August 22, 2018.
On January 4, 2018, NYSE Arca, Inc. (“NYSE Arca”) filed with the Securities and Exchange Commission (“Commission”), pursuant to Section 19(b)(1) of the Securities Exchange Act of 1934 (“Exchange Act”) 
and Rule 19b-4 thereunder,
a proposed rule change to list and trade the shares (“Shares”) of the following exchange-traded products under NYSE Arca Rule 8.200-E, Commentary .02: Direxion Daily Bitcoin Bear 1X Shares (“1X Bear Fund”), Direxion Daily Bitcoin 1.25X Bull Shares (“1.25X Bull Fund”), Direxion Daily Bitcoin 1.5X Bull Shares (“1.5X Bull Fund”), Direxion Daily Bitcoin 2X Bull Shares (“2X Bull Fund”), and Direxion Daily Bitcoin 2X Bear Shares (“2X Bear Fund”) (each a “Fund” and, collectively, the “Funds”). The proposed rule change was published for comment in the Federal Register on January 24, 2018.
The comment period for the Notice of Proposed Rule Change closed on February 14, 2018.
On March 1, 2018, pursuant to Section 19(b)(2) of the Exchange Act,
the Commission designated a longer period within which to approve the proposed rule change, disapprove the proposed rule change, or institute proceedings to determine whether to approve or disapprove the proposed rule change.
On April 23, 2018, the Commission instituted proceedings under Section 19(b)(2)(B) of the Exchange Act 
to determine whether to approve or disapprove the proposed rule change.
The comment period and rebuttal comment period for the Order Instituting Proceedings closed on May 18, 2018, and June 1, 2018, respectively. Finally, on July 18, 2018, the Commission extended the period for consideration of the proposed rule change to September 21, 2018.
As of August 21, 2018, the Commission had received six comments on the proposed rule change.
This order disapproves the proposed rule change. Although the Commission is disapproving this proposed rule change, the Commission emphasizes that its disapproval does not rest on an evaluation of whether bitcoin, or blockchain technology more generally, has utility or value as an innovation or an investment. Rather, the Commission is disapproving this proposed rule change because, as discussed below, the Exchange has not met its burden under the Exchange Act and the Commission's Rules of Practice to demonstrate that its proposal is consistent with the requirements of the Exchange Act Section 6(b)(5), in particular the requirement that a national securities exchange's rules be designed to prevent fraudulent and manipulative acts and practices.
Among other things, the Exchange has offered no record evidence to demonstrate that bitcoin futures markets are “markets of significant size.” That failure is critical because, as explained below, the Exchange has failed to establish that other means to prevent fraudulent and manipulative acts and practices will be sufficient, and therefore surveillance-sharing with a regulated market of significant size related to bitcoin is necessary to satisfy the statutory requirement that the Exchange's rules be designed to prevent fraudulent and manipulative acts and practices.
II. Description of the Proposal
The Exchange proposes to list and trade the Shares under NYSE Arca Rule 8.200-E, Commentary .02, which Start Printed Page 43913governs the listing and trading of Trust Issued Receipts on the Exchange.
Each Fund will be a series of the Direxion Shares ETF Trust II (“Trust”), and the Trust and the Funds will be managed and controlled by Direxion Asset Management, LLC (“Sponsor”). Bank of New York Mellon will be the custodian and transfer agent for the Funds. U.S. Bancorp Fund Services, LLC will serve as the administrator for the Funds, and Foreside Fund Services, LLC will serve as the distributor of the Shares (“Distributor”).
According to the Notice, each Fund will create and redeem Shares in one or more Creation Units (a Creation Unit is a block of 50,000 Shares of a Fund).
According to the Notice, the Funds will seek to obtain daily short, leveraged long, or leveraged short exposure (before fees and expenses) to the target benchmark, which is the lead-month bitcoin futures contract traded on the Chicago Mercantile Exchange (“CME”), the Cboe Global Markets, Inc. (“CBOE”), or any other U.S. exchange that subsequently trades bitcoin futures contracts (“Bitcoin Futures Contract”).
