Self-Regulatory Organizations; NASDAQ OMX PHLX LLC; Notice of Filing and Immediate Effectiveness of Proposed Rule Change Relating to Surveillance Agreements

Pursuant to Section 19(b)(1) of the Securities Exchange Act of 1934 (“Act”), and Rule 19b-4 thereunder, notice is hereby given that, on March 16, 2015, NASDAQ OMX PHLX LLC (“Phlx” or “Exchange”) filed with the Securities and Exchange Commission (“SEC” or “Commission”) the proposed rule change as described in Items I and II 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.

I. Self-Regulatory Organization's Statement of the Terms of Substance of the Proposed Rule Change

The Exchange proposes to amend Rule 1009 (Criteria for Underlying Securities) to allow the listing of options overlying Exchange-Traded Fund Shares (“ETFs”) that are listed pursuant to generic listing standards on equities exchanges for series of portfolio depositary receipts (“PDRs”) and index fund shares (“IFSs”) based on international or global indexes, pursuant to which a comprehensive surveillance agreement is not required.

The text of the proposed rule change is available on the Exchange's Web site at http://www.nasdaqtrader.com/micro.aspx?id=PHLXRulefilings,, at the principal office of the Exchange, 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 amend Commentary .06 to Rule 1009 to allow the listing of options overlying ETFs that are listed pursuant to generic listing standards on equities exchanges for series of PDRs and IFSs based on international or global indexes under which a CSSA is not required. Adding proposed new Commentary .06(b)(i) to Rule 1009 will enable the Exchange to list and trade options on ETFs without a CSSA provided that the underlying ETF is listed on an equities exchange pursuant to the generic listings standards that do not require a CSSA pursuant to Rule 19b-4(e) of the Exchange Act.

Rule 19b-4(e) provides that the listing and trading of a new derivative securities product by an SRO shall not be deemed a proposed rule change, pursuant to paragraph (c)(l) of Rule 19b-4 if the Commission has approved, pursuant to Section 19(b) of the Act, the SRO's trading rules, procedures and listing standards for the product class that would include the new derivatives securities product, and the SRO has a surveillance program for the product class. This proposal allows the Exchange to list and trade options on ETFs based on international or global indexes that meet the generic listing standards.

The Surveillance Agreement Requirement for Options on Exchange-Traded Funds

The surveillance agreement requirement (also known as the “requirement” or “regime”) was initially put into effect for options on ETFs well over a decade ago but has proven to have anti-competitive effects that are detrimental to investors. Specifically, the requirement limits the investing public's ability to hedge risk or engage in options strategies that may be afforded to other investors in domestic securities.

The Exchange allows for the listing and trading of options on ETFs. Commentary .06 to Rule 1009 provides the listings standards for options on ETFs, which includes [sic] ETFs with non-U.S. component securities, such as ETFs based on international or global indexes. Currently, Commentary .06 to Rule 1009 regarding options on ETFs has a three-level surveillance agreement requirement (reproduced in relevant part):

(i) Whether any non-U.S. component stocks on which the Fund Shares are based that are not subject to comprehensive surveillance agreements do not in the aggregate represent more than 50% of the weight of the index or portfolio;

(ii) stocks for which the primary market is in any one country that is not subject to a comprehensive surveillance agreement do not represent 20% or more of the weight of the index; and

(iii) stocks for which the primary market is in any two countries that are not subject to comprehensive surveillance agreements do not represent 33% or more of the weight of the index.

The Exchange proposes to modify the surveillance agreement requirement for options on ETFs that are listed pursuant to generic listing standards for series of PDRs and IFSs, based on international or global indexes—for which case a comprehensive surveillance agreement is not required.

