[Federal Register Volume 84, Number 186 (Wednesday, September 25, 2019)]
[Notices]
[Pages 50490-50495]
[FR Doc No: 2019-20708]

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SECURITIES AND EXCHANGE COMMISSION

[Release No. 34-87013; File No. SR-CBOE-2019-048]

Self-Regulatory Organizations; Cboe Exchange, Inc.; Notice of
Filing of a Proposed Rule Change To Adopt Rule 6.49C

September 19, 2019.
    Pursuant to Section 19(b)(1) of the Securities Exchange Act of 1934
(the ``Act'') \1\ and Rule 19b-4 thereunder,\2\ notice is hereby given
that on September 6, 2019, Cboe Exchange, Inc. (the ``Exchange'' or
``Cboe Options'') filed with the Securities and Exchange Commission
(``Commission'') the proposed rule change as described in Items I, II,
and III below, which Items have been prepared by the Exchange. The
Commission is publishing this notice to solicit comments on the
proposed rule change from interested persons.
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    \1\ 15 U.S.C. 78s(b)(1).
    \2\ 17 CFR 240.19b-4.
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I. Self-Regulatory Organization's Statement of the Terms of Substance
of the Proposed Rule Change

    Cboe Exchange, Inc. (the ``Exchange'' or ``Cboe Options'') proposes
to adopt Rule 6.49C. The text of the proposed rule change is provided
below.
(additions are italicized; deletions are [bracketed])
* * * * *
    Rules of Cboe Exchange, Inc.
* * * * *

Rule 6.49C. In-Kind Exchange of Options Positions and ETF Shares

    Notwithstanding the prohibition set forth in Rule 6.49, positions
in options listed on the Exchange may be transferred off the Exchange
by a Trading Permit Holder in connection with transactions to purchase
or redeem creation units of ETF shares between an authorized
participant and the issuer of such ETF shares, which transfer occurs at
a price related to the net asset value of such ETF shares. For purposes
of this Rule:
    (a) an ``authorized participant'' is an entity that has a written
agreement with the issuer of ETF shares or one of its service
providers, which allows the authorized participant to place orders for
the purchase and redemption of creation units (i.e., specified numbers
of ETF shares); and
    (b) an ``issuer of ETF shares'' is an entity registered with the
Commission as an open-end management investment company under the
Investment Company Act of 1940.
* * * * *
    The text of the proposed rule change is also available on the
Exchange's website (http://www.cboe.com/AboutCBOE/CBOELegalRegulatoryHome.aspx), at the Exchange's Office of the
Secretary, and at the Commission's Public Reference Room.

II. Self-Regulatory Organization's Statement of the Purpose of, and
Statutory Basis for, the Proposed Rule Change

    In its filing with the Commission, the Exchange included statements
concerning the purpose of and basis for the proposed rule change and
discussed any comments it received on the proposed rule change. The
text of these statements may be examined at the places specified in
Item IV below. The Exchange has prepared summaries, set forth in
sections A, B, and C below, of the most significant aspects of such
statements.

A. Self-Regulatory Organization's Statement of the Purpose of, and
Statutory Basis for, the Proposed Rule Change

1. Purpose
    The Exchange proposes to adopt Rule 6.49C to add a new exception to
the Exchange's general requirement that transfers of options contracts
listed on the Exchange be effected on an exchange, as set forth in Rule
6.49.\3\ Rule 6.49A specifies the circumstances under which Trading
Permit Holders may currently effect transfers of positions off the
trading floor, notwithstanding the prohibition in Rule 6.49.
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    \3\ Rule 6.49(a) (Transactions Off the Exchange) generally
requires transactions of option contracts listed on the Exchange for
a premium in excess of $1.00 to be effected on the floor of the
Exchange or on another exchange.
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Background

    As discussed further below, the ability to effect ``in kind''
transfers is a key component of the operational structure of an
exchange-traded fund

(``ETF''). Currently, in general, ETFs can effect in-kind transfers
with respect to equity securities and fixed-income securities. The in-
kind process is a major benefit to ETF shareholders and, in general,
the means by which assets may be added to or removed from ETFs. In-kind
transfers protect ETF shareholders from the undesirable tax effects of
frequent ``creations and redemptions'' (described below) and improve
the overall tax efficiency of the products. However, currently, the
Exchange Rules do not allow ETFs to effect in-kind transfers of options
off of the Exchange, resulting in tax inefficiencies for ETFs that hold
them. As a result, the use of options by ETFs is substantially limited.
    Current Rule 6.49A(a) lists the circumstances under which Trading
Permit Holders may transfer their positions off of the Exchange. The
circumstances currently listed include: (1) The dissolution of a joint
account in which the remaining Trading Permit Holder assumes the
positions of the joint account; (2) the dissolution of a corporation or
partnership in which a former nominee of the corporation or partnership
assumes the positions; (3) positions transferred as part of a Trading
Permit Holder's capital contribution to a new joint account,
partnership, or corporation; (4) the donation of positions to a not-
for-profit corporation; (5) the transfer of positions to a minor under
the Uniform Gifts to Minors Act; and (6) a merger or acquisition where
continuity of ownership or management results.\4\
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    \4\ The Exchange notes that other options exchanges have adopted
rules that provide for off-floor transfers under similar
circumstances. See, e.g., Nasdaq OMX PHLX LLC Rule 1058(a); and NYSE
Arca, Inc. Rule 6.78-O(d)(1). The Exchange recently proposed changes
to Rule 6.49A, which rule filing is currently pending with the
Securities and Exchange Commission (the ``Commission''). See
Securities Exchange Act Release No. 86400 (July 17, 2019), 84 FR
35438 (July 23, 2019) (SR-CBOE-2019-035).
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    The Exchange proposes to add a new circumstance under which off-
floor transfers of options positions would be permitted to occur.
Specifically, under proposed Rule 6.49C, positions in options listed on
the Exchange would be permitted to be transferred off the Exchange by a
Trading Permit Holder in connection with transactions to purchase or
redeem ``creation units'' of ETF shares between an ``authorized
participant'' \5\ and the issuer \6\ of such ETF shares,\7\ which
transfer would occur at the price used to calculate the net asset value
(``NAV'') of such ETF shares. The NAV for ETF shares is represented by
the traded price for ETFs holding options positions on days of creation
or redemption, and an options pricing model on days in which creations
and redemptions do not occur. This proposed new exception, although
limited in scope, would have a significant impact in that it would help
protect ETF shareholders from undesirable tax consequences and
facilitate tax-efficient operations. The frequency with which ETFs and
authorized participants would rely on the proposed exception would
depend upon such factors as the number of ETFs holding options
positions traded on the Exchange, the market demand for the shares of
such ETFs, the redemption activity of authorized participants, and the
investment strategies employed by such ETFs.
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    \5\ The Exchange is proposing that, for purposes of proposed
Rule 6.49C, the term ``authorized participant'' would be defined as
an entity that has a written agreement with the issuer of ETF shares
or one of its service providers, which allows the authorized
participant to place orders for the purchase and redemption of
creation units (i.e., specified numbers of ETF shares). While an
authorized participant may be a Trading Permit Holder and directly
effect transactions in options on the Exchange, an authorized
participant that is not a Trading Permit Holder may effect
transactions in options on the Exchange through a Trading Permit
Holder on its behalf.
    \6\ The Exchange is proposing that, for purposes of proposed
6.49C, any issuer of ETF shares would be registered with the
Commission as an open-end management investment company under the
Investment Company Act of 1940 (the ``1940 Act'').
    \7\ An ETF share is a share or other security traded on a
national securities exchange and defined as an NMS stock, as set
forth in Rule 5.3, Interpretation and Policy .06, which includes
open-end management investment companies registered with the
Commission. See Rule 1.1.
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    As described in further detail below, while ETFs do not sell and
redeem individual shares to and from investors, they do sell large
blocks of their shares to, and redeem them from, authorized
participants in conjunction with what is known as the ETF creation and
redemption process. Although currently prohibited in light of Rule
6.49, under the proposed exception, ETFs that hold options listed on
the Exchange would be permitted to effect creation and redemption
transactions with authorized participants on an ``in-kind'' basis,
which is the process that may generally be utilized by ETFs for other
asset types. This ability would allow such ETFs to function as more
tax-efficient investment vehicles to the benefit of investors that hold
ETF shares. In addition, it may also result in transaction cost savings
for the ETFs, which may be passed along to investors.
    While the Exchange recognizes that, in general, the execution of
options transactions on exchanges provides certain benefits, such as
price discovery and transparency, based on the circumstances under
which proposed Rule 6.49C would apply, the Exchange does not believe
that such benefits would be compromised. In this regard, as discussed
more fully below, the Exchange notes that in conjunction with the
creation and redemption process, positions would be transferred at a
price related to the NAV of ETF shares. In addition, although options
positions would be transferred off of the Exchange, they would not be
closed or ``traded.'' Rather, they would reside in a different clearing
account until closed in a trade on the Exchange or until they expire.
Further, as discussed below, proposed Rule 6.49C would be clearly
delineated and limited in scope, given that the proposed exception
would apply only to transfers of options effected in connection with
the creation and redemption process.
The ETF Creation and Redemption Process \8\
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    \8\ The following summary of the ETF creation and redemption
process is based largely on portions of the discussion set forth in
Investment Company Act Release No. 33140 (June 28, 2018), 83 FR
37332 (July 31, 2018) (the ``Proposed ETF Rule Release'') in which
the Commission proposed a new rule under the 1940 Act that would
permit ETFs registered as open-end management investment companies
that satisfy certain conditions to operate without the need to
obtain an exemptive order. The proposed rule is currently pending.
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    Due to their ability to effect in-kind transfers with authorized
participants in conjunction with the creation and redemption process
described below, ETFs have the potential to be significantly more tax-
efficient than other pooled investment products, such as mutual funds.
ETFs issue shares that may be purchased or sold during the day in the
secondary market at market-determined prices. Similar to other types of
investment companies, ETFs invest their assets in accordance with their
investment objectives and investment strategies, and ETF shares
represent interests in an ETF's underlying assets. ETFs are, in certain
respects, similar to mutual funds in that they continuously offer their
shares for sale. In contrast to mutual funds, however, ETFs do not sell
or redeem individual shares. Rather, through the creation and
redemption process referenced above, authorized participants that have
contractual arrangements with an ETF and/or its service provider (e.g.,
its distributor)