Specifically, the 1.25X Bull Fund, the 1.5X Bull Fund, and the 2X Bull Fund will seek daily investment results (before fees and expenses) that are 125%, 150%, or 200%, respectively, of the daily return of the target benchmark.
The 1X Bear Fund and the 2X Bear Fund will seek daily inverse investment results (before fees and expenses) that are −100% or −200%, respectively, of the daily return of the target benchmark.
According to the Notice, the target benchmark's value will be calculated as the last sale price published by CME or CBOE, or any other U.S. exchange that subsequently trades bitcoin futures contracts, on or before 11:00 a.m. E.T. for the Bitcoin Futures Contract and may reflect trades occurring and published by CME, CBOE, or another U.S. exchange that subsequently trades bitcoin futures contracts outside the normal trading session for the Bitcoin Futures Contract.
Each Fund will compute its NAV as of 11:00 a.m. E.T., or such earlier time that the NYSE may close.
According to the Notice, each Fund, under normal market conditions, will seek to achieve its daily investment objective by investing in the Bitcoin Futures Contract, swaps on the Bitcoin Futures Contract, or listed options on bitcoin or the Bitcoin Futures Contract (collectively, “Bitcoin Financial Instruments”). The Funds' investments in Bitcoin Financial Instruments will be used to produce economically “leveraged” or “inverse leveraged” investment results for the Funds.
A Fund may invest in the listed options and swaps described above in a manner consistent with its investment objective in situations where the Sponsor believes that investing in such financial instruments is in the best interests of a Fund. In addition, a Fund may invest in swap contracts referencing the Bitcoin Futures Contract if the market for a specific bitcoin futures contract experiences emergencies or if position, price, or accountability limits (if any) are reached with respect to a specific bitcoin futures contract. Each trading day at the close of the U.S. equity markets, each Fund will position its portfolio to ensure that the Fund's exposure to the target benchmark is consistent with the Fund's investment objective.
The Notice also states:
[U]nlike the futures markets for traditional physical commodities, the market for exchange-traded bitcoin futures contract[s] has limited trading history and operational experience and may be riskier, less liquid, more volatile and more vulnerable to economic, market and industry changes than more established futures markets. The liquidity of the market will depend on, among other things, the adoption of bitcoin and the commercial and speculative interest in the market for the ability to hedge against the price of bitcoin with exchange-traded bitcoin futures contracts.
The Exchange represents that trading in the Shares of each Fund will be subject to the existing trading surveillances administered by the Exchange, as well as cross-market surveillances administered by FINRA on behalf of the Exchange, which are designed to detect violations of Exchange rules and applicable federal securities laws.
The Exchange asserts that these procedures are adequate to properly monitor Exchange trading of the Shares in all trading sessions and to deter and detect violations of Exchange rules and federal securities laws applicable to trading on the Exchange.
A. The Applicable Standard for Review
The Commission must consider whether the Exchange's proposal is consistent with Exchange Act Section 6(b)(5), which requires, in relevant part, that the rules of a national securities exchange be designed “to prevent fraudulent and manipulative acts and practices” and “to protect investors and the public interest.” 
Under the Commission's Rules of Practice, the “burden to demonstrate that a proposed rule change is consistent with the Exchange Act and the rules and regulations issued thereunder . . . is on the self-regulatory organization [`SRO'] that proposed the rule change.” 
The description of a proposed rule change, its purpose and operation, its effect, and a legal analysis of its consistency with applicable requirements must all be sufficiently detailed and specific to support an affirmative Commission finding,
and any failure of an SRO to provide this information may result in the Commission not having a sufficient basis to make an affirmative finding that a proposed rule change is consistent with the Exchange Act and the applicable rules and regulations.
Moreover, “unquestioning reliance” on an SRO's representations in a proposed rule change is not sufficient to justify Commission approval of a proposed rule change.
B. Preventing Fraudulent and Manipulative Practices
1. Applicable Legal Standard
To approve the Exchange's proposal to list the Shares, the Commission must be able to find that the proposal is, consistent with Exchange Act Section 6(b)(5), “designed to prevent fraudulent Start Printed Page 43914and manipulative acts and practices.” 
