Comments of Nasdaq Liffe Markets LLC on S7-14-02

June 7, 2002

By Federal Express and Electronic Mail

Mr. Jonathan G. Katz
Secretary
Securities and Exchange Commission
450 Fifth Street, NW
Washington, DC 20549-0609

Re: Assessments on Security Futures Transactions and Fees on Sales of Securities Resulting from Physical Settlement of Security Futures Pursuant to Section 31 of the Exchange Act-SEC Release No. 34-45854; File No. S7-14-02

Dear Mr. Katz:

Nasdaq Liffe Markets, LLC welcomes the opportunity to comment on the Securities and Exchange Commission's ("SEC's" or "Commission's") proposed rule amendments concerning fees payable on sales of securities resulting from physical settlement of security futures products.¹

We agree with the Commission's interpretation of the term "round-turn" under Section 31(d) of the Securities Exchange Act of 1934 (the "Exchange Act") and the proposed amendment to the Preliminary Note to Rule 31-1 that would establish the method for calculating Section 31(d) assessments. Therefore, we do not address those issues in this letter. Rather, after a brief description of Nasdaq Liffe Markets, this letter focuses on the Commission's proposed use of the initial trade price for the assessment of Section 31(b) and (c) fees. Instead of this approach, we believe that the Commission should base fee assessments on the price defined by exchange rule as the deliverable price of the security underlying a security futures contract (i.e., the settlement price of the contract at expiration).

A. Nasdaq Liffe Markets.

Nasdaq Liffe Markets is a new electronic trading market for futures contracts on equity securities and other products. Our trading system, LIFFE CONNECTTM, is the state-of-the-art electronic trading system already used by the London International Financial Futures and Options Exchange ("LIFFE") to trade financial derivatives. The LIFFE CONNECTTM system provides an anonymous and fully transparent central limit order book with each member of Nasdaq Liffe Markets having instantaneous, continuous, and equal electronic connectivity to our market. We are jointly owned by two parents:

The Nasdaq Stock Market, Inc., which is the world's largest electronic stock market; and
LIFFE Ventures, Inc., a wholly-owned subsidiary of LIFFE (Holdings) plc, which was recently acquired by Euronext NV, a pan-European equity and derivatives exchange.

Nasdaq Liffe Markets is a contract market designated by the Commodity Futures Trading Commission ("CFTC").² In addition, we will shortly file our notice registration with the SEC to become a national securities exchange for the purpose of listing security futures products.

B. Section 31(b) and (c) Fees Should be Based Upon the Settlement Price.

The Commission proposes to amend the Preliminary Note to Rule 31-1 to "clarify that the aggregate dollar amount of sales of securities resulting from the physical settlement of a security future should be calculated based on the price at which the security future was sold by the market participant effecting delivery of the underlying security upon settlement."³ In addition, the Commission proposes that the obligation to pay a Section 31(b) or (c) fee on a sale of a security underlying a physically-settled security future "does not accrue until the time that physical settlement occurs."⁴

Under Sections 31(b) and (c) of the Exchange Act, the statutory predicate for imposing a fee is the sale of a security. For purposes of calculating the applicable regulatory fees, Sections 31(b) and (c) do not state when the sale occurs of a security underlying a security futures contract or at what price. However, Congress's specific exclusion of security futures contracts from Section 31(b) and (c) assessments suggests that Congress did not intend to assess or calculate fees at the time of formation of the contract, but instead at physical delivery of the underlying security.

In the case of security futures contracts, like all other physically settled futures contracts, the seller delivers, and the buyer takes, the underlying security only if the contract is held to expiration. At physical delivery, the buyer pays, and the seller receives, the settlement price of the underlying security, which is determined by exchange rules.⁵ The initial trade price of the security futures contract is not the price paid by the buyer, or received by the seller, for the security at expiration. The initial trade price will only have past relevance to the buyer and seller as the price from which the payment of initial variation margin gains or losses was calculated based upon daily marking-to-market of the contract price. Variation margin payments represent the difference between the current settlement price and the initial trade price or, for an existing position, the previous day's settlement price. Fluctuations in the price of the underlying security will be reflected in actual payments of variation margin representing the profits and losses to the buyer and seller through the expiration of the contract. The result is that, whether or not the initial trade price nets to a profit or loss for the buyer or seller at settlement of the contract, those profits and losses already will have been received or paid prior to settlement. Therefore, at expiration, the underlying security changes hands at a single uniform price: the settlement price. Because the underlying security can only change hands at expiration and only at the settlement price, we believe that the settlement price is the price at which the security is sold for purposes of calculating Section 31(b) and (c) fees.