purchase and redeem shares directly from that ETF in large aggregations
known as ``creation units.'' In general terms, to purchase a creation
unit of ETF shares from an ETF, in return for depositing a ``basket''
of securities and/or other assets identified by the ETF on a particular
day, the authorized participant will receive a creation unit of ETF
shares. The basket deposited by the authorized participant is generally
expected to be representative of the ETF's portfolio \9\ and, when
combined with a cash balancing amount (i.e., generally an amount of
cash intended to account for any difference between the value of the
basket and the NAV of a creation unit), if any, will be equal in value
to the aggregate NAV of the shares of the ETF comprising the creation
unit. After purchasing a creation unit, an authorized participant may
then hold individual shares of the ETF and/or sell them in secondary
market transactions. Investors may purchase individual ETF shares in
the secondary market. In connection with effecting redemptions, the
creation process described above is reversed. More specifically, the
authorized participant will redeem a creation unit of ETF shares to the
ETF in return for a basket of securities and/or other assets (along
with any cash balancing amount).
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    \9\ Under certain circumstances, however, and subject to the
provisions of its exemptive relief from various provisions of the
1940 Act obtained from the Commission, an ETF may substitute cash
and/or other instruments in lieu of some or all of the ETF's
portfolio holdings. For example, currently, because there is no
applicable exception from Rule 6.49(a), positions in options traded
on the Exchange would be generally substituted with cash.
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    The ETF creation and redemption process, coupled with the secondary
market trading of ETF shares, facilitates arbitrage opportunities that
are intended to help keep the market price of ETF shares at or close to
the NAV per share of the ETF. Authorized participants play an important
role because of their ability, in general terms, to add ETF shares to,
or remove them from, the market. In this regard, if shares of an ETF
are trading at a discount (i.e., below NAV per share), an authorized
participant may purchase ETF shares in the secondary market, accumulate
enough shares for a creation unit and then redeem them from the ETF in
exchange for the ETF's more valuable redemption basket. Accordingly,
the authorized participant will profit because it paid less for the ETF
shares than it received for the underlying assets. The reduction in the
supply of ETF shares available on the secondary market, together with
the sale of the ETF's basket assets, may cause the price of ETF shares
to increase, the price of the basket assets to decrease, or both,
thereby causing the market price of the ETF shares and the value of the
ETF's holdings to move closer together. In contrast, if the ETF shares
are trading at a premium (i.e., above NAV per share), the transactions
are reversed (and the authorized participant would deliver the creation
basket in exchange for ETF shares), resulting in an increase in the
supply of ETF shares which may also help to keep the price of the
shares of an ETF close to the value of its holdings.
    In comparison to other pooled investment vehicles, one of the
significant benefits associated with an ETF's in-kind redemption
feature is tax efficiency. In this regard, by effecting redemptions on
an in-kind basis (i.e., delivering certain assets from the ETF's
portfolio instead of cash), there is no need for the ETF to sell assets
and potentially realize capital gains that would be distributed to
shareholders. As indicated above, however, because there is currently
no applicable exception from Rule 6.49(a), ETFs that invest in options
traded on the Exchange are generally required to substitute cash in
lieu of such options when effecting redemption transactions with
authorized participants. Because they must sell the options to obtain
the requisite cash, such ETFs (and, therefore, investors that hold
shares of those ETFs) are not able to benefit from the tax efficiencies
afforded by in-kind transactions.
    An additional benefit associated with the in-kind feature is the
potential for transaction cost savings. In this regard, by transacting
on an in-kind basis, ETFs may avoid certain transaction costs they
would otherwise incur in connection with purchases and sales of
securities and other assets. Again, however, without an exception to
Rule 6.49(a), this benefit is not available to ETFs with respect to
their options holdings.
Discussion
    The Exchange notes that the Commission approved Rule 6.49A in 1995
because the Exchange recognized, and the Commission agreed, that under
certain circumstances, off-floor transfers were justified.\10\ The
Exchange believes that it is appropriate to permit off-floor transfers
of options positions in connection with the creation and redemption
process and recognizes that the prevalence and popularity of ETFs have
increased greatly since the adoption of Rule 6.49A. Currently, ETFs
serve both as popular investment vehicles and trading tools \11\ and,
as discussed above, the creation and redemption process, along with the
arbitrage opportunities that accompany it, are key ETF features.
Accordingly, the Exchange believes that providing an additional, narrow
exception to the prohibition of off-exchange transfers of option
positions to make it possible for ETFs that invest in options to effect
creations and redemptions on an in-kind basis is justified.
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    \10\ See Exchange Act Release No. 36647 (December 28, 1995), 61
FR 566 (January 8, 1996) (Order Approving and Notice of Filing and
Order Granting Accelerated Approval of Amendments No. 1 and 2 to a
Proposed Rule Change Relating to the Transfer of Positions on the
Floor of the Exchange in Cases of Dissolution and other Situations)
(File No. SR-CBOE-95-36).
    \11\ As noted in the Proposed ETF Rule Release, during the first
quarter of 2018, trading in U.S.-listed ETFs comprised approximately
18.75% of U.S. equity trading by share volume and 28.2% of U.S.
equity trading by dollar volume (based on trade and quote data from
the New York Stock Exchange and Trade Reporting Facility data from
the Financial Industry Regulatory Authority, Inc. (FINRA)). See the
Proposed ETF Rule Release at 83 FR 37334.
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    The Exchange submits that the proposed exception is clearly
delineated and limited in scope and not intended to facilitate
``trading'' options off of the Exchange in order to circumvent the
current prohibition of Rule 6.49. In this regard, the proposed
exception would be available solely in the context of transfers of
options positions effected in connection with transactions to purchase
or redeem creation units of ETF shares between ETFs and authorized
participants.\12\ As a result of this process, such transfers would
occur at a price related to the NAV of the applicable ETF shares (as
discussed above), which removes the need for price discovery on an
Exchange for pricing these transfers. Moreover, as described above,
ETFs and authorized participants are not seeking to effect the opening
or closing of new options positions in connection with the creation and
redemption process. Rather, the options positions would reside in a
different clearing account until closed in a trade on the Exchange or
until they expire.
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    \12\ See supra note 3. The term ``authorized participant'' is
specific and narrowly defined. As noted in the Proposed ETF Rule
Release, the requirement that only authorized participants of an ETF
may purchase creation units from (or sell creation units to) an ETF
``is designed to preserve an orderly creation unit issuance and
redemption process between ETFs and authorized participants.''
Furthermore, an ``orderly creation unit issuance and redemption
process is of central importance to the arbitrage mechanism.'' See
Proposed ETF Rule Release at 83 FR 37348.
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    The proposed transfers, while occurring between two different
parties, will occur off the Exchange and will not be considered
transactions (as is the case for current off-floor transfers

