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Change in the US Regulatory Status of the KRX300 Futures Contract

May 20, 2020

Effective July 1, 2020, the KRX300 (a Korean Large-Cap Index) Futures Contract will no longer be considered a broad-based security index futures contract and instead will be subject to joint regulation by the CFTC and SEC as a foreign security futures contract.

The Korea Exchange (KRX) announced on May 19 a change in the US regulatory status of the KRX300 futures contract. KRX received US Commodity Futures Trading Commission (CFTC) certification of the KRX300 futures contract in March 2019, allowing KRX to offer and sell this contract as a broad-based security index to persons located within the United States. However, in light of changes in the market values of certain components of the index, the index will be considered a narrow-based security index effective July 1, 2019. As a result, the US regulatory status of the futures on the KRX300 will also change because of the index’s new characterization. KRX has advised those US persons who are not permitted to hold positions in non-US narrow-based security index futures to liquidate their positions by the close of trading on June 30, 2020. KRX experienced a similar recharacterization with the KOSPI 200 futures contract in April 2020.

As a result of the change in regulatory status, futures on the KRX300 will now be “security futures contracts,” with a number of consequences for US persons (including funds) that trade futures on the KRX300. Security futures are deemed to be both securities and futures, subject to joint jurisdiction and regulation by the CFTC and the US Securities and Exchange Commission (SEC.) A US person that wishes to trade this foreign security futures product must comply with the relevant SEC order and CFTC advisory,[1] and a CFTC registrant must comply with the CFTC/NFA rules relating to offer and sale of security futures.

If a US person continues to trade the KRX300 futures contract, it should consider the following points:

  • Funds that are US persons investing in foreign securities futures are required to be Qualified Institutional Buyers (generally a requirement that a fund, if a US person, have at least $100 million of assets under management). Natural persons do not qualify as QIBs.
  • Security futures are both futures and securities, and under SEC rules, US persons may NOT have direct market access to these products that are offered by a non-US securities exchange. Thus, a US fund may only have intermediated access, typically through a Rule 15a-6 arrangement.
  • Positions and associated margin of a US person must be held in an account carried by a dually-regulated broker-dealer and futures commission merchant (BD/FCM), either a fully dually-registered BD/FCM or one which is notice registered.
  • A CFTC registrant’s associated persons that are involved in the solicitation or sales activities related to a fund or separately managed account that engages in security futures will need to complete the NFA’s security futures training module.
  • Consider the need for additional disclosures in the PPM.

WHAT’S NEXT?

US persons that engage in KRX300 futures contracts should take steps to confirm that they will qualify after June 30 or liquidate their positions before the status of the futures contract changes. To the extent that US persons continue to trade KRX300 futures contracts once these contracts are considered security futures, they should confirm that they are in compliance with SEC and CFTC requirements and take any necessary steps to become compliant with regulatory obligations ahead of the July 1 effective date.

Contacts

If you have any questions or would like more information on the issues discussed in this LawFlash, please contact any of the following Morgan Lewis lawyers:

Boston
Katherine Dobson Buckley

Chicago
Sarah V. Riddell
Michael M. Philipp

New York
Thomas V. D’Ambrosio

Washington, DC
Ignacio Sandoval


[1] SEC Order under Section 36 of the Securities Exchange Act of 1934 Granting an Exemption from Exchange Act Section 6(h)(1) for Certain Persons Effecting Transactions in Foreign Security Futures and under Exchange Act Section 15(a)(2) and Section 36 Granting Exemptions from Exchange Act Section 15(a)(1) and Certain Other Requirements, Release No. 34-60194 (Jun. 30, 2009); Division of Clearing and Intermediary Oversight Advisory Concerning the Offer and Sale of Foreign Security Futures Products to Customers Located in the United States, See Division of Clearing and Intermediary Oversight Advisory Concerning the Offer and Sale of Foreign Security Futures Products to Customers Located in the United States (Jun 8, 2010).