The surveillance agreement requirement was instituted in 2001 when ETFs were, comparatively speaking, in a developmental state. The first ETF introduced in 1993 was a broad-based domestic equity fund tracking the S&P 500 index. The development of ETF products was very limited during the first decade of their existence, such that at the end of 2001, there was a total of only 102 ETFs listed on U.S. markets. Since 2001, however, the ETF market has matured tremendously and grown exponentially, such that at the end of 2012 there were a total of 1,194 listed ETFs. Many of these are very well known, highly traded and liquid products, such as, for example, SPDR S&P 500 Trust ETF (SPY), iShares MSCI Emerging Markets ETF (EEM), and PowerShares QQQ Trust, Series 1 ETF (QQQQ) [sic], that market participants from institutional to retail and public investors have been using for trading, hedging, and investing purposes with varying timelines. The ETF market is one of the most highly-developed, sophisticated markets that provide traders and investors the opportunity to access practically all industries and enterprises. In 2012 investor demand for ETFs in all asset classes increased substantially. And in 2011 the demand for global and international equity ETFs, to which the requirement applies, more than doubled. The Exchange believes that the surveillance agreement requirement no longer serves a necessary (or indispensable) function in today's highly developed ETF market, and actually creates a dynamic that negatively impacts the number of markets that can competitively trade ETF option products, to the detriment of market participants.

The current surveillance requirement has, at times, resulted in the investing public having to forego the opportunity to hedge risk or engage in other listed options strategies in a competitive environment. ETFs may lack active options contracts that would be more likely to develop if multiple exchanges could compete to offer and promote them. For example, an investor in the iShare [sic] MSCI Indonesia ETF (EIDO) is not permitted to sell call options or purchase protective puts simply because the Exchange cannot obtain a surveillance agreement with Bursa Efek Indonesia. However, an investor in iShare [sic] MSCI Emerging Markets Fund (EEM) is afforded the right to engage in listed options trading to hedge risk or execute other beneficial options strategies. Both underlying exchange-traded funds, EIDO and EEM, are listed for trading in the U.S., subject to constant regulatory scrutiny, and permitted to be purchased and sold via registered broker/dealers, yet, options can now be offered only on EEM. The Exchange believes this disparate treatment between investors of foreign-based instruments, especially between those that buy and sell options contracts on ETFs, which currently require surveillance agreements, as opposed to those that buy and sell shares of the underlying ETFs, which currently do not have the same onerous surveillance agreement requirement that ETF options have, is not in the best interest. The Exchange therefore proposes to establish that options on generically-listed global or international ETFs would not require surveillance agreements for listing.

The current surveillance agreement requirements, as well as all other requirements to list options on ETFs, are not affected by this proposal and will continue to remain in place for options on ETFs that do not meet generic listing standards on equities exchanges for ETFs based on international and global indexes.

Generic Listing Standards for Exchange-Traded Funds

The Exchange notes that the Commission has previously approved generic listing standards pursuant to Rule 19b-4(e) of the Exchange Act for ETFs based on indexes that consist of stocks listed on U.S. exchanges including NASDAQ, the ETF listing exchange within the Group. In general, the criteria for the underlying component securities in the international and global indexes are similar to those for the domestic indexes, but with modifications as appropriate for the issues and risks associated with non-U.S. securities.

In addition, the Commission has previously approved proposals for the listing and trading of options on ETFs based on international indexes as well as global indexes (e.g., based on non-U.S. and U.S. component stocks). In approving ETFs for equities exchange trading, the Commission thoroughly considered the structure of the ETFs, their usefulness to investors and to the markets, and SRO rules that govern their trading. The Exchange believes that allowing the listing of options overlying ETFs that are listed pursuant to the generic listing standards on equities exchanges for ETFs based on international and global indexes and applying Rule 19b-4(e) should fulfill the intended objective of that rule by allowing options on those ETFs that have satisfied the generic listing standards to commence trading, without the need for the public comment period and Commission approval. The proposed rule has the potential to reduce the time frame for bringing options on ETFs to market, thereby reducing the burdens on issuers and other market participants. The failure of a particular ETF to comply with the generic listing standards under Rule 19b-4(e) would not, however, preclude the Exchange from submitting a separate filing pursuant to Section 19(b)(2), requesting Commission approval to list and trade options on a particular ETF. Moreover, the Exchange notes that the generic standards such as those in proposed Commentary .06(b)(i) to Rule 1009 are not new in the options world, and have been used extensively for listing options on narrow-based and broad-based indexes.

Requirements for Listing and Trading Options Overlying ETFs Based on International and Global Indexes

Options on ETFs listed pursuant to these generic standards for international and global indexes would be traded, in all other respects, under the Exchange's existing trading rules and procedures that apply to options on ETFs and would be covered under the Exchange's surveillance program for options on ETFs.