permitted by Rule 6.49A).\13\ While the prices of options transactions
effected on the Exchange are disseminated to OPRA, back-office
transfers of options positions in clearing accounts held at The Options
Clearing Corporation (``OCC'') (in accordance with OCC Rules) \14\ are
not disseminated to OPRA or otherwise publicly available, as they are
considered position transfers, rather than executions.\15\ The Exchange
believes that price transparency is important in the options market.
However, the Exchange expects any transfers pursuant to the proposed
rule will constitute a minimal percentage of average daily volume of
options. Additionally, as noted above, the NAV for the transfers will
generally be based on the disseminated closing price for an option
series on the day of a creation or redemption, and thus the price
(although not the time or quantity of the transfer) at which these
transfers will generally be effected will be publicly available.
Further, the Exchange generally expects creations or redemptions to
include corresponding transactions by the authorized participant that
will occur on an exchange and be reported to OPRA.\16\ Therefore, the
Exchange expects that any impact the proposed rule change could have on
price transparency in the options market would be de minimis.
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    \13\ For this reason, the Exchange notes that Rule 6.51(c) does
not require reporting of off-floor transfers effected pursuant to
Rule 6.49A, or that would be effected pursuant to proposed Rule
6.49C.
    \14\ OCC has informed the Exchange that it has the operational
capabilities to effect the proposed position transfers. All
transfers pursuant to proposed Rule 6.49C would be required to
comply with OCC rules. See Rule 4.2 (which requires all TPHs that
are members of OCC to comply with OCC's Rules).
    \15\ For example, any transfers effected pursuant to the current
exemptions to Rule 6.49 contained in Rule 6.49A are not disseminated
to OPRA.
    \16\ The Exchange notes that for in-kind creations, an
authorized participant will acquire the necessary options positions
in an on-exchange transaction that will be reported to OPRA. For in-
kind redemptions, the Exchange generally expects that an authorized
participant will acquire both the shares necessary to effect the
redemption and an options position to offset the position that it
will receive as proceeds for the redemption. Such an options
position would likely be acquired in an on-exchange transaction that
would be reported to OPRA. Such transactions are generally identical
to the way that creations and redemptions work for equities and
fixed income transactions--while the transfer between the authorized
participant and the fund is not necessarily reported, there are
generally corresponding transactions that would be reported,
providing transparency into the transactions.
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    Other than the transfers covered by the proposed exception,
transactions involving options, whether held by an ETF or an authorized
participant, would be fully subject to Rule 6.49 (except as provided by
any other applicable exceptions) and all other applicable trading
Rules.\17\ Accordingly, the Exchange does not believe that the proposed
new exception would compromise price discovery or transparency.
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    \17\ As indicated above, the operation of the arbitrage
mechanism accompanying the creation and redemption process generally
contemplates ongoing interactions between authorized participants
and the market in transactions involving both ETF shares and the
assets comprising an ETF's creation/redemption basket.
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    Further, the Exchange believes that providing an additional
exception to make it possible for ETFs that invest in options to effect
creations and redemptions on an in-kind basis is justified because,
while the proposed exception would be limited in scope, the benefits
that may flow to ETFs that hold options and their investors may be
significant. Specifically, the Exchange expects such ETFs and their
investors would benefit from increased tax efficiencies and potential
transaction cost savings. By making such ETFs more attractive to both
current and prospective investors, the proposed rule change would
enable them to compete more effectively with other ETFs that, due to
their particular portfolio holdings, may effect in-kind creations and
redemptions without restriction.
2. Statutory Basis
    The Exchange believes the proposed rule change is consistent with
the Act and the rules and regulations thereunder applicable to the
Exchange and, in particular, the requirements of Section 6(b) of the
Act.\18\ Specifically, the Exchange believes the proposed rule change
is consistent with the Section 6(b)(5) \19\ requirements that the rules
of an exchange be designed to prevent fraudulent and manipulative acts
and practices, to promote just and equitable principles of trade, to
foster cooperation and coordination with persons engaged in regulating,
clearing, settling, processing information with respect to, and
facilitating transactions in securities, to remove impediments to and
perfect the mechanism of a free and open market and a national market
system, and, in general, to protect investors and the public interest.
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    \18\ 15 U.S.C. 78f(b).
    \19\ 15 U.S.C. 78f(b)(5).
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    The Exchange believes that permitting off-floor transfers in
connection with the in-kind ETF creation and redemption process
promotes just and equitable principles of trade and helps remove
impediments to and perfect the mechanism of a free and open market and
a national market system, as it would permit ETFs that invest in
options traded on the Exchange to utilize the in-kind creation and
redemption process that is available for ETFs that invest in equities
and fixed-income securities. This process represents a significant
feature of the ETF structure generally, with advantages that
distinguish ETFs from other types of pooled investment vehicles. In
light of the associated tax efficiencies and potential transaction cost
savings, the Exchange believes the ability to utilize an in-kind
process would make such ETFs more attractive to both current and
prospective investors and enable them to compete more effectively with
other ETFs that, based on their portfolio holdings, may effect in-kind
creations and redemptions without restriction. In addition, the
Exchange believes that because it would permit ETFs that invest in
options traded on the Exchange to benefit from tax efficiencies and
potential transaction cost savings afforded by the in-kind creation and
redemption process, which benefits the Exchange expects would generally
be passed along to investors that hold ETF shares, the proposed rule
change would protect investors and the public interest.
    Moreover, the Exchange submits that the proposed exception is
clearly delineated and limited in scope and not intended to facilitate
``trading'' options off the Exchange in order to circumvent the current
prohibition of Rule 6.49. Other than the transfers covered by the
proposed exception, transactions involving options, whether held by an
ETF or an authorized participant, would be fully subject to Rule 6.49
(except as provided by any other applicable exceptions) and all other
applicable trading Rules. Additionally, the transfers covered by the
proposed exception would occur at a price related to the NAV of the
applicable ETF shares, which removes the need for price discovery on an
Exchange. Accordingly, the Exchange does not believe that the proposed
rule change would compromise price discovery or transparency.
    When Congress charged the Commission with supervising the
development of a ``national market system'' for securities, Congress
stated its intent that the ``national market system evolve through the
interplay of competitive forces as unnecessary regulatory restrictions
are removed.\20\ Consistent with this purpose, Congress and the
Commission have repeatedly stated their preference for competition,
rather than regulatory intervention to determine products and services
in the

securities markets.\21\ This consistent and considered judgment of
Congress and the Commission is correct, particularly in light of
evidence of robust competition among exchanges. The fact that an
exchange proposed something new is a reason to be receptive, not
skeptical -- innovation is the life-blood of a vibrant competitive
market -- and that is particularly so given the continued
internalization of the securities markets, as exchanges continue to
implement new products and services to compete not only in the United
States but throughout the world. Exchanges continuously adopt new and
different products and trading services in response to industry demands
in order to attract order flow and liquidity to increase their trading
volume. This competition has led to a growth in investment choices,
which ultimately benefits the marketplace and the public.
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    \20\ See H.R. Rep. No. 94-229, at 92 (1975) (Conf. Rep.).
    \21\ See S. Rep. No. 94-75, 94th Cong., 1st Sess. 8 (1975)
(``The objective [in enacting the 1975 amendments to the Exchange
Act] would be to enhance competition and to allow economic forces,
interacting within a fair regulatory field, to arrive at appropriate
variations in practices and services.''); Order Approving Proposed
Rule Change Relating to NYSE Arca Data, Securities Exchange Act
Release No. 59039 (December 2, 2008), 73 FR 74770 (December 9, 2008)
(``The Exchange Act and its legislative history strongly support the
Commission's reliance on competition, whenever possible, in meeting
its regulatory responsibilities for overseeing the [self-regulatory
organizations] and the national market system. Indeed, competition
among multiple markets and market participants trading the same
products is the hallmark of the national market system.''); and
Regulation NMS, 70 FR at 37499 (observing that NMS regulation ``has
been remarkably successful in promoting market competition in [the]
forms that are most important to investors and listed companies'').
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    Currently, the Exchange Rules do not allow ETFs to effect in-kind
transfers of options off of the Exchange, resulting in tax
inefficiencies for ETFs that hold them. As a result, the use of options
by ETFs is substantially limited. While the proposed exception would be
limited in scope, the Exchange believes the benefits that may flow to
ETFs that hold options and their investors may be significant.
Specifically, the Exchange expects that such ETFs and their investors
could benefit from increased tax efficiencies and potential transaction
cost savings. By making such ETFs more attractive to both current and
prospective investors, the proposed rule change would enable them to
compete more effectively with other ETFs that, due to their particular
portfolio holdings, may effect in-kind creations and redemptions
without restriction. This may lead to further development of ETFs that
invest in options, thereby fostering competition and resulting in
additional choices for investors, which ultimately benefits the
marketplace and the public.

B. Self-Regulatory Organization's Statement on Burden on Competition

    The Exchange does not believe that the proposed rule change will
impose any burden on competition that is not necessary or appropriate
in furtherance of the purposes of the Act. The Exchange does not
believe the proposed rule change will impose any burden on intramarket
competition that is not necessary or appropriate in furtherance of the
purposes of the Act. Utilizing the proposed exception would be
voluntary, and the exception is not intended as a competitive trading
tool. As an alternative to the normal auction process, the proposed
rule change would provide market participants with an efficient and
effective means to transfer positions under the specified
circumstances. The proposed exception would enable all ETFs that hold
options to enjoy the benefits of in-kind creations and redemptions
already available to other ETFs (and to pass these benefits along to
investors). The proposed rule change would apply in the same manner to
all entities that meet the definition of ``authorized participant.''
    The Exchange does not believe the proposed rule change will impose
any burden on intermarket competition that is not necessary or
appropriate in furtherance of the purposes of the Act. As indicated
above, it is intended to provide an additional clearly delineated and
limited exception to the requirement that options positions be
transferred on the floor of an exchange. Further, the Exchange believes
the proposed rule change will eliminate a significant competitive
disadvantage for ETFs that invest in options. Finally, as indicated
above, in light of the significant benefits provided (e.g., tax
efficiencies and potential transaction cost savings), the proposed
exception may lead to further development of ETFs that invest in
options, thereby fostering competition and resulting in additional
choices for investors, which ultimately benefits the marketplace and
the public. Other options exchanges in their discretion may pursue the
adoption of similar exceptions.

C. Self-Regulatory Organization's Statement on Comments on the Proposed
Rule Change Received From Members, Participants, or Others

    The Exchange neither solicited nor received written comments on the
proposed rule change.

III. Date of Effectiveness of the Proposed Rule Change and Timing for
Commission Action

    Within 45 days of the date of publication of this notice in the
Federal Register or within such longer period up to 90 days (i) as the
Commission may designate if it finds such longer period to be
appropriate and publishes its reasons for so finding or (ii) as to
which the Exchange consents, the Commission will:

A. By order approve or disapprove such proposed rule change, or

B. institute proceedings to determine whether the proposed rule change
should be disapproved.

IV. Solicitation of Comments

    Interested persons are invited to submit written data, views, and
arguments concerning the foregoing, including whether the proposed rule
change is consistent with the Act. Comments may be submitted by any of
the following methods:

Electronic Comments

     Use the Commission's internet comment form (http://www.sec.gov/rules/sro.shtml); or
     Send an email to<EMAIL_ADDRESS>Please include
File Number SR-CBOE-2019-048 on the subject line.

