SEC Order Exempts Foreign Single Stock Futures and Narrow-Based Index Futures from Exchange Requirements

The Securities and Exchange Commission (SEC) recently provided relief for certain institutional investors to trade in futures on foreign securities and foreign securities indexes.  Pursuant to an exemptive order issued on June 30, 2009[1], subject to certain conditions, qualified institutional buyers (QIBs),[2] non-U.S. persons and certain other institutional investors are now allowed to trade security futures based on a foreign security or a narrow-based security index that consists 90 percent of foreign securities on a foreign board of trade or contract market.  In connection with the exemption, the order also provides for a limited exemption to foreign broker-dealers that solicit those transactions. 

Exchange Requirement

Section 6(h)(1) of the Securities Exchange Act of 1934 (the “Exchange Act”) makes it unlawful to effect a transaction in any future contract based on the value of a security or a narrow-based security index[3] if the security future is not listed on a national securities exchange or registered national securities association.  This section is not limited in application to security futures relating to U.S. securities and, therefore, effectively bans trading in security futures on foreign securities.

Trading Relief under the Order

As noted above, the order exempts trading in foreign security futures, or transactions to close out a foreign security future, for QIBs, persons that are not “U.S. persons”[4] and—to the extent that they are effecting transactions for QIBs or non-U.S. persons—brokers, dealers or banks acting pursuant to certain exemptions.  To qualify for the relief provided by the order, the relevant foreign security future must relate to (1) the securities issued by a foreign private issuer for which at least 55 percent of the worldwide trading volume is effected through a foreign securities market in a foreign jurisdiction or two foreign jurisdictions if at least one of the two jurisdictions has more volume than the trading in the United States for the same class of securities, (2) debt securities issued or guaranteed by a foreign government that are eligible to be registered with the SEC under Schedule B under the Securities Act or (3) a narrow-based security index that is 90 percent composed of securities of foreign private issuers that satisfy the requirements of (1) above or government securities that satisfy (2) above and no more than 10 percent of the securities at the time of the transaction, both in terms of the number of securities or weighting in the index, are issued by companies that are required to file reports under Section 13 or 15(d) of the Exchange Act.  In addition, the transaction must be executed on an exchange or contract market and cleared by a clearing entity, both of which are located outside of the United States and are not required to register with the SEC.  Finally, the security future must not be able to be closed out by effecting an offsetting transaction in the United States.

Exemption for Broker-Dealers

The SEC also exempted foreign broker-dealers that induce QIBs to purchase foreign security futures from the Exchange Act requirements relating to registration with the SEC, reporting requirements and other obligations of U.S. broker-dealers if they comply with the requirements for foreign broker-dealers transacting business with U.S. institutional investors set forth in paragraphs (a)(3)(i) through (iii) of Rule 15a-6 under the Exchange Act.[5] 


By issuing the order, the SEC has adopted a territorial approach that will greatly expand institutional investors’ ability to hedge their foreign securities risk.  Note, however, that the order does not exempt QIBs from the registration requirements of the Securities Act, which will continue to apply. 

Per the Food, Conservation and Energy Act of 2008, the SEC and/or the CFTC were required to take action by June 30, 2009 to permit the trading of futures and certain foreign security indexes.  To date, only the SEC has taken action related to security futures.  Given the CFTC’s joint jurisdiction over single stock futures and narrow-based security indexes, it is unclear whether the CFTC will take any regulatory action at this point.

[1] Order Granting Exception for Certain Persons Effecting Transactions in Foreign Security Futures, Exchange Act Release No. 60,194 (June 30, 2009).

[2] The order incorporates the definition of “qualified institutional buyer” by reference to Rule 144A under the Securities Act of 1933 (the “Securities Act”).  Rule 144A defines a QIB to include, among other things, a corporation or partnership, acting for its own account or the account of other QIBs, that “in the aggregate owns and invests on a discretionary basis at least $100 million in securities of issuers that are not affiliated with the entity. . . .”

[3] A “narrow-based security index” is defined as an index that, subject to various exceptions, (1) has nine or fewer component securities, (2) in which a component security comprises more than 30 percent of the index’s weighting, (3) in which the five highest-weighted component securities in the aggregate comprise more than 60 percent of the index’s weighting, or (4) in which the lowest weighted component securities comprising, in the aggregate, 25 percent of the index’s weighting have an aggregate dollar value of average daily trading volume of less than $50 million (or in the case of an index with 15 or more component securities, $30 million), except that, if there are two or more securities with equal weighting that could be included in the calculation of the lowest-weighted component securities comprising, in the aggregate, 25 percent of the index’s weighting, such securities shall be ranked from lowest to highest dollar value of average daily trading volume and shall be included in the calculation based on their ranking starting with the lowest ranked security.  Futures on security indexes that are not narrow-based indexes are not subject to the jurisdiction of the SEC.

[4] The order defines “U.S. Person” by reference to the definition contained in Rule 902 under the Securities Act.

[5] Foreign broker-dealers may utilize a notice-registered broker-dealer in connection with their obligations under Rule 15a-6.  However, notice-registered broker-dealers will be required to comply with Commodity Futures Trading Commission (CFTC) Rule 1.17 in lieu of paragraph (a)(iii)(A)(5) of Rule 15a-6 and the CFTC’s segregation requirements instead of the requirements in (a)(iii)(A)(6) of Rule 15a-6.


If you have any questions concerning this alert, please contact—

Mark H. Barth


New York
David M. Billings


J.P. Bruynes


New York
Barry Y. Greenberg


Parkash H. Mehta


Washington, D.C.
Eliot D. Rafflkind


Simon Thomas


Stephen M. Vine


New York