Select Committee on Treasury Minutes of Evidence

Further memorandum submitted by LIFFE




  1.1  LIFFE, along with other non-US derivatives exchanges, faces barriers which prevent it from making its full range of products and services available in the United States. While, on the face of it, these barriers are regulatory in nature they cannot, in our view, be justified on regulatory grounds because regulatory standards in the UK and the United States are comparable. While some of the barriers have been removed in recent years—following protracted and intensive periods of lobbying, conducted with the invaluable help and support of HM Treasury, the British Embassy in Washington DC, the Financial Services Authority and the Bank of England—others remain in place to this day. The purpose of this note is to explain the problems that LIFFE has faced and continues to face.

  1.2  LIFFE would like the remaining barriers to be removed so that its members could do the following:

    (i)  Market LIFFE's Security Futures (known as Universal Stock Futures) to US persons.

    (ii)  Market LIFFE's Securities (ie options on individual stocks and stock indices) to a wider group of US persons than is currently permitted.

    (iii)  Conduct business in LIFFE's Security Futures and Securities direct on LIFFE CONNECTTM from the United States (in the same way that LIFFE's Futures business is conducted).

  1.3  Before describing the barriers that LIFFE faces, it is necessary to explain briefly the relevant elements of the US regulatory framework. Unlike the arrangements in the UK, the regulatory framework in the United States remains fragmented. This means that the business that LIFFE conducts, or wishes to conduct, in the US comes under the jurisdiction of two separate federal agencies, ie the Commodity Futures Trading Commission ("CFTC") and the Securities and Exchange Commission ("SEC"). The CFTC regulates "Futures" business—including futures (and options on futures) relating to interest rates, bonds, broad-based stock indices and commodities)—whereas the SEC regulates "Securities" business, which includes equity trading and trading in options both on individual stocks and stock indices. The SEC and CFTC have joint jurisdiction over futures based on single stocks and narrow-based stock indices (known collectively as "Security Futures"), although in practice the more powerful SEC takes the lead.

  1.4  LIFFE enjoys a good working relationship with the CFTC and the CFTC now generally permits LIFFE to make available those products and services over which it has exclusive jurisdiction in the United States (ie Futures). Unfortunately, the same is not true of the SEC, which continues severely to restrict LIFFE's ability to make its products and services that relate to Securities and Security Futures available in the United States.


  2.1  The barriers that LIFFE faces/has faced in the US fall into the following two separate but inter-related categories:

    (i)  Trading restrictions—ie restrictions on LIFFE's ability to make its electronic trading system, LIFFE CONNECTTM, directly available to LIFFE members—and through members, to other customers—in the United States.

    (ii)  Marketing restrictions—ie restrictions preventing life members from marketing (ie offering and selling) specific LIFFE products either to their US customers generally or to particular categories of US customer.

  2.2  The remainder of this note explains the barriers that LIFFE previously faced in relation to Futures (under the CFTC's jurisdiction); and the barriers that it continues to face in relation to Securities (SEC jurisdiction) and Security Futures (joint SEC and CFTC jurisdiction, although with the SEC taking the lead in practice).


  3.1  LIFFE faced a severe trading restriction in the US during 1999, at a time when it was migrating its main Futures products from the market floor to LIFFE CONNECTTM. This was a time of intensive competition between LIFFE and its major European competitors, including Eurex. In 1996 the CFTC had permitted Eurex—through granting a so-called "No-Action Letter"[4]—to make its electronic trading system available in the United States for the trading of Futures.

  3.2  In 1998, the CFTC had place a moratorium on granting No-Action Letters for these purposes while it worked on designing a new regime which would govern electronic access to non-US markets. The moratorium had the effect of discriminating against LIFFE because the CFTC would not consider LIFFE's request for a No-Action Letter, whereas Eurex continued—under its No-Action Letter—to make its trading system available to existing customers in the US (although it was not permitted to distribute it to new customers while the moratorium was in place).

  3.3  This issues was politically charged because the main US futures exchanges, which continued to be floor-based, feared competition from cheaper and more efficient screen-based foreign markets. LIFFE lobbied for an eighteen month period (from early spring 1998 until summer 1999) to obtain regulatory approval to make LIFFE CONNECTTM available in the United States. In doing so, it benefited enormously from the active support and assistance of HM Treasury, the British Embassy in Washington DC, the Financial Services Authority and the Bank of England. HMA, Sir Christopher Meyer, intervened personally and he and his team were instrumental in the efforts to persuade influential Senators and Congressmen of the force of LIFFE's case.

  3.4  The moratorium was finally lifted in June 1999 following the departure from office of the incumbent CFTC Chairperson. LIFFE was eventually granted a No-Action Letter in July 1999, although there were conditions attached (eg in relation to the Futures that could be made available on the system in the US. The conditions in relation to Futures have, as a result of further lobbying, now largely been removed. The main exception relates to futures on broad-based stock indices, for which LIFFE is still required to obtain approval from the CFTC on a product by product basis.



  4.1  The SEC imposes marketing restrictions in relation to LIFFE's Securities (ie options on individual stocks and stock indices) and Security Futures (ie futures on individual stocks, known as Universal Stock Futures). The former may only be offered and sold to a very limited group of US persons[5], while the latter may not be offered and sold to any US persons (including branch offices of US corporations located outside the United States).

  4.2  In addition, the SEC imposes a trading restriction in relation to both LIFFE's Securities and its Security Futures. This means that these products may not be made directly available on LIFFE CONNECTTM to LIFFE members in the United States, whereas they are available on the system to members located outside the United States. This trading restriction applies even where the marketing restriction described in paragraph 4.1 does not apply. So, in circumstances where a LIFFE member is permitted to offer and sell a LIFFE Security to a US person, the member may not submit his client's order into LIFFE CONNECTTM directly from the United States. Instead, such orders must be routed, either electronically or by telephone, via a member based outside the United States.

  4.3  In 1982 Security Futures had been prohibited in the United States under the so-called Shad Johnson Accord between the SEC and the CFTC. This was put in place as a "temporary" measure and was the result of (i) a disagreement between the SEC and CFTC about which agency should have jurisdiction over these products and (ii) concern on the part of the SEC that US legislation in relation to Futures did not contain the same protections as Securities legislation (eg at the time, although not now, there was no prohibition on insider dealing in the Futures legislation).


  4.4  These differences continued until the end of 1999, when the President's Working Group on Financial Markets (which included both the SEC and CFTC) recommended that the Shad Johnson Accord should be repealed. In 2000, provisions to give effect to the repeal of Shad Johnson were included in Bills before Congress.

  4.5  The proposed legislation—the Commodity Futures Modernization Act of 2000—became bogged down in Congress, mainly due to divisions over the tax and regulatory treatment of Security Futures compared with stock options. Moreover, time was short given the approaching Presidential and Congressional elections and it seemed likely that the legislation would fail to be signed into law in time (or that the controversial elements like the repeal of Shad Johnson would be ditched).

  4.6  Progress began to be made in September 2000. The SEC and CFTC unexpectedly published proposed arrangements for allowing Security Futures to be traded in the US under their joint supervision; and LIFFE announced that, in January 2001, it would launch its own Security Futures, known as Universal Stock Futures. During September 2000, LIFFE implemented a concerted lobbying campaign to persuade Congress that the legislation (and the arrangements proposed by the SEC and CFTC) should cater adequately for non-US exchanges wishing to make Security Futures available in the United States. LIFFE lobbied Members of the President's Working Group (in particular the Chairmen on the CFTC and SEC) and Members of the relevant Senate and House committees. In doing so, once again LIFFE worked closely with the British Ambassador in Washington, who lobbied on LIFFE's behalf, and LIFFE provided proposed Bill language to the relevant Congressional committees. The US Futures Industry Association ("FIA") also became a key ally as the campaign progressed, as they had been in LIFFE's lobbying efforts in 1998 and 1999 to obtain its No-Action Letter from the CFTC in relation to LIFFE CONNECTTM.