Paper Comments

     Send paper comments in triplicate to Secretary, Securities
and Exchange Commission, 100 F Street NE, Washington, DC 20549-1090.
All submissions should refer to File Number SR-CBOE-2019-048. This file
number should be included on the subject line if email is used. To help
the Commission process and review your comments more efficiently,
please use only one method. The Commission will post all comments on
the Commission's internet website (http://www.sec.gov/rules/sro.shtml).
Copies of the submission, all subsequent amendments, all written
statements with respect to the proposed rule change that are filed with
the Commission, and all written communications relating to the proposed
rule change between the Commission and any person, other than those
that may be withheld from the public in accordance with the provisions
of 5 U.S.C. 552, will be available for website viewing and printing in
the Commission's Public Reference Room, 100 F Street, NE, Washington,
DC 20549, on official business days between the hours of 10:00 a.m. and
3:00 p.m. Copies of the filing also will be available for

inspection and copying at the principal office of the Exchange. All
comments received will be posted without change. Persons submitting
comments are cautioned that we do not redact or edit personal
identifying information from comment submissions. You should submit
only information that you wish to make available publicly. All
submissions should refer to File Number SR-CBOE-2019-048, and should be
submitted on or before October 16, 2019.

    For the Commission, by the Division of Trading and Markets,
pursuant to delegated authority.\22\
---------------------------------------------------------------------------

    \22\ 17 CFR 200.30-3(a)(12).
---------------------------------------------------------------------------

Jill M. Peterson,
Assistant Secretary.
[FR Doc. 2019-20708 Filed 9-24-19; 8:45 am]
 BILLING CODE 8011-01-P


concerns it has with inadequate access to market data, resources, or
personnel, and describe the steps it has taken with the RTO or ISO to
resolve these concerns. We also seek comment on the question of how
independence on the part of MMUs can best be achieved.
2. Oversight
    112. As several commenters pointed out at the technical conference,
there is an inherent tension in a structure that requires MMUs to
report to RTO/ISO management yet, at the same time, perform evaluations
and issue reports that may be critical of that management. For example,
MMUs are expected to evaluate and report on RTO/ISO market designs and
performance, and to include RTO/ISO operations in their analyses of
market flaws or inefficiencies. Further, if an MMU detects a potential
tariff violation on the part of its RTO or ISO, it is obligated to
bring the matter to the attention of the Commission. It can be
difficult for an MMU to discharge these oversight and reporting
obligations effectively unless it has some degree of independence from
RTO/ISO management. Such a reporting relationship can create a conflict
of interest because the MMU may temper its opinions out of deference to
management, or those opinions may be overruled by management.
Importantly, these concerns can be present whether the MMU personnel
are in an internal or external structural relationship to their RTO or
ISO.
    113. Therefore, the Commission proposes that each RTO and ISO, in
addition to maintaining a market monitoring function, be required to
have its MMU report either directly to the RTO's or ISO's board of
directors or directly to a committee of independent board directors.
This requirement would apply to all structural types of MMU, whether
internal, external or a hybrid combination of the two.\95\ The
Commission is of the view that it has the authority to impose this type
of requirement on RTOs and ISOs, but seeks comment on this issue as
well as on the proposal itself.
3. Functions
    114. The issue of independence is integrally related to the
functions that the MMUs are expected to perform. Most of the functions
performed by MMUs have remained relatively constant since the inception
of market monitoring, and center around market analysis and the
evaluation of participant behavior. Commenters at the technical
conference were generally supportive of the functions which the
Commission identified in its 2005 Policy Statement, with one exception
discussed below.
---------------------------------------------------------------------------

    \94\ PJM's tariff, for instance, requires PJM to provide
appropriate staffing for its MMU, and to ensure that the MMU has
adequate resources, access to required information, and the
cooperation of PJM staff. PJM Interconnection, L.L.C., FERC Electric
Tariff, Attachment M, Section V.
    \95\ The Commission notes that, if adopted, this policy would
mark a departure from the holding in PJM Interconnection, L.L.C.,
116 FERC ] 61,038, at P 38, order on reh'g 117 FERC ] 61,263 (2006).
After giving due consideration to the comments submitted at the
technical conference, and for the reasons stated above, the
Commission believes that a generic change in policy may be
appropriate and is therefore seeking comment on the issue.
---------------------------------------------------------------------------

    115. The MMU functions upon which there was general agreement at
the technical conference were: (1) Identifying ineffective market rules
and tariff provisions and recommending proposed rule and tariff
changes, (2) reviewing and reporting on the performance of the
wholesale markets, and (3) identifying and notifying the Commission
staff of instances in which a market participant's behavior may require
investigation. The Commission supports these three functions and
proposes to continue them, with one important modification. In the
Policy Statement, the MMUs were directed to advise the RTO or ISO of
any recommendations for rule or tariff changes, with no mention being
made of also advising the Commission. The Commission proposes adding
the requirement that the MMUs also advise the Commission and other
interested entities, which would include relevant state commissions and
market participants. This added requirement would go a long way toward
ensuring the transparency desired by many of the commenters.
Furthermore, as noted above, MMUs should refer to the Commission any
suspected rule or tariff violation committed by an RTO or ISO, as well
as those committed by market participants.
    116. The Commission also proposes retaining the Protocols governing
referral of potential market violations to the Commission, which are
included as an Appendix to the Policy Statement. However, since
issuance of the Policy Statement, Market Behavior Rule 2, referred to
in the Protocols, has been rescinded and replaced by the Commission's
Anti-Manipulation Rules.\96\ Therefore, violations currently to be
referred to the Commission include conduct suspected of violating the
Anti-Manipulation Rules, as well as tariff violations and violations of
the remaining, codified Market Behavior Rules. In addition, the
Commission proposes that the MMU also refer any suspected violations of
other Commission-approved rules and

regulations, such as Codes of Conduct \97\ and Standards of Conduct.
4. Mitigation and Operations
    117. As mentioned, one of the four MMU functions listed in the
Policy Statement was the source of some debate at the technical
conference. The function in question is that of providing support to
the RTO or ISO in the administration of its tariff, which usually takes
the form of MMU-conducted market power mitigation.\98\ Certain
commenters were concerned that such mitigation is being conducted
without an adequate theoretical or empirical basis and is having a
deleterious effect on the electric power market.
    118. The Commission does not believe this rulemaking is the
appropriate forum to address issues of market power and mitigation.
However, the Commission is concerned that an MMU's performance of these
mitigation functions can compromise its independence in evaluating and
reporting on market performance. In order for the MMU to support the
RTO or ISO in tariff administration, it must be subordinate to RTO and
ISO management. The operations and mitigation functions performed by
MMUs directly affect market outcomes and performance. Because of this,
there is an inherent conflict between an MMU reporting on market
outcomes that the MMU itself has influenced. This conflict is of
particular concern where the MMU has significant discretion in
affecting offers, bids, and prices. There is significant potential for
conflict between an MMU maintaining independence of RTO and ISO
management and supporting tariff administration in a subordinate
capacity. It may not be possible for MMUs to maintain independence
while supporting tariff administration.
    119. For the foregoing reasons, the Commission believes operational
activities affecting the market, including mitigation, are more
properly performed by the RTOs and ISOs themselves as part of their
responsibility to administer their Commission-approved tariffs.
Maintaining a clear functional separation in this regard between RTOs
and ISOs and the MMUs would free the MMUs to report objectively on
whether the RTOs and ISOs have done an appropriate job in designing and
administering wholesale power markets. Therefore, the Commission
proposes requiring that MMUs refrain from assisting the RTO or ISO in
tariff administration, from participating in RTO/ISO market operations,
and from taking direct actions to influence the market, and instead
concentrate on their role of providing market evaluation, reports, and
advice.
---------------------------------------------------------------------------

    \96\ See Market Manipulation Order, FERC Stats. & Regs. ]
31,202.
    \97\ The term ``Code of Conduct'' has been replaced by
``Affiliate Restrictions'' in the Final Rule for Market-Based Rates
for Wholesale Sales of Electric Energy, Capacity, and Ancillary
Services by Public Utilities, 119 FERC ] 61,295 (2007).
    \98\ This function was not part of the original conception of
market monitoring as expressed in Order No. 2000.
---------------------------------------------------------------------------

5. Ethics
    120. In order for an MMU to carry out its functions, an activity
which requires disinterested objectivity, it is vital that MMU
personnel maintain the highest ethical standards. Removal of the
conflicts of interest noted above should go a long way toward
facilitating the achievement of those standards. However, as a further
safeguard, the Commission proposes imposing certain minimum ethics
standards upon market monitor personnel, whether the MMU is internal or
external to its RTO or ISO, in particular prohibiting such personnel
from owning financial interests in any market participants. The
Commission notes that all existing RTOs and ISOs have some type of
conflict of interest or standard of conduct provision, although not
always in their tariffs. The Commission proposes standardizing such
provisions and requiring their inclusion in the tariffs themselves. The
Commission solicits comments as to whether the provisions should be
standardized and, if so, what particular provisions would be
appropriate.
6. Tariff Provisions
    121. In order for MMUs to achieve transparency of function, the
detailed obligations imposed upon them must be made clear and
accessible. Likewise, the provisions safeguarding MMU independence and
delineating MMU functions must be included in the tariffs of the RTOs
and ISOs in order to be reviewed, approved and enforced by the
Commission. Currently, MISO and SPP are the only RTOs or ISOs that
centralize the MMU provisions in their tariffs.\99\ Others scatter
their MMU provisions in multiple sections of their tariffs and in other
documents or, in the case of NYISO, not in the tariff at all.\100\ The
Commission proposes that each RTO and ISO set forth all its provisions
involving market monitoring in one section of its tariff.

