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October 4, 2007

New Foreign Exchange Trading Rules Coming

By Peter Chapman

Access to foreign stock exchanges by U.S. trading houses is likely to get easier under a new Securities and Exchange Commission initiative, but only if the agency is satisfied with the standards of the regulatory regime under which the exchange operates.

Based on recent comments by senior SEC officials, the regulator is setting the bar high in its bid to revamp the rules governing foreign stock exchanges and broker-dealers operating in the U.S.

Under the agency's "mutual recognition" initiative, the SEC plans to significantly lessen the registration burden on foreign exchanges and brokers seeking to conduct business in the U.S. But that's only if the foreign regulatory environment is sufficiently comprehensive and rigorous when it comes to rulemaking, surveillance, and enforcement.

"If we did this," Bob Colby, the SEC's deputy director of market regulation, said at this year's FIA/OIC New York Equity Options Conference, "we would look to see if the markets are comparable. We would look to see how effective the enforcement regimes are. And we would look to see how well they cooperate with us when we have issues."

Erik Sirri, head of the SEC's division of market regulation, speaking at the same conference, said the Commission "would need to engage in detailed conversations with the regulators in the foreign jurisdiction to explore the regulatory regime, considering whether it adequately addressed aspects currently part of the U.S. regulatory scheme."

If the foreign jurisdiction meets the SEC's standards, the regulator will provide an "exemptive regulation" for all broker-dealers and exchanges in that country, Colby said. Currently, foreign exchanges are prohibited from offering U.S.-based broker-dealers electronic access to their markets unless they register themselves and the securities they trade with the SEC. None do.

And despite the recent tie-ups between the New York Stock Exchange and Euronext and the International Securities Exchange and Eurex, neither of those foreign partners is permitted to conduct business in the U.S. Over the years, many foreign exchanges and broker-dealers have complained that the SEC's rules vis-à-vis foreign institutions only serve to protect Wall Street and do nothing for investors.

They and their regulators have pressed the SEC to accept their own standards of regulatory oversight as sufficient protection for U.S. persons dealing with foreign brokers and exchanges.

Even if the SEC did recognize the foreign regulatory regime, Colby said there would be limits as to who could trade directly on the exchange and in which issues. Any new rules would likely only permit sellside, but not buyside, traders to use the foreign screens. Also, tradable stocks would be limited to foreign WKSIs, which stands for well-known, seasoned issues. In other words, no trading of U.S. stocks or stocks of small, new foreign companies.

Also, the exchange itself must be a bona-fide foreign mart, not a U.S. exchange claiming to be operating offshore. The exchange would have to be well-established and not a new "fly-by-night" exchange, Colby noted. Exchanges would also have to "operate reliably," treat all customers fairly, and provide transparent quotes and trade reports, Colby said. Exchanges would probably still have to register with the SEC, he added.

The regulator would not tell Traders Magazine which countries the SEC was considering recognizing, noting he didn't want to "create an international incident." He did say some of the likely candidates would come as a surprise. Sirri says a new set of mutual recognition rules could emerge by the end of the year. Colby, however, says SEC staff has just begun to think about the issue.