Series 3 - National Commodities Futures

AAA

Regulations - Single Stock Futures Regulation

Single Stock Futures Regulation
Single security futures enable the future purchase of individual company shares in the present. Contracts typically represent a round lot of 100 shares. A few represent a lot of 1,000. Settlement requires delivery in-kind (shares), rather than cash. The buyer would be required to receive shares at maturity and the seller would be required to deliver them.

The Securities and Exchange Commission (SEC) and the Commodity Futures Trading Commission (CFTC) jointly regulate the listing of these types of futures pursuant to the Commodity Futures Modernization Act of 2000. FINRA and the NFA have joint jurisdiction, as well. The underlying type of shares must receive joint approval. Permissible issues include common stock, American Depository Receipts (ADRs), Closed End Mutual Funds (CEFs) and Exchange Traded Funds (ETFs) which must maintain minimum trading volume, number of shareholders and shares outstanding. Listing standards must equal or exceed in rigor those of listed options. An organization with arrangements with a registered clearing corporation is permitted to make delivery of shares. Trading of the contracts and the underlying cannot be subject to manipulation, and intermarket surveillance to monitor for such activity is required. A process to coordinate trading halts for both the contracts and underlying shares must be established.

Margin requirements (both initial and maintenance) are 20%, unlike the 50% Regulation T requirement for individual share purchases. Securities futures margin must be comparable to that of similar stock options, in accordance with the Commodities Futures Modernization Act of 2000. These requirements differ somewhat from typical futures margin requirements, which clearinghouses and their exchanges set, and which are not subject to government regulation. No cross-margin is permitted (e.g., permitting lower margin requirements on related futures contracts used to hedge the common stock position). Security futures may use a strategy offset, which affords the client lower margin on a strategy such as a strangle or a spread, than the aggregate margin of the individual positions. Single stock futures may not use portfolio-based margin systems.

Additionally, securities futures positions may not be offset or delivered on an exchange other than the originating one (e.g. there is no fungibility).

Other Regulatory Considerations
Notice registration: Because of the hybrid nature of securities futures (share and futures contract at once), these instruments must be registered with both the SEC and CFTC. Notice registration facilitates the process by allowing the respective markets to register with the other agency (e.g. futures markets are registered with the CFTC; securities markets are registered with the SEC. They register with one another to trade securities futures.)

Dual Agency Registration of Brokerage Firms: Firms that conduct business in securities futures must be registered with both the CFTC and the SEC. Some large brokerages are fully registered with both agencies and may offer a full complement of futures and securities products. Firms that register through the notice registration process to be able to offer securities futures only will be limited to this type of business, however.

Only registered clearinghouses whose security futures the regulator has approved may clear trades in these instruments. The Options Clearing Corporation is the agency approved to clear these types of trades.

Account protection: Securities accounts receive customer account protection through the Securities Investor Protection Corporation (SIPC). Commodity Exchange Act and CFTC rules provide for segregation of customer accounts from firm assets. Fully registered brokerage firms may offer both securities and futures accounts. By contrast, a futures brokerage (FCM) or broker/dealer registered with one regulator and that gives notice registration with the other, may only offer an account of its primary jurisdiction (e.g., FCM gives notice registration to the SEC, but may only offer a futures account as it comes primarily within the remit of the CFTC).

NFA suitability and best execution requirements mirror those of FINRA. Essentially, an associated person must make futures purchase recommendations that are suitable for the customer and meet the criteria of best execution (in a timely manner and at competitive rates appropriate for the transaction size and type and the liquidity of the market in which it trades.

Risk Disclosure Statement - this document must be delivered to the customer at or before a principal's approval of the account. The document discusses the risk of trading futures contracts, describes their mechanics, the use of leverage, how margin works, how accounts are settled, the difference between the futures contract and the underlying, and protection afforded customer accounts (segregation).

Single stock futures trading is subject to regulatory trading halts and the use of circuit breakers (where a market decline beyond a certain percentage triggers a cessation of trading for a set period that is a function itself of the degree of decline.). Antifraud provisions apply equally to security futures and securities accounts including prohibitions against front running and insider trading.

Supervisory processes for securities futures account opening and trading parallel those of a FINRA general securities principal. A futures principal must approve (non) discretionary account openings, all manner of correspondence (mail and e-mail) in- and outbound and account (trading) activity.

Specific continuing education, rather than a separate exam, is required of securities and futures registrants who became licensed prior to or within six months of the advent of securities futures. The training specifies market and regulatory information pertinent to security futures.

Arbitration And Disciplinary Procedures
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