C. Information Sharing

    122. As noted in the Policy Statement, a key function which MMUs
are expected to perform is that of analyzing the markets to determine
if they are competitive, and proposing actions which might be useful in
eliminating design flaws. Although RTOs and ISOs are subject to the
exclusive jurisdiction of the Commission, we recognize the relationship
between wholesale and retail markets. The Commission also recognizes
the state commission interest in the performance of wholesale power
markets. In Order No. 2000, the Commission acknowledged that
information developed by MMUs would be beneficial not only to itself,
but to others as well.\101\ However, inasmuch as there is a wealth of
data gathered by MMUs, it is important to identify the types of
information that each constituency needs to assist it in performing its
tasks. The Commission favors both a fuller sharing of information and
identification of the relevant information desired, so that the needs
of the Commission, the state commissions, market participants, and the
public may be satisfied.
1. Information Needs
    123. Representatives of state commissions and several other
interested parties submitted comments at the technical conference
expressing their desire to receive more information from the MMUs. The
state commission representatives argue that they need such information
to assist them in performing their regulatory functions, given the
integral relationship between wholesale and retail rates. The
Commission is sympathetic to these requests. The Commission recognizes
that state commissions are not stakeholders, but a separate class from
market participants. As noted above, although RTOs and ISOs are subject
to the exclusive jurisdiction of the Commission, state commissions have
a legitimate interest in the performance of wholesale power markets.
However, their requests for information must be balanced, in some
cases, against confidentiality concerns. Public disclosure of certain
information, such as participant-specific offers or cost data, could
harm market participants or could facilitate collusion under some
circumstances. The Commission must therefore balance state concerns

regarding information access with these countervailing confidentiality
concerns.
    124. The comments submitted at the technical conference did not
identify the particular categories of information needed by state
commissions. The Commission therefore proposes below general areas of
information which it believes could be provided to the states without
jeopardizing the need for confidentiality on the part of market
participants. The Commission requests comments as to whether our
proposal meets the needs of the state commissions, and whether there
are other kinds of information that are needed by state commissions to
fulfill their regulatory responsibilities. We further request comment
on whether there is a generic standard or test that could be used to
determine what specific information should be provided to a state
commission. The Commission also proposes that some, but not all, of the
information to be supplied to the state commissions also be made
available to market participants. Finally, the Commission sets forth
the information which it believes must remain protected, and solicits
comment on whether harm could result from our proposed information
disclosures.
2. Information To Be Provided
    125. The Commission proposes that MMUs be required to report
comprehensively on aggregate market and RTO/ISO performance on a
regular basis, no less frequently than quarterly, to the Commission
staff, to staff of interested state commissions, and to the management
and board of directors of the RTOs and ISOs. The MMUs would be required
to deliver materials supporting their conclusions, and make one or more
of their staff members available for a conference call attended by
representatives of these constituencies. During this process, the MMU
representative would be expected to work cooperatively to develop any
further materials which might be useful to the Commission, to the state
commissions and to the RTOs and ISOs. The Commission envisions that
such combined reporting and conference calls would permit targeted
requests for information and encourage a fuller exchange of relevant
data than may be provided in the MMUs' yearly State of the Market
reports, which are currently required by tariff or the internal
policies of all the RTOs and ISOs.
---------------------------------------------------------------------------

    \99\ Midwest Independent Transmission System Operator, Inc.,
Open Access Transmission and Energy Markets Tariff, Module D;
Southwest Power Pool, Inc., Open Access Transmission Tariff,
Attachments AG, AH.
    \100\ NYISO's market monitoring plan is available on its Web
site and may be found at http://www.nyiso.com/public/documents/tariffs/market_services.jsp
.

    \101\ Order No. 2000, FERC Stats. & Regs., Regulations Preambles
July 1996-December 2000 ] 31,089 at 31,156.
---------------------------------------------------------------------------

    126. The Commission cautions that such reports and meetings are in
no way intended to restrict the MMU from meeting individually with
Commission staff, staff of state commissions, market participants, or
other stakeholders, or sharing information with these various
constituencies, subject to appropriate restrictions on confidentiality.
The Commission is of the view that, in general, as much helpful and
appropriate information about the performance of RTO/ISO markets as
possible should be made public.
    127. The Commission proposes that offer and bid data, without
identification of the market participants, be posted on the RTO's or
ISO's Web site, where it will be available to the Commission, to
interested state commissions, and to stakeholders. The Commission
proposes a lag of three months for posting this data and solicit
comments as to whether that time period is sufficient to protect
commercially sensitive data and to guard against misuse of the data.
3. Tailored Requests for Information
    128. The Commission proposes that state commissions may make
requests for additional information from the MMUs. The Commission
understands that information such as general analyses of the market and
aggregated price data may assist state commissions in performing their
regulatory functions, and believes reasonable requests along those
lines may be appropriate. The Commission seeks comment on how to
structure this proposal to ensure that the information requests are
useful to the states, while at the same time respectful of the limited
resources of the MMUs, and how to ensure confidentiality with respect
to certain market data.
    129. The Commission believes that the foregoing proposal allowing
states to request tailored information should be for information
regarding general market trends and performance, not information
designed to aid state enforcement or related actions against individual
companies. States have their own enforcement agencies which are more
properly employed for such tasks. The limited resources of the MMUs
should be confined to providing information regarding the workings of
the market itself and identifying any structural flaws which the MMUs
think should be addressed.\102\ However, a state commission would
remain free, on a case-by-case basis, to request that the Commission
authorize the release of otherwise proscribed data. The Commission
would evaluate any such request to determine if it demonstrates a
compelling need for the requested information, and decide whether
adequate protections can be fashioned for commercially sensitive
material.
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    \102\ However, if during the ordinary course of its activities
an MMU were to discover evidence of wrongdoing that was within a
state commission's jurisdiction, it is expected that the MMU would
report such information to the state commission.
---------------------------------------------------------------------------

4. Commission Referrals
    130. The Commission continues to believe that MMUs should respect
the confidentiality of their referrals of suspected tariff and rule
violations to the Commission, and not disclose such referrals to other
entities, including state commissions.\103\ Nor does the Commission
intend to share such information, or the result of its activities that
are initiated based upon a MMU referral, on a generic basis. The
Commission notes that its rules require that such information be kept
nonpublic unless the Commission authorizes, in any given case, that it
be publicly disclosed.\104\ Such disclosure is the exception and not
the rule, and each such instance is carefully considered by the
Commission with due regard to the commercially sensitive nature of the
material and to the effect disclosure may have on the willingness of
jurisdictional entities to file self reports with the Commission and
otherwise cooperate in its investigations. As the Commission has
observed previously, confidentiality provides reasonable protection to
persons who become involved in these investigations and fosters
cooperation with the Commission. It also protects innocent persons who
might be erroneously alleged to have committed wrongdoing or be
otherwise adversely affected by simply being associated with an
investigation.\105\ The Commission notes, however, that its staff does
give MMUs generic feedback regarding enforcement issues, and we intend
to continue this practice in order to provide guidance in matters
relating to their referral function.
---------------------------------------------------------------------------

    \103\ See PJM Tariff Rehearing Order, 117 FERC ] 61,263 at P 27.
    \104\ 18 CFR 1b.9 (2006). Other exceptions include cases where
the information has been made a matter of public record in an
adjudicatory proceeding, and where disclosure is required by the
Freedom of Information Act, 5 U.S.C. 552 et seq. (2006).
    \105\ PJM Tariff Rehearing Order, 117 FERC ] 61,263 at P 27.
---------------------------------------------------------------------------

D. Pro Forma Tariff Section

    131. The Commission intends to include in its subsequent Notice of
Proposed Rulemaking a proposed pro forma MMU section for the RTOs' and
ISOs' OATTs. The Commission anticipates that each RTO and ISO may wish
to modify certain provisions, or add others, to such pro forma tariff
to suit its particular needs. Nonetheless, the Commission believes it
will be useful to develop specific core provisions that are
standardized across the various RTOs and ISOs, particularly

in the areas of independence, MMU functions, and information sharing.
The Commission anticipates including in the pro forma tariff protocols
for the referral of tariff and market manipulation violations to the
Office of Enforcement, as well as protocols for the referral of
perceived market design flaws and recommended tariff changes to the
Office of Energy Markets and Reliability. The Commission solicits
comments on the structure and content of such a pro forma section.

E. Conclusion

    132. The Commission's goal is to strengthen market monitoring, and
we advance proposals in this ANOPR that respond to concerns expressed
by commenters at the technical conference, as well as that reflect our
own observations formed over the years from working within the
framework of the existing market monitoring provisions. The Commission
seeks comment on its proposals and on other matters germane to market
monitoring.

VI. Responsiveness of RTOS and ISOS

    133. This section of the ANOPR addresses proposals to increase RTO/
ISO responsiveness to stakeholders. The Commission proposes one reform
to increase the responsiveness of RTO/ISO boards and seeks comment on
whether any other reforms are necessary.

A. The Challenge of Improving RTO and ISO Responsiveness to
Stakeholders

    134. Order Nos. 888 and 2000 require that an ISO or RTO be
independent from market participants. The Commission requires this
independence to ensure that market participants have nondiscriminatory
access to the grid and market rules are developed and administered in a
manner that does not favor one market participant over another. After
five to ten years of experience with several such entities, however,
some stakeholders are concerned that RTOs and ISOs have achieved
independence without being adequately sensitive to the needs of their
customers and members.
    135. Given the size and complexity of RTOs and ISOs today, it is
not surprising that tension has arisen between the goals of
independence and responsiveness. An RTO or ISO cannot satisfy every
group on every issue. When an RTO or ISO makes a difficult decision,
those who support the decision often believe it has acted
``objectively'' and ``independently,'' while those who oppose that
decision often believe the RTO or ISO has not been ``responsive'' to
their concerns.
    136. This natural tension between independence and responsiveness
is compounded by the number of functions that an RTO or ISO performs
and for which it is ultimately held accountable by these several types
of entities. An RTO or ISO has the primary responsibility to operate
the regional transmission system safely in accordance with good utility
practice and reliably in accordance with Commission-approved
reliability standards. It is responsible for providing open and non-
discriminatory transmission access under a regional transmission
tariff. The provision of open-access transmission service in itself
requires that many subordinate functions be carried out, such as
maintaining an efficient transmission reservation system, scheduling
transmission services, managing congestion on the grid, coordinating
local transmission system enhancements, and developing the region's
long-term transmission plan. RTOs and ISOs typically have adopted
innovative transmission pricing mechanisms such as locational pricing
with allocations or auctions of financial transmission rights that
hedge transmission congestion.
    137. An RTO or ISO is also responsible for administering the
organized energy markets. Depending on the region, there are day-ahead
and real-time energy markets, markets for various ancillary services,
and forward capacity markets, with provisions for ensuring that demand
response resources can participate in these markets. It is responsible
for all aspects of operation of these markets and for providing an
independent market monitor. The RTO or ISO may also have
responsibilities regarding resource adequacy. Every RTO or ISO must
maintain a reliable system for metering and measuring power flows and
customer services systems for billing and settling accounts for many
large financial transactions.
    138. As an RTO's or ISO's functional responsibilities grow, some
customers may value the new functions while others prefer the regional
organization to focus on its original basic functions. New services
come at a cost. Start-up costs can be significant for new services, and
the RTO or ISO must decide how to recover the costs from its customers.
These decisions may be controversial. In particular, determining who
benefits from new transmission facilities and how their costs should be
allocated can be very contentious and can lead to customer
dissatisfaction with the RTO or ISO. Decisions related to resource
adequacy, such as whether to adopt capacity markets or to rely more
heavily on energy price signals to incent new generation and demand
response, have also become very contentious.
    139. Given these challenges, the Commission is considering, as
discussed further below, proposals to improve RTO/ISO responsiveness in
a manner that does not compromise their independence.

B. Prior Commission Actions Regarding RTO and ISO Responsiveness

    140. In Order No. 888, the Commission encouraged but did not
require the formation of ISOs. Order No. 888 delineated eleven
principles defining the operations and structure of a properly
functioning ISO.\106\ Similarly, in Order No. 2000, the Commission
encouraged utilities to join RTOs voluntarily and set out the
characteristics that an RTO must possess and the minimum functions that
it must perform.\107\ Embodied in both Order Nos. 888 and 2000 is the
requirement that the regional transmission entity be independent from
market participants so that it can provide regional transmission and
energy market services on a non-discriminatory basis.
---------------------------------------------------------------------------

    \106\ Order No. 888, FERC Stats. & Regs., Regulations Preambles
January 1991-June 1996 ] 31,036 at 31,730-32.
    \107\ Order No. 2000, FERC Stats. & Regs., Regulations Preambles
July 1996-December 2000 ] 31,089 at 30,993-94.
---------------------------------------------------------------------------

    141. Although it required independence, Order No. 2000 did not
mandate detailed governance requirements for an RTO board of directors.
Instead, it stated that the Commission would review governance
proposals on a case-by-case basis.\108\ The Commission emphasized the
importance of stakeholder input regarding both RTO formation and
ongoing operations, and it required the RTO or ISO to consult with its
members and other stakeholders through an advisory committee prior to
taking action. The Commission stated that, because there is a non-
stakeholder board, it is important that this board not become
isolated.\109\ For this reason, the Commission explained that there
should be both formal and informal mechanisms to ensure that
stakeholders can convey their concerns to the non-stakeholder board.
    142. The Commission also required that RTOs have an ``open
architecture'' so that the organization and its members have the
necessary flexibility to improve the structure, geographic scope,
market scope, and operations of the

organization, as long as proposed changes continue to satisfy RTO
minimum characteristics and functions.\110\ Stated another way, ``open
architecture'' meant that the original RTO design could evolve as
needed to reflect changes in member needs.
    143. Over the past few years, many RTO and ISO customers have
raised concerns at the Commission about RTO or ISO responsiveness to
customers on such matters as the level or growth rate of RTO or ISO
administrative costs and the effectiveness of the customer voice in
processes for deciding whether to undertake new expenditures. In
response to concerns over accounting and financial reporting rules for
RTOs and ISOs, the Commission issued a Financial Reporting Notice of
Inquiry (NOI) on September 16, 2004. It asked for comments on RTO and
ISO accounting matters and whether RTOs and ISOs have appropriate
incentives to be cost-effective.\111\ This led directly to Commission
Order No. 668, Accounting and Financial Reporting for Public Utilities
Including RTOs.\112\ Order No. 668 amended the Commission's regulations
to update the accounting requirements for public utilities and
licensees, including RTOs and ISOs. Specifically, Order No. 668 created
new financial accounts to better categorize costs and changed the
reporting requirements for all public utilities, including RTOs and
ISOs, to improve financial reporting of operations, revenue, and
expense accounts. The new financial reporting requirements allow the
Commission and other interested persons to compare public utility
expenditures more readily than under the prior rule, which improves the
transparency of financial information and facilitates clear
understanding of RTO/ISO costs.\113\
    144. In addition to Commission actions, RTOs and ISOs themselves
have undertaken efforts to improve relations and communications with
customers and other stakeholders. For example, the CAISO has enhanced
its participatory budget development process to allow stakeholders to
ask questions and raise concerns well before the budget becomes final.
PJM, at the request of its stakeholders, has introduced procedures
under which stakeholder issues may be immediately reviewed by the
board.\114\ PJM has also proposed to reintroduce a stakeholder
``liaison committee''--a committee of stakeholder representatives that
will advise the PJM board directly--and is seeking stakeholder input on
how that committee should be structured.\115\
---------------------------------------------------------------------------

    \108\ Id. at 31,073-74.
    \109\ Id.
    \110\ Id. at 31,170.
    \111\ Financial Reporting and Cost Accounting and Recovery
Practices for Regional Transmission Organizations and Independent
System Operators, Notice of Inquiry, FERC Stats. & Regs. ] 35,546
(2004).
    \112\ Accounting and Financial Reporting for Public Utilities
Including RTOs, Order No. 668, 70 FR 77,626 (Dec. 30, 2005), FERC
Stats. & Regs., Regulations Preambles 2001-2005 ] 31,199 (2005),
order on reh'g, Order No. 668-A, 71 FR 28,513 (May 16, 2006), FERC
Stats. and Regs. ] 31,215 (2006).
    \113\ Order No. 668, FERC Stats. & Regs., Regulations Preambles
2001-2005 ] 31,199 at P 5.
    \114\ See May 4, 2007 letter from Phillip G. Harris, Chairman
and CEO, PJM Interconnection, L.L.C., to PJM Members and
Stakeholders, at http://www.pjm.com/committees/members/postings/20070504-letter-to-members-post.pdf.
 See also Transcript of

Conference at 204, Conference on Competition in Wholesale Power
Markets, Docket No. AD07-7-000 (May 8, 2007).
    \115\ Id.
---------------------------------------------------------------------------

    145. The Commission is considering below whether additional reforms
should be adopted to further increase RTO and ISO responsiveness.

C. Proposed Commission Action To Improve RTO and ISO Responsiveness

    146. In this section, the Commission proposes reforms related to
ISO and RTO boards and seeks comment on whether any other reforms are
appropriate.
1. A Responsive RTO or ISO Board of Directors \116\
---------------------------------------------------------------------------

    \116\ The term ``board of directors'' is used in this ANOPR to
refer to the highest governing body. Certain RTOs and ISOs may use
another term. For example, the California Independent System
Operator Corporation uses the term ``Board of Governors.''
---------------------------------------------------------------------------

    147. Customer responsiveness must begin with the RTO/ISO board. A
well-functioning and responsible board of directors is necessary for
establishing the strategic direction of the RTO or ISO, including
customer orientation. Board members are expected to have the expertise
needed to set such direction and assess whether it is being followed
successfully. When approving an application for RTO status, the
Commission has considered primarily the independence of board members
in the board selection process.\117\
---------------------------------------------------------------------------

    \117\ Grid Florida, L.L.C., 94 FERC ] 61,020 (2001); Arizona
Public Service Co., 101 FERC ] 61,033, order on reh'g, 101 FERC ]
61,350 (2002).
---------------------------------------------------------------------------