As the Commission recently explained in an order disapproving a listing proposal for the Winklevoss Bitcoin Trust (“Winklevoss Order”), although surveillance-sharing agreements are not the exclusive means by which an exchange-traded product (“ETP”) listing exchange can meet its obligations under Exchange Act Section 6(b)(5), such agreements are a widely used means for exchanges that list ETPs to meet their obligations, and the Commission has historically recognized their importance.
The Commission has therefore determined that, if the listing exchange for an ETP fails to establish that other means to prevent fraudulent and manipulative acts and practices will be sufficient, the listing exchange must enter into a surveillance-sharing agreement with a regulated market of significant size because “[s]uch agreements provide a necessary deterrent to manipulation because they facilitate the availability of information needed to fully investigate a manipulation if it were to occur.” 
Accordingly, a surveillance-sharing agreement with a regulated market of significant size is required to ensure that, in compliance with the Exchange Act, the proposal is “designed to prevent fraudulent and manipulative acts and practices.” 
In this context, the Commission has interpreted the terms “significant market” and “market of significant size” to include a market (or group of markets) as to which (a) there is a reasonable likelihood that a person attempting to manipulate the ETP would also have to trade on that market to successfully manipulate the ETP, so that a surveillance-sharing agreement would assist the ETP listing market in detecting and deterring misconduct, and (b) it is unlikely that trading in the ETP would be the predominant influence on prices in that market.
Thus, a surveillance-sharing agreement must be entered into with a “significant market” to assist in detecting and deterring manipulation of the ETP, because someone attempting to manipulate the ETP is reasonably likely to also engage in trading activity on that “significant market.”
Although the Winklevoss Order applied these standards to a commodity-trust ETP based on bitcoin, the Commission believes that these standards are also appropriate for an ETP based on bitcoin futures. When approving the first commodity-futures ETP, the Commission specifically noted that “[i]nformation sharing agreements with primary markets trading index components underlying a derivative product are an important part of a self-regulatory organization's ability to monitor for trading abuses in derivative products.” 
And the Commission's approval orders for commodity-futures ETPs consistently note the ability of an ETP listing exchange to share surveillance information either through surveillance-sharing agreements or through membership by the listing exchange and the relevant futures exchanges in the Intermarket Surveillance Group.
While the Start Printed Page 43915Commission in those orders did not explicitly undertake an analysis of whether the related futures markets were of “significant size,” the exchanges proposing commodity-futures ETPs on a single reference asset or benchmark generally made representations regarding the trading volume of the underlying futures markets,
and the Commission was in each of those cases dealing with a large futures market that had been trading for a number of years before an exchange proposed an ETP based on those futures.
And where the Commission has considered a proposed ETP based on futures that had only recently begun trading,
the Commission specifically addressed whether the futures on which the ETP was based—which were futures on an index of well-established commodity futures—were illiquid or susceptible to manipulation.
Accordingly, the Commission examines below whether the representations by the Exchange, and the comments received from the public, support a finding that the Exchange has entered into a surveillance-sharing agreement with a market of significant size relating to bitcoin, the asset underlying the proposed ETPs, or that alternative means of preventing fraud and manipulation would be sufficient to satisfy the requirement of Exchange Act Section 6(b)(5) that the proposed rule change be designed to prevent fraudulent and manipulative acts and practices.
2. Comments Received
One commenter states that the market for bitcoin derivatives other than bitcoin exchange-traded futures appears to be developing and that financial institutions are reportedly moving toward launching bitcoin-related trading desks and other operations. This commenter believes that the proposed offering of both long and short ETPs raises the possibility that market makers in bitcoin-related derivatives could make two-sided markets if interest in the long and short ETPs is similar in magnitude. The commenter further believes that interest outside of the bitcoin ETPs may be sufficient to motivate market makers to maintain Start Printed Page 43917bitcoin derivatives desks.
In addition, the commenter suggests that questions about bitcoin derivatives markets can be addressed through market depth analyