are
consistent with the Commission's Net Capital Rule \12\ for the
underlying corporate debt securities.
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\12\ 17 CFR 240.15c3-1.
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(g) Surveillance
CBOE will implement a surveillance plan to monitor trading in
CDSOs. The surveillance plan will include, but not be limited to,
monitoring for insider trading, mini-manipulation, manipulation,
frontrunning, and capping and pegging. The Exchange will also monitor
the media for rating downgrades and other corporate actions to ensure
the Exchange's maintenance standards are fulfilled, and monitor for any
corporate actions that may influence the pricing of corporate debt
securities and options thereon.
(h) Information Bulletin
CBOE will issue a circular to its members before the initiation of
trading in CDSOs that will describe the special characteristics of
CDSOs. This circular will highlight the exercise methodology of the
series, explain the cash adjustment procedures, identify the new
symbols for the CDSO series, and identify the initial expiration months
and strike prices available for trading.
(i) Trading Halts
The Exchange proposes CBOE Rule 28.10 which would allow floor
officials to consider the following factors, in addition to those set
forth in CBOE Rule 6.3, in determining whether to halt trading in a
CDSO:
Whether TRACE is inoperative; and
whether the issuer or trustee, as applicable under the
agreements governing the underlying corporate debt security, provides
notification to holders of the corporate debt security that the
corporate debt security is to be redeemed in whole or part.
III. Summary of Comments and CBOE Response
The Commission received one comment on the proposal. The commenter,
TBMA, generally supported the proposed rule change, but suggested
modifying it in certain respects. TBMA noted that the initial principal
amount for bonds underlying an option is typically $500 million in the
OTC market, and suggested that CBOE raise its threshold. CBOE responded
that the $250 million issue threshold gave the Exchange the flexibility
to list options on smaller issues that CBOE believed were actively
traded.
Furthermore, TBMA believed that the float and trading volume
requirements may not be sufficiently high. TBMA also requested
additional information on how the initial and ongoing trading volume
and float would be determined by the Exchange. CBOE responded that the
float and trading volume requirements for its CDSOs should not be
significantly higher than for equities. Setting the listing criteria
too high for CDSOs could prevent the listing of options on corporate
debt securities where options could be listed on equities of the same
issuer. CBOE also stated that it will determine the initial $200
million float by looking at public information submitted by investors
who are required to report their holdings.
TBMA claimed that differences exist between CBOE's proposed margin
requirements and other self-regulatory organizations (``SROs'').
Specifically, TBMA notes the differences in the definition of
``investment grade'' and the range of products eligible for portfolio
margining. CBOE, however, believed that its proposed margin levels are
appropriate. CBOE asserted that the definition of investment grade is
consistent with the definition of that term as used by other SROs, and
that CBOE's definition is more comprehensive. With respect to the range
of equity products available for portfolio margining, CBOE stated that
it supports the inclusion of fixed income products within the portfolio
margining regime and expects that CDSOs will be incorporated at a later
stage. CBOE noted that it would consider amending its margin rules at
that time.
TBMA requested information on how CBOE would exclude 10% holders in
determining the total float amount. CBOE stated that the Exchange
anticipates using Bloomberg's ``HDS'' function to obtain this
information in a timely manner. CBOE added that the Exchange intends to
implement monitoring procedures to identify corporate actions on an
ongoing basis.
TBMA claimed that the expiration date of CBOE's CDSOs differed from
the general practice of OTC options on corporate bonds, which typically
expire on the 20th of the relevant month. TBMA believed that this
difference could affect how CBOE's options were used to hedge OTC
options. CBOE stated that final trading on third Fridays allows
settlement on Saturdays and allows dovetailing of processing of equity
and bond options. CBOE noted that, while the 20th of the month may be
the standard settlement date for credit index derivatives, it is not
clear that this settlement date has been adopted for the less active
market for CDSOs. CBOE added that it would nevertheless consider
amending its rule to adopt this standard at a later time.
