SEC Provides Relief for Familiarization Activities of Foreign Options Markets

by Morgan Lewis
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The no-action relief provided by the staff of the Division of Trading and Markets is generally consistent with the relief previously provided to foreign options markets.

On July 1, the staff of the Securities and Exchange Commission's (SEC's) Division of Trading and Markets (TM Staff) issued a class no-action letter (Class Relief)[1] that permits foreign options markets to familiarize certain registered broker-dealers and large financial institutions in the United States with the foreign options market and some of the products available on that market without becoming subject to regulation in the United States.

The Class Relief contains a number of conditions with which a foreign options market and persons affiliated with that market must comply. In addition, although the Class Relief does not require a foreign options market to prepare and distribute an options disclosure document, it does require a foreign options market that plans to rely on the relief to notify the Division of Trading and Markets of its intent to do so, make certain representations in that respect, and make certain information about the market available on its website in English.

Permissible Activities

The following are listed in the Class Relief as permissible activities that foreign options markets and their affiliated persons may engage in when performing familiarization activities:

  • Representatives[2] of a foreign options market,[3] wherever located, may respond to inquiries from eligible broker-dealers/eligible institutions[4] concerning eligible options[5] and the foreign options market, including any over-the-counter (OTC) options processing service.[6]
  • Representatives may make personal calls to, and correspond or otherwise communicate with, entities that such representatives reasonably believe are eligible broker-dealers/eligible institutions to familiarize them with the foreign options market, including any OTC options processing service and its operations.
  • Representatives may participate in programs and seminars conducted in the United States regarding the foreign options market and its operations, including any OTC options processing service.
  • If requested by an eligible broker-dealer/eligible institution, representatives may make available to the requesting party a list of all foreign options market members and any registered U.S. broker-dealer affiliates of such foreign options market members.
  • A foreign options market and its members may make available to eligible broker-dealers/eligible institutions any OTC options processing service operated by the foreign options market.

Conditions

In order to rely on the Class Relief, foreign options markets, members of foreign options markets, and representatives of foreign options markets must satisfy the below conditions set forth in the Class Relief.

Foreign Options Markets

Foreign options markets must satisfy the following conditions:

  • The foreign options market must send a letter signed by its chief legal officer or its U.S. counsel to the director of the Division of Trading and Markets that (i) identifies the foreign options market and the eligible options for which familiarization activities are to occur, (ii) represents that SEC staff will be provided with a list of the specific equity and index options subject to familiarizations and identifies the primary listing market for each such instrument, (iii) represents that steps have been taken to assure initial and continuing compliance with the terms of the Class Relief, and (iv) represents that all entities covered by the Class Relief will comply with the terms of the Class Relief, including the restriction on securities of U.S. issuers.[7]
  • The foreign options market is and will remain regulated outside the United States.
  • The foreign options market does not engage in general solicitation or advertising regarding eligible options in the United States.
  • The foreign options market does not provide direct electronic access to persons located in the United States.
  • The foreign options market maintains current information, in English, on its website regarding its trading rules, clearance and settlement procedures, hours of operation, holidays, and other material information.
  • For eligible options, the foreign options market has in place a market-to-market surveillance sharing agreement with the primary market for the underlying security or securities or other surveillance sharing agreement.
  • The foreign options market is either supervised by a foreign securities authority that is a signatory to the International Organization of Securities Commissions' "Multilateral Memorandum of Understanding for Consultation Cooperation and the Exchange of Information"[8] or has in place another information-sharing agreement with the SEC.
  • The foreign options market advises its members that, under U.S. law, members of the foreign options market that are not U.S.-registered broker-dealers may deal with eligible institutions only in accordance with Exchange Act Rule 15a-6, principally through U.S.-registered broker-dealers.
  • The foreign options market institutes rules requiring its members to obtain and maintain certain representations from eligible broker-dealers/eligible institutions.
  • The foreign options market advises its members that options on, or indexes that include, U.S. securities are not eligible for sale to U.S. persons.
  • The foreign options market adopts written policies and procedures to monitor for and ensure compliance with the terms and conditions of the Class Relief.