  4.7  Throughout this period the fate of the legislation remained very uncertain. LIFFE's lobbying efforts continued until late December 2000, when the Commodity Futures Modernization Act of 2000 was finally signed into law. LIFFE had succeeded in getting a provision into the legislation requiring the SEC and CFTC to make rules governing the marketing in the US of Security Futures traded on non-US exchanges. However, we had been unable to persuade Congress to include a "timeliness" provision which would require the regulatory agencies to make the rules in respect of foreign markets by a certain date. In contrast, the SEC and CFTC were required by the legislation to make rules for Security Futures traded on US exchanges in time for trading to begin one year after enactment (ie on 21 December 2001).

  4.8  Moreover, the legislation did nothing to lift the trading restriction described in paragraph 4.2 above, ie it does not permit a non-US exchange to provide direct electronic access from the US to its Security Futures products.

  4.9  LIFFE made two lobbying visits to Washington in January 2001 ahead of the launch of Universal Stock Futures on 29 January 2001. The main purpose of the visits was to encourage the SEC and CFTC to produce rules for non-US exchanges which would enable their Security Futures to be offered and sold to US investors from 21 December 2001, when the US exchanges were to be permitted to begin trading such products. Notwithstanding these efforts, LIFFE judged that the SEC and CFTC were likely to focus on the rules for US exchanges and neglect those for their foreign counterparts. This was one of the catalysts for LIFFE to establish a joint venture in the US with the Nasdaq Stock Market to trade Security Futures, which was announced on 26 March 2001.

  4.10  LIFFE and Nasdaq then embarked jointly on detailed work to prepare the new market—known as Nasdaq LIFFE Markets—for launch. That market, which is regulated by the CFTC, will open once the final rules governing the trading of Security Futures on US exchanges have been promulgated by SEC and CFTC. Those rules, which were due to be promulgated by 21 December 2001, have been delayed due to the ramifications of the 11 September tragedy. They are now expected to be in place in the Spring.

  4.11  However, so far the SEC and CFTC have made no progress with the rules governing the marketing in the US of Security Futures traded on non-US markets like LIFFE. LIFFE has written to the SEC and CFTC requesting that they implement the necessary rules in respect of Security Futures listed on US and non-US exchanges at the same time. The British Ambassador has pledged his support and intends to pursue this issue with the SEC and CFTC, and Congressmen if appropriate.


  5.1  While, as a result of intensive lobbying, the situation has been much improved in relation to Futures, the restrictions that LIFFE faces in the United States in relation to Securities and Security Futures continue to prevent US customers from using those products. This is in stark contrast to the situation in the UK where, since 1988, non-UK exchanges have been able to apply for approval to make their electronic trading systems available here for the trading of Futures, Securities and Security Futures alike.

  5.2  LIFFE would like the remaining barriers to be removed so that its members could do the following:

    (i)  Market LIFFE's Security Futures (known as Universal Stock Futures) to US persons.

    (ii)  Market LIFFE's Securities (ie options on individual stocks and stock indices) to a wider group of US persons than is currently permitted.

    (iii)  Conduct business in LIFFE's Security Futures and Securities direct on LIFFE CONNECTTM from the United States (in the same way that LIFFE's Futures business is conducted).

24 January 2002


4   As there is no formal regime in the US for granting approval to a non-US exchange wishing to make its electronic trading system directly available in the United States, the CFTC staff instead make use of an informal "No-Action Letter" procedure. A No-Action Letter is a written statement which permits the recipient to makes its trading system available in the US on the basis agreed by the CFTC staff. Such letters are only granted if, following a due diligence exercise, the CFTC staff are satisfied that there are comparable regulatory standards in the jurisdiction of the applicant and in the United States. Back

5   Essentially, the SEC has stipulated that these products may only be offered and sold to certain professional intermediaries (US Broker-Dealers) and large institutional investors. Back

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