Pursuant to proposed Commentary .06(b)(i) to Rule 1009, the Exchange may list and trade options on an ETF without a CSSA provided that the ETF is listed pursuant to generic listing standards for series of PDRs and IFSs based on international or global indexes, in which case a comprehensive surveillance agreement is not required. As noted, one such rule, which discusses things such as weighting, capitalization, trading volume, minimum number of components, and where components are listed, is NASDAQ Rule 5705(b)(3)(A)(ii) regarding ETFs (IFSs and PDRs). The Exchange believes that these generic listing standards are intended to ensure that securities with substantial market capitalization and trading volume account for a substantial portion of the weight of an index or portfolio.

The Exchange believes that this proposed listing standard for options on ETFs is reasonable for international and global indexes, and, when applied in conjunction with the other listing requirements, will result in options overlying ETFs that are sufficiently broad in scope and not readily susceptible to manipulation. The Exchange also believes that allowing the Exchange to list options overlying ETFs that are listed on equities exchanges pursuant to generic standards for series of PDRs and IFSs based on international or global indexes under which a CSSA is not required, will result in options overlying ETFs that are adequately diversified in weighting for any single security or small group of securities to significantly reduce concerns that trading in options overlying ETFs based on international or global indexes could become a surrogate for trading in unregistered securities.

The Exchange believes that ETFs based on international and global indexes that have been listed pursuant to the generic standards are sufficiently defined so as to make options overlying such ETFs not susceptible instruments for manipulation. The Exchange believes that the threat of manipulation is, as discussed below, sufficiently mitigated for underlying ETFs that have been listed on equities exchanges pursuant to generic listing standards for series of PDRs and IFSs based on international or global indexes under which a comprehensive surveillance agreement is not required and for the overlying options; the Exchange does not see the need for a CSSA to be in place before listing and trading options on such ETFs. The Exchange notes that its proposal does not replace the need for a CSSA as provided in current Commentary .06(b) to Rule 1009. The provisions of Commentary .06(b), including the need for a CSSA, remain materially unchanged and will continue to apply to options on ETFs that are not listed on an equities exchange pursuant to generic listing standards for series of PDRs and IFSs based on international or global indexes. Instead, proposed Commentary .06(b)(i) adds an additional listing mechanism for certain qualifying options on ETFs to be listed on the Exchange.

Finally, to account for proposed Commentary .06(b) to Rule 1009 and make Commentary .06 easier to follow, the Exchange proposes technical changes to the formatting of this section of the rule. The Exchange proposes re-numbering Commentary .06(b)(i), (ii) and (iii) as Commentary .06(b)(ii)(A), (B), and (C), respectively; and re-numbering Commentary .06(b)(iv) and (v) as Commentary .06(b)(iii) and (iv), respectively. This is merely re-numbering and there are no changes to the language of these sections of Commentary .06.

No Economic Risk

The proposal does not raise a concern regarding economic risk or manipulation. The proposal does not increase the risk of manipulation of the ETF itself, as the ETF trades in the U.S. and trading is subject to the U.S. surveillance requirement and follows Exchange rules. One might try to argue that the proposal raises a concern about a theoretical manipulation risk of the underlying international components of the ETF trading in the U.S. If such manipulation were successful, the argument would go, then the ETF could be fairly priced relative to its components but the price of the components potentially may not reflect fair market value. The Exchange firmly believes that the proposal does not raise any such theoretical concern.

For manipulation to be successful the expected cost of the contemplated manipulation must be less than the expected gain. In other words, manipulation will not be attempted if the prospective profit from the attempt is zero or less, even ignoring the quite real costs associated with regulatory risk. In approving the rules for narrow based indices, it was thought that the costs of manipulating such an index based on component securities with the same parameters as those proposed ETFs would be prohibitive relative to any prospective gains. The Exchange's proposal does not suggest a different paradigm.

Moreover, the Commission reviewed and approved the ability to list ETFs without surveillance agreements if they meet the generic listing standards for ETFs based on international or global indices. The Exchange believes that the argument and economic conclusion that allowing the listing of options on these same underlying ETFs with components outside the U.S. that are sufficiently large, transparent, diversified, and liquid to make manipulation unprofitable is valid.