Members of Foreign Options Markets

Members of foreign options markets that are not U.S.-registered broker-dealers may only deal with eligible institutions in accordance with the provisions of Exchange Act Rule 15a-6. Before effecting a transaction in eligible options, a member of a foreign options market is required to obtain and maintain a record of representations from the eligible broker-dealer/eligible institution that sets forth the following:

  • It is an eligible broker-dealer/eligible institution.[9]
  • Its transactions in eligible options will be for its own account, for the account of another eligible broker-dealer/eligible institution, or for the managed account of a non-U.S. person within the meaning of Regulation S.
  • It will not transfer any interest or participation in an eligible option to any other U.S. person or a person in the United States who is not an eligible broker-dealer/eligible institution.
  • It will cause any dispositions of an eligible option to be effected and settled on the foreign options market, and any required payments in connection with the eligible option will be made in the designated currency.
  • It understands that, if it has a contract as a writer of an eligible option with a foreign options market member, margin must be provided to that foreign options market member in such form and amount as determined by that member. Additionally, such member, if it is a nonclearing member of the foreign options market, must provide margin to its clearing member in such form and amount as determined by that clearing member, and such member, if it is a clearing member of the foreign options market, must maintain, measure, and deposit margin on such eligible option with the clearing entity in such form and amount as determined by the clearing entity.
  • If it is acting for another eligible broker-dealer/eligible institution, it will receive the representations mentioned above and will provide them to the foreign options market member upon demand.
  • It will notify the foreign options market member of any changes in the representations mentioned above.

Representatives of Foreign Options Markets

Representatives of foreign options markets must satisfy the following conditions:

  • They may not engage in any general solicitation or general advertisement concerning eligible options in the United States.
  • They may not give investment advice or make recommendations with respect to specific eligible options.
  • They may not solicit, take, or direct orders or recommend or refer particular foreign options market members.
  • They must maintain a reasonable supply of the foreign options market's most recently published annual report in English to respond to requests for the report from eligible broker-dealers/eligible institutions.

Implications

The Class Relief improves the ability of foreign options markets to familiarize U.S. institutional investors with the products and services available in those markets. The Class Relief is a significant operational improvement because foreign options markets will no longer need to seek individualized no-action relief; the Class Relief is self-executing, provided a foreign options market submits the appropriate notification to the Division of Trading and Markets. Additionally, although foreign options markets that have already received individualized relief may continue to rely on their particular letters, they may instead elect to rely on the Class Relief. In that case, if foreign options markets provide the proper notification to the Division of Trading and Markets of their intent to rely on the Class Relief, they would no longer have to prepare and require their members to provide options disclosure documents to U.S. investors.

[1]. View the no-action letter here. In the Class Relief, TM Staff provided assurances that it would not recommend enforcement action against foreign options markets and certain affiliated persons and entities under sections 5 (exchange registration), 6 (exchange registration), 15 (broker-dealer registration), and 17A (clearing agency registration) of the Securities Exchange Act of 1934 (Exchange Act).

[2]. A "representative" is defined as an employee of the foreign options market who is located inside or outside the United States, has been appointed to act as a representative of the foreign options market, and may engage in the permissible activities.

[3]. A "foreign options market" means a non-U.S. derivatives market (1) on which eligible options trade and (2) that is an organized exchange operated and regulated outside the United States.

[4]. These terms are defined to mean a "qualified institutional buyer," as defined in Rule 144A(a)(1) under the Securities Act of 1933 (Securities Act), or an international organization excluded from the definition of "U.S. person" in Rule 902(k)(2)(vi) of Regulation S under the Securities Act that has prior experience with traded options in the U.S. options market (and therefore would have received the disclosure document for U.S. standardized options called for by Rule 9b-1 under the Exchange Act).

[5]. An "eligible option" means an index option or option on an individual security traded on a foreign options market that is not fungible or interchangeable with options traded on any market other than the foreign options market, and, accordingly, each position in an eligible option issued by a clearing member of the foreign options market can be closed out only on the foreign options market.

[6]. "OTC options processing service" means a mechanism for submitting to a foreign options market an options contract on a foreign security that has been negotiated and completed in an OTC transaction so that the foreign options market may replace the OTC contract with an equivalent exchange-traded options contract.

[7]. TM Staff made clear that such letters would be made publicly available.

[8]. View the Multilateral Memorandum here.

[9]. As an eligible broker-dealer/eligible institution, it owns and invests, on a discretionary basis, eligible securities in amounts that would make it qualify as a qualified institutional buyer under Securities Act Rule 144A; it has prior actual experience in the U.S. standardized options market; and it has received the options disclosure document prepared by the Options Clearing Corporation and the U.S. options exchanges.

DISCLAIMER: Because of the generality of this update, the information provided herein may not be applicable in all situations and should not be acted upon without specific legal advice based on particular situations.

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