TBMA suggested that CBOE work with the OCC to revise the Options
Disclosure Document (``ODD'') to accommodate CDSOs, and that the ODD be
made available for review and comment before approval of the proposal.
In order to accommodate the listing and trading of CDSOs, CBOE expects
that the OCC would amend its By-Laws and Rules to reflect CDSOs, which
would be subject to public
[[Page 37554]]
comment.\13\ In addition, the Exchange believes that the OCC would seek
to revise the ODD to incorporate CDSOs.\14\ Further, CBOE clarified
that the Exchange is working with OCC to develop procedures to address
actions including full and partial redemptions, conversions to
equities, bankruptcies, conversion to new series, and other actions.
According to CBOE, the OCC intends to use a major data vendor to
determine the market value of the underlying corporate debt securities
of CDSOs. The data vendor will view TRACE and several other price
reporting services to derive a composite price for each underlying
security on a daily basis.
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\13\ Telephone conversation between Jennifer L. Klebes, Senior
Attorney, CBOE and Marc McKayle, Special Counsel, Division of Market
Regulation, Commission, on June 28, 2007.
\14\ See also Exchange Act Rule 9b-1(b)(2)(i) which requires the
relevant option market to file material changes to the ODD with the
Commission, if the ODD without such changes would become inaccurate,
incomplete, or misleading.
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IV. Discussion and Commission's Findings
After careful review, the Commission finds that the proposed rule
change, as amended, is consistent with the requirements of the Act and
the rules and regulations thereunder applicable to a national
securities exchange.\15\ In particular, the Commission believes that
the proposed rule change is consistent with Section 6(b)(5) of the
Act,\16\ which requires that the rules of an 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 for a free and open market and a national market system,
and, in general, to protect investors and the public interest.
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\15\ In approving this proposed rule change, the Commission
notes that it has considered the proposed rule's impact on
efficiency, competition, and capital formation. See 15 U.S.C.
78c(f).
\16\ 15 U.S.C. 78s(b)(5).
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The Commission believes that the listing rules proposed by CBOE for
CDSOs are reasonable and consistent with the Act. The Commission notes
that, for a CDSO to be listed, the underlying corporate debt security
must, among other things, have substantial trading volume, initial
principal amount, and outstanding float; the issuer of the corporate
debt security must have at least one class of equity security
registered under Section 12(b) of the Act; and such equity securities
must satisfy the requirements for options trading on CBOE. These
requirements are reasonably designed to facilitate investors' access to
information that may be necessary to price a CDSO appropriately.
The Commission believes that the proposed position limits and
margin rules for CDSOs are reasonable and consistent with the Act. The
proposed position limits reasonably balance the promotion of a free and
open market for these securities with minimization of incentives for
market manipulation and insider trading. The proposed margin rules are
reasonably designed to deter a member or its customer from assuming an
imprudent position in CDSOs.
In support of the proposed rule change, the Exchange has made the
following representations:
1. The Exchange has sufficient operational capacity to accommodate
the listing and trading of CDSOs.
2. The Exchange's surveillance procedures are adequate to properly
monitor the trading of the CDSOs.
3. The Exchange will inform its members in an Information Circular
of the special characteristics and risks associated with trading the
CDSOs.
4. The Exchange will delist CDSO series for which there is no open
interest.
This approval order is conditioned on the Exchange's adherence to
these representations.
V. Conclusion
It is therefore ordered, pursuant to Section 19(b)(2) of the
Act,\17\ that the proposed rule change (SR-CBOE-2003-41), as modified
by Amendment No. 4, be, and hereby is, approved.
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\17\ 15 U.S.C. 78s(b)(2).
For the Commission, by the Division of Market Regulation,
pursuant to delegated authority.\18\
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\18\ 17 CFR 200.30-3(a)(12).
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Florence E. Harmon,
Deputy Secretary.
[FR Doc. E7-13275 Filed 7-9-07; 8:45 am]
BILLING CODE 8010-01-P