A second theoretical source of manipulation risk may be seen to be the creation/redemption process for ETFs. If the creation/redemption process could be manipulated then the market price of the ETF could materially differ from the fair value of the ETF derived from a fair market value of the components. Again, the Exchange does not agree that this is a significant manipulation risk for ETFs, let alone options on ETF. As noted, ETFs are a much more mature asset class today than in 2001 when the current rules were adopted. The development of ETFs as an established asset class and the listing and trading of ETFs, including the creation/redemption process, has developed immensely since the introduction of ETFs, and options on them. Since manipulation of the creation/redemption process would create economic profits for the manipulator, but such manipulation has not been manifest during the significant expansion of ETFs as an international asset class, this offers convincing evidence that manipulation risk in the creation/redemption process is, indeed, theoretical and not an increased risk with this proposal regarding the listing of ETF options. The Exchange believes that its proposal will not lead to increased economic risk.

The Exchange requests approval of its proposal to allow the listing of options overlying ETFs (PDRs and IFSs) based on international or global indexes, without a comprehensive surveillance agreement. The proposal will, as discussed, be beneficial to investors and is in conformity with the Act.

2. Statutory Basis

The Exchange believes that its proposal is consistent with Section 6(b) of the Act in general, and furthers the objectives of Section 6(b)(5) of the Act in particular, in that it is designed to promote just and equitable principles of trade, 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. In particular, the proposed rule change has the potential to reduce the time frame for bringing options on ETFs to market, thereby reducing the burdens on issuers and other market participants. The Exchange also believes that enabling the listing and trading of options on ETFs pursuant to this proposed new listing standard will benefit investors by providing them with valuable risk management tools. The Exchange notes that its proposal does not replace the need for a CSSA as provided in Commentary .06 to Rule 1009. The provisions of current Commentary .06, including the need for a CSSA, remain materially unchanged and will continue to apply to options on ETFs that are not listed on an equities exchange pursuant to generic listing standards for series of PDRs and IFSs based on international or global indexes under which a comprehensive surveillance agreement is not required. Instead, proposed Commentary .06(b)(i) to Rule 1009 adds an additional listing mechanism for certain qualifying options on ETFs to be listed on the Exchange in a manner that is 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 facilitating transactions in securities, to remove impediments to and perfect the mechanisms of a free and open market and a national market system and, in general, to protect investors and the public interest.

The proposal would promote just and equitable principles of trade. The surveillance agreement requirement was instituted in 2001 when ETFs were, comparatively speaking, in a developmental state. The first ETF introduced in 1993 was a broad-based domestic equity fund tracking the S&P 500 index. After the introduction of the first ETF in 1993, the development of ETF products was very limited during the first decade of their existence. Since the end of 2001, when there was a total of only 102 ETFs listed on U.S. markets, however, the ETF market has matured tremendously and grown exponentially. With a total of 1,194 listed ETFs at the end of 2012, the ETF market is now one of the most highly-developed, sophisticated markets with many very well known, highly traded and liquid products that provide traders and investors the opportunity to access practically all industries and enterprises. While investor demand for ETFs in all asset classes increased substantially, in 2011 the demand for global and international equity ETFs, to which the requirement applies, more than doubled. The Exchange believes that the current surveillance requirement no longer serves a necessary function in today's highly developed market, and, as discussed, actually creates a dynamic that negatively impacts the number of markets that can competitively trade ETF option products. This hurts market participants. The Exchange therefore proposes to establish that pursuant to proposed Commentary .06(b)(i) to Rule 1009 options may be listed on certain ETFs that are based on global and international funds and meet generic listing standards.

The proposal would in general protect investors and the public interest. The Exchange believes that modifying the surveillance agreement requirement for ETFs would not hinder the Exchange from performing surveillance duties designed to protect investors and the public interest. There are various data consolidators, vendors, and outlets that can be used to access data and information regarding ETFs and the underlying securities (e.g., Bloomberg, Dow Jones, FTEN). In addition, firms that list ETFs on an exchange receive vast amounts of data relevant to their products that could be made available to listing exchanges as needed. The Exchange has access to the activity of the direct underlying instrument and the ETF, and through the Intermarket Surveillance Group (“ISG”) the Exchange can obtain such information related to the underlying security as needed. Moreover, other than the surveillance agreement requirement there are, as discussed, numerous requirements in Rule 1009 that must be met to list options on ETFs on the Exchange.