    148. The Commission's preliminary conclusion is that
representatives of customers and other stakeholders must have some form
of effective direct access to the board of directors. Each RTO or ISO
would be required to develop and implement a means to ensure that
customers and other stakeholders have effective direct access to the
board. The mechanism would not have to be the same for each RTO or ISO.
One RTO or ISO might choose to form a committee of stakeholder
representatives with some form of direct access to the board, and this
committee may be distinct from the various technical committees that
have already been formed. Another RTO or ISO might choose to create
direct access by having a hybrid board of directors composed of both
independent members and representatives of stakeholders. A third RTO or
ISO might devise a distinct third means. However, each mechanism would
have to be effective in allowing customers and other stakeholders to
present their views on major issues directly to the board.
    149. The Commission seeks comment on whether RTO or ISO
responsiveness to stakeholders requires some form of direct board
access. If so, what steps can be taken to ensure that both majority and
minority interests have access to the board? If not, is there a better
way to ensure that RTO and ISO boards of directors are responsive to
customers?
    150. The Commission stresses its intent to be flexible regarding
how the RTOs and ISOs may improve responsiveness to stakeholders. As
mentioned, at least two mechanisms, if carefully designed and
implemented, could accomplish this, hybrid boards and board advisory
committees.
    151. A hybrid board would be composed of both independent members
and stakeholder members. Each member would have a seat on the board and
participate fully in board decisions with an equal vote. The Commission
believes it should be possible to structure a hybrid board that does
not sacrifice overall board independence.\118\ Adding non-independent
stakeholders to the board would expose the board to the concerns of
stakeholders in the most direct manner.
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    \118\ We remind RTOs and ISOs that the Commission's regulations
regarding RTO governance require periodic audits of the RTO or ISO
governance by an independent auditor. See 18 CFR 35.34(j)(1)(iv)(A)
(2006).
---------------------------------------------------------------------------

    152. An RTO or ISO that intends to satisfy this proposed
requirement with a hybrid board would have to address certain matters.
Stakeholder members must not be allowed to serve their own interests
inappropriately. Accordingly, the Commission presents here for comment
certain restrictions that may be necessary for a hybrid board proposal.
First, the number of stakeholder members must be a minority of the
board. The stakeholder members cannot make up more than forty-nine
percent of the board, and a lower percentage such as twenty-five
percent may be more appropriate. Second, all subcommittees of the board
should be structured so that the

stakeholder members together cannot overcome the unanimous vote of the
independent board members. Third, any appointment to an RTO or ISO
board of a senior official or director of a stakeholder company that
would constitute an interlocking directorate position under FPA section
305 \119\ would require prior Commission approval before the member
would join the RTO/ISO board.\120\
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    \119\ 16 U.S.C. Sec.  825d (2000).
    \120\ See 16 U.S.C. 825d(b)-(c) (2000); 18 CFR 45 (2006).
Pursuant to section 305(b) of the FPA, interlocks between
unaffiliated public utilities, interlocks between a public utility
and other specified entities, and interlocks among affiliated public
utilities must be submitted to the Commission for approval before a
prospective director holds and assumes the duties of the
interlocking position.
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    153. A second way to satisfy the proposed requirement would be a
board advisory committee. It would be comprised of senior executives of
the various stakeholder groups, serving as an expert panel that would
inform the board of stakeholder views. The board advisory committee
would have no voting authority on board decisions. It would, however,
have authority to make recommendations directly to the board on matters
before the board and on matters it believes the board should address.
The board advisory committee could advise the board about the expected
effect on customers and other stakeholder groups of proposals before
the board. The board advisory committee would not necessarily make
decisions on what to recommend to the board; instead, minority views
could also be presented directly to the board.
    154. The Commission envisions a board advisory committee of senior
stakeholder representatives that would not necessarily consist of those
on technical stakeholder committees in RTOs and ISOs today. Members of
the board advisory committee would be selected to represent a
reasonable range of diverse interests. The number of members should be
decided with attention to forming a committee of reasonable size that
can engage the board in thoughtful discussion.
    155. The Commission encourages interested parties to comment
regarding the proposal and possible approaches. In addition, the
Commission seeks responses to the following questions about customer
access to the board of an RTO or ISO:
     How should any hybrid board be structured? What is an
appropriate limit on the percentage of non-independent board members?
If a variety of customer views are to be represented, what implications
does this have for the size of the board?
     What, if any, rules and restrictions should be placed on
the stakeholder board members of a hybrid board?
     Can the reform proposed here be met through other means
such as increased direct board interaction with customers and other
stakeholders, e.g., through open board meetings or through required
attendance of board members at major stakeholder meetings of the RTO?
     Are there measures--such as customer satisfaction
measures, cost oversight benchmarks, or stakeholder participation
measures--that RTOs and ISOs should use to assess the success of the
mechanism for improving responsiveness?
2. Inquiry Regarding Better Responsiveness Through Improved Practices
and Processes
    156. The Commission also requests comment about whether any other
reforms should be adopted to improve RTO and ISO responsiveness to its
customers and other stakeholders. The Commission is interested in
particular in whether RTOs and ISOs could achieve better
responsiveness--or make their responsiveness more apparent to their
stakeholders--through improvements in the areas of (1) RTO and ISO
executive management practices, (2) effective RTO and ISO stakeholder
processes, and (3) transparent RTO and ISO budget processes.
a. RTO and ISO Executive Management Practices
    157. Executive management ensures that RTO and ISO goals set by the
board are met, including any goal to be responsive to customers and
other stakeholders. Executive management evaluates such things as how
to improve RTO/ISO services, whether to provide new services, and how
to contain administrative costs. Management is likely to be the first
to hear directly from customers about their concerns with current RTO/
ISO operations or proposed new programs or expenditures.
    158. Managers should be responsive to stakeholders but cannot be
beholden to any particular stakeholder group. At a minimum, managers
should seek out customer concerns and pay serious attention to these
concerns. Managers should evaluate whether some appropriate action is
needed to address these concerns. They may decide to address some
concerns and not others, keeping in mind the independence of the RTO or
ISO, its appropriate role in the region as transmission provider and
market administrator, and the trade-off between new services and cost
containment.
    159. The Commission requests comment on whether any reforms are
necessary to increase management responsiveness to stakeholder
concerns. For example, should the Commission encourage or require RTOs
or ISOs to:
     Publish a strategic plan that includes plans for assuring
responsiveness to customers and other stakeholders.
     Measure or otherwise assess customer satisfaction
periodically, through a survey or other means.
     Have a formal process for gathering and evaluating
recommendations for improving services to customers.
     Set performance criteria for executive managers based in
part on responsiveness to stakeholders.
     Relate executive compensation to a measure of
responsiveness to stakeholders.
b. Effective RTO and ISO Stakeholder Processes
    160. The stakeholder processes in RTOs and ISOs today serve several
purposes. They are intended to provide the views of various customer
and stakeholder groups to the RTOs and ISOs. Some are also intended to
help the RTOs and ISOs make decisions on sometimes contentious
transmission and market matters. The Commission is interested in
comments about how well these processes are working and how their
effectiveness might be improved.
    161. The Commission requests replies to the following questions
about RTO and ISO stakeholder processes:
     What stakeholder processes have proved to be particularly
effective?
     How can the effectiveness of a stakeholder process be
assessed?
     Does the voting structure of RTO and ISO stakeholder
groups achieve balanced representation?
     Are minority interests adequately represented in
stakeholder processes?
     How should an RTO or ISO respond when it must make a
decision, such as deciding how to comply with a Commission regulation,
and a stakeholder consensus cannot be reached?
     What actions, if any, can the Commission take to improve
stakeholder processes? For example, should the Commission ask each RTO
or ISO to review and report on the strengths and weaknesses of its
current stakeholder processes?
c. Transparent RTO and ISO Budgeting Processes
    162. Some market participants contend that they do not have an

adequate opportunity to review or understand an RTO's or ISO's budget
in time to influence the budget decision. They point in particular to
RTOs and ISOs that use a formula rate to pass costs through to
customers. Although the Commission has found the current cost recovery
mechanisms for all these entities to be just and reasonable,\121\
stakeholders express concern about ineffective review of significant
cost increases before the costs flow through a formula rate. The NYISO
and Midwest ISO, for example, recover their costs of administering the
transmission grid and market operations through a formula rate.\122\
Some customers believe that the budget for an RTO or ISO with a formula
rate may not include enough details to understand the reason for an
expenditure or its effect on their rates.\123\ This suggests that, in
an RTO or ISO with a formula rate, there may be a greater need for
customer discussion of budget decisions with major cost consequences
before the costs are incurred.
---------------------------------------------------------------------------

    \121\ See California Independent System Operator Corp., 103 FERC
] 61,114 (2003), order on reh'g, 106 FERC ] 61,032 (2004);
California Independent System Operator Corp., 110 FERC ] 61,090
(2005); Midwest Independent Transmission System Operator, Inc., 97
FERC ] 61,033 (2001); Midwest Independent Transmission System
Operator, Inc., 101 FERC 61,221 (2002), order on reh'g, 103 FERC ]
61,035 (2003); New England Power Pool, 96 FERC ] 61,261 (2001); ISO
New England, Inc., 105 FERC ] 61,397 (2003); New York Independent
System Operator, 86 FERC ] 61,062 (1999); PJM Interconnection,
L.L.C., 112 FERC 61,236 (2005), order approving settlement, 115 FERC
] 61,249 (2006).
    \122\ The CAISO, PJM, and ISO-NE, in contrast, use stated rates
for their grid administration and market services charges.
    \123\ After-the-fact review is considered insufficient. Even if
the Commission were to disallow an expenditure after the fact as not
used and useful or otherwise imprudently incurred, an RTO or ISO has
no profits to be reduced by the amount of any disallowed costs. Many
market participants assert that there is no good remedy for these
RTOs and ISOs once imprudent costs are incurred. RTO and ISO
customers are among the first to tell the Commission that, in
practice, once costs are incurred by a not-for-profit RTO or ISO
with a formula rate, these costs must be passed through to its
customers.
---------------------------------------------------------------------------

    163. The Commission requests comment on possible approaches to
address these concerns. For example, should each RTO and ISO:
     Review its cost accountability processes with its
customers and other stakeholders and consider how to improve them?
     Present budget information to customers with adequate
detail, transparency, and cost support? For example, an RTO or ISO with
a formula rate could develop its budget presentation to stakeholders
using the format required for a filing with the Commission to change a
previously-filed stated rate. This would provide stakeholders with
clear information about the proposed expenditures, its effect on rates,
and how the proposed budget relates to recent budgets.
     Provide its customers a timely opportunity to review
budget proposals, ask budget questions, and comment before major
expenditures are finally decided?
     Submit to the Commission as an informational filing the
budget materials provided to stakeholders for review?