C. Use of Initial Trade Prices Rather than Settlement Prices Would Create Undue Costs for Market Participants.

In addition to the above, if the Commission was to require the calculation of Section 31(b) and (c) fees based on initial trade price rather than settlement price, this would create undue cost and burden for market participants. Neither Nasdaq Liffe Markets nor our clearinghouse, The Options Clearing Corporation ("OCC"), tracks initial trade price information pertaining to open positions for more than one day. And, to our knowledge, this initial trade information is not tracked by other futures exchanges or their clearinghouses. Therefore, if Section 31(b) and (c) fees were based on the initial trade price, member firms would need to provide open position and initial trade price information to Nasdaq Liffe Markets, which in turn would then have to provide the information to OCC to calculate Section 31 fees. Calculating the Section 31(b) and (c) fees based on initial trade prices thus would necessitate significant operational modifications, which would be both time-consuming and costly. We expect that the required systems modifications would take approximately three months to complete and that member firms, the futures exchanges, and OCC would incur significant costs as a result.

In addition, use of the initial trade price as the "sale" price would mean that the amount of Section 31 fees would be verifiable only through post-trade, post-fee assessment audits of member firms. Since member firms are currently the sole source for tracking the initial trade price information, even with the substantial systems modifications discussed above, Nasdaq Liffe Markets and OCC would not be able to verify the trade price information received. Relying on data that is not verifiable by the exchanges or their clearing organizations would require manual review of Section 31 fee calculations during audits of broker-dealers and futures commission merchants, causing revisions to the audit programs of self-regulatory organizations and imposing additional audit costs. In contrast, if the fees were based on the settlement price, Nasdaq Liffe Markets and OCC currently maintain the requisite price information and no systems modifications would be needed for either calculation or verification of Section 31 fees.

D. Conclusion.

Based on the above, we respectfully urge the Commission to modify its rule proposal to establish the settlement price of the security future at expiration as the sale price of the underlying security for purposes of Section 31(b) and (c) assessments.

We appreciate the opportunity to address the Commission concerning this matter. If you have any questions concerning this letter, please contact me at (212) 858-4471.

Sincerely,

/signed/

Kathleen M. Hamm
Senior Vice President Regulation and Compliance
Nasdaq Liffe Markets, LLC

_______________________________

¹ See Assessments on Security Futures Transactions and Fees on Sales of Securities Resulting From Physical Settlement of Security Futures Pursuant to Section 31 of the Exchange Act, 67 Fed. Reg. 30,628 (May 7, 2002).
² See In the Matter of the Application of Nasdaq Liffe Markets, LLC for Designation as a Contract Market, CFTC Final Order of Designation (May 24, 2002).
³ 67 Fed. Reg. at 30,629.
⁴ Id.
⁵ For example, Nasdaq Liffe Markets' draft rules provide that:
On the last day of trading for an expiring Security Futures Contract, the Settlement Price (known as the "Expiration Day Settlement Price") is the official closing price of the underlying common stock or American Depository Receipt on its primary exchange as of 4:30 p.m. Eastern time.

¹	See Assessments on Security Futures Transactions and Fees on Sales of Securities Resulting From Physical Settlement of Security Futures Pursuant to Section 31 of the Exchange Act, 67 Fed. Reg. 30,628 (May 7, 2002).
²	See In the Matter of the Application of Nasdaq Liffe Markets, LLC for Designation as a Contract Market, CFTC Final Order of Designation (May 24, 2002).
³	67 Fed. Reg. at 30,629.
⁴	Id.
⁵	For example, Nasdaq Liffe Markets' draft rules provide that: On the last day of trading for an expiring Security Futures Contract, the Settlement Price (known as the "Expiration Day Settlement Price") is the official closing price of the underlying common stock or American Depository Receipt on its primary exchange as of 4:30 p.m. Eastern time.