The proposal would remove impediments to and perfect the mechanism of a free and open market and a national market system. Multiple listing of ETFs, options, and other securities and competition are some of the central features of the current national market system. The Exchange believes that the surveillance agreement requirement has led to clearly anti-competitive results in a market that is based on competition. As such, the Exchange believes that the surveillance agreement requirement for options on certain ETFs is no longer necessary and proposes new Commentary .06(b)(i) to Rule 1009. The proposed rule change will significantly benefit market participants. As discussed at length, the proposed rule will negate the negative anti-competitive effect of the current surveillance agreement requirement that has resulted in de facto regulatory monopolies where only solitary exchanges, or only a few exchanges, are able to list certain ETF options products. The Exchange believes this is inconsistent with Commission policies and the developing national market system, as well as the competitive nature of the market, and therefore proposes amendment. The Exchange believes that the proposal would encourage a more open market and national market system based on competition and multiple listing. The generic listing standards for ETFs based on global or international indexes have specific requirements regarding relative weighting, minimum capitalization, minimum trading volume, and minimum number of components that have been approved by the Commission years ago for foreign ETFs. Moreover, such listing standards have been in continuous use for listing options on narrow-based and broad-based indexes on the Exchange. Allowing the listing of options on underlying ETFs based on global and international indexes that meet generic listing standards would encourage a free and open market and national market system to the benefit of market participants.

Finally, the Exchange's proposal for limiting the necessity of surveillance agreements to list options on ETFs does not, as discussed above, raise a concern regarding manipulation. The Exchange believes that its proposal is not indicative of increased economic risk.

For the above reasons, the Exchange believes the proposed rule change is consistent with the requirements of Section 6(b)(5) of the Act.

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. To the contrary, the Exchange believes that the proposal is, as discussed, decidedly pro-competitive and is a competitive response to the inability to list products because of the surveillance agreement requirement. The Exchange believes that the proposed rule change will result in additional investment options and opportunities to achieve the investment objectives of market participants seeking efficient trading and hedging vehicles, to the benefit of investors, market participants, and the marketplace in general. Competition is one of the principal features of the national market system. The Exchange believes that this proposal will expand competitive opportunities to list and trade products on the Exchange as noted.

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

No written comments were either solicited or received.

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

Because the proposed rule change does not (i) significantly affect the protection of investors or the public interest; (ii) impose any significant burden on competition; and (iii) become operative for 30 days from the date on which it was filed, or such shorter time as the Commission may designate, the proposed rule change has become effective pursuant to Section 19(b)(3)(A) of the Act and Rule 19b-4(f)(6) thereunder.

A proposed rule change filed pursuant to Rule 19b-4(f)(6) under the Act normally does not become operative for 30 days after the date of its filing. However, Rule 19b-4(f)(6)(iii) permits the Commission to designate a shorter time if such action is consistent with the protection of investors and the public interest. The Exchange has asked the Commission to waive the 30-day operative delay so that the proposal may become operative immediately upon filing. The Exchange stated that waiver of the operative delay will permit the Exchange to list and trade certain ETF options on the same basis as another options market. The Commission believes the waiver of the operative delay is consistent with the protection of investors and the public interest. Therefore, the Commission hereby waives the operative delay and designates the proposal operative upon filing.

At any time within 60 days of the filing of the proposed rule change, the Commission summarily may temporarily suspend such rule change if it appears to the Commission that such action is necessary or appropriate in the public interest, for the protection of investors, or otherwise in furtherance of the purposes of the Act. If the Commission takes such action, the Commission shall institute proceedings to determine whether the proposed rule should be approved or 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 rule-comments@sec.gov. Please include File Number SR-Phlx-2015-27 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-Phlx-2015-27. 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 Web site ( 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 Web site 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; the Commission does not edit personal identifying information from submissions. You should submit only information that you wish to make available publicly. All submissions should refer to File Number SR-Phlx-2015-27 and should be submitted on or before April 16, 2015.