VII. Additional Questions

    164. It is our preliminary view that that the Commission should
institute a proceeding under section 206 of the FPA \124\ to reform RTO
and ISO tariffs to address certain issues discussed above. The
Commission may conduct this process either through a notice-and-comment
rulemaking under the Administrative Procedure Act \125\ or an
adjudicative process.
---------------------------------------------------------------------------

    \124\ 16 U.S.C. 824e (2000).
    \125\ 5 U.S.C. 553 (2000).
---------------------------------------------------------------------------

    165. The Commission requests comment on which of these procedures
is likely to produce the most effective reforms, and on the appropriate
time frame in which to conduct the proceedings. The Commission also
seeks input as to the length of time that might be necessary for RTOs
and ISOs to implement any reforms that result from this process.
Specifically, the Commission requests input as to how much time--
including time for stakeholder processes--might be needed for technical
development of compliance filings.

VIII. Comment Procedures

    166. The Commission invites interested persons to submit comments
on these matters and any related matters or alternative proposals that
commenters may wish to discuss. Comments are due August 16, 2007.
Comments must refer to Docket No. AD07-7-000 and must include the
commenter's name, the organization he or she represents, if applicable,
and his or her address.
    167. Comments may be filed electronically via the eFiling link on
the Commission's Web site at http://www.ferc.gov. The Commission

accepts most standard word processing formats and commenters may attach
additional files with supporting information in certain other file
formats. Commenters filing electronically do not need to make a paper
filing.
    168. Commenters that are not able to file comments electronically
must send an original and 14 copies of their comments to: Federal
Energy Regulatory Commission, Secretary of the Commission, 888 First
Street, NE., Washington, DC, 20426.
    169. All comments will be placed in the Commission's public files
and may be viewed, printed, or downloaded remotely as described in the
Document Availability section below. Commenters are not required to
serve copies of their comments on other commenters.

IX. Document Availability

    170. In addition to publishing the full text of this document in
the Federal Register, the Commission provides all interested persons an
opportunity to view and/or print the contents of this document via the
Internet through FERC's Home Page (http://www.ferc.gov. and in FERC's

Public Reference Room during normal business hours (8:30 a.m. to 5 p.m.
Eastern time) at 888 First Street, NE., Room 2A, Washington, DC 20426.
    171. From the Commission's Home Page on the Internet, this
information is available in its eLibrary. The full text of this
document is available in the eLibrary both in PDF and Microsoft Word
format for viewing, printing, and/or downloading. To access this
document in eLibrary, type the docket number of this document,
excluding the last three digits, in the docket number field.
    172. User assistance is available for eLibrary and FERC's Web site
during normal business hours from our Help line at<PHONE_NUMBER> or
the Public Reference Room at<EMAIL_ADDRESS>
    By direction of the Commission. Commissioner Kelly concurring in
part and dissenting in part with a separate statement attached.
Kimberly D. Bose,
Secretary.
KELLY, Commissioner, concurring in part and dissenting in part:

    I generally support the efforts of this Advanced Notice of
Proposed Rulemaking (ANOPR) in setting forth proposals and seeking
comment on improvements to the operation of organized wholesale
electric markets. I am writing separately to express my views on
certain of the proposals related to strengthening market monitoring,
improving demand response and promoting RTO/ISO responsiveness.
    First, I would have added certain proposals to the ANOPR to
strengthen market monitoring. For reasons I have previously
explained,\126\ I would have proposed requiring RTOs/ISOs to file
tariff provisions to allow them to take enforcement action with
respect to objectively identifiable

behavior that does not subject the seller to sanctions or
consequences other than those expressly approved by the Commission
and set forth in the tariff, and with the right of appeal to the
Commission, consistent with the Policy Statement on Market
Monitoring Units.\127\ In addition, the ANOPR states that the
Commission does not intend to share with the MMU information about
suspected tariff and rule violations referred by the MMU to the
Commission. I believe the Commission should generally provide
information to the MMUs on the referrals they have made to the
Commission, subject to appropriate confidentiality restrictions.
Such feedback could be structured so as to provide responsible
disclosure of information while preserving confidentiality. In
addition, I would have proposed requiring the MMU to make
recommendations related to its reports on RTO/ISO performance.
Therefore, I concur in part on the ANOPR.
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    \126\ See PJM Interconnection, L.L.C., 116 FERC ] 61,038, order
on reh'g, 117 FERC ] 61,263 (2006).
    \127\ See 111 FERC ] 61,267 (2005) at P 5.
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    Second, I disagree with two of the proposals being made in the
ANOPR. One proposal involves facilitating greater participation of
demand response in organized markets by modifying market power
mitigation rules in organized markets, such as raising the energy
bid caps and market-wide caps in an emergency situation. Before the
Commission considers whether to pursue such market rule
modifications, I think it is important to address other barriers
that may significantly restrict demand response participation. For
example, the FERC Staff Demand Response Assessment concluded that
the technologies needed to support significant deployment of demand
resources, such as advanced metering, have little market
penetration.\128\ Without the necessary technology already in place
that would allow demand resources to respond to price signals in
wholesale or retail markets, it is unclear how quickly they could
develop the ability to respond after energy bid caps or market-wide
caps are raised or eliminated. In other words, the technology and
associated demand response capability must be in place before we
consider raising or eliminating these price caps. Otherwise these
higher energy prices may not elicit any demand reduction in a
fashion capable of disciplining those prices and keeping them just
and reasonable. In addition, rather than asking questions in this
ANOPR on how to value demand response, I think the Commission should
have proposed a compensation method and postponed consideration of
modifying market power mitigation rules until after the valuation
issue had been addressed.
---------------------------------------------------------------------------

    \128\ FERC Staff Demand Response Assessment, Docket No. AD06-2-
000, at page xii.
---------------------------------------------------------------------------

    Third, although I recognize that some stakeholder groups have
raised concerns about the responsiveness of the RTO/ISO, I disagree
with the ANOPR's proposal to promote responsiveness by establishing
a hybrid RTO/ISO board of directors composed of both independent
members and non-independent stakeholder members. Under this
proposal, each member would have a seat on the board and participate
fully in board decisions with an equal vote. I think it would be
inadvisable and difficult to implement such a proposal.
    Order Nos. 888 and 2000 require that an ISO or RTO be
independent from market participants so that they can provide
regional transmission and energy market services on a non-
discriminatory basis. A fundamental principle for ISOs, as set forth
in Order No. 888, is that the ISO should be independent of any
individual market participant or any one class of participants
(e.g., transmission owners or end-users).\129\ Similarly, Order No.
2000 emphasized that independence is the bedrock principle on which
the ISOs and RTOs must be built and stressed that an RTO ``needs to
be independent in both reality and perception.''\130\ I believe that
establishing a hybrid board would jeopardize the fundamental
principle of independence upon which ISOs and RTOs are based.
---------------------------------------------------------------------------

    \129\ Order No. 888, FERC Stats. & Regs. ] 31,036 at 31,730-31.
    \130\ Order No. 2000, FERC Stats. & Regs. ] 31,089 at 31,061.
---------------------------------------------------------------------------

    Moreover, although the ANOPR states that stakeholder members
would be directed not to serve their own interests inappropriately,
it is not clear to me how one would distinguish between
``inappropriate'' advocacy for one's interests, and perfectly
reasonable advocacy for one's interests. Additionally, a hybrid
board composed of independent and non-independent board members
could needlessly complicate the board dynamic and make cooperative
decision-making more difficult and time consuming. Currently, the
independent board coupled with the stakeholder process, can be
viewed as similar to the judicial model of governance. The
stakeholders are like adversaries in a judicial proceeding arguing
their cases to a disinterested judge, the independent board, which
is capable of balancing the various equities in reaching a timely
decision that is fair to all.
    A stakeholder board, even a hybrid one, would be more akin to
the legislative model with no overarching independent judge making
the final calls. Such a model requires constant negotiation and can
often lead to stalemate or decisions that address only the lowest
common denominator rather than the ideal approach. While that model
is certainly appropriate in many situations, I do not believe it is
workable for the board of an RTO or ISO given the many important and
time-critical issues they deal with. Furthermore, most investor
owned utilities, with whom RTOs and ISOs share many features, do not
appear to follow the legislative model of governance and it is not
clear to me why the RTOs and ISOs should be treated differently. If
the Commission is to consider providing stakeholders with some form
of direct board access, I think that the board advisory committee
proposed in this ANOPR would more effectively serve this purpose.
    Accordingly, for the reasons stated above, I concur in part and
dissent in part on this ANOPR.

Suedeen G. Kelly

 [FR Doc. E7-12550 Filed 6-29-07; 8:45 am]

BILLING CODE 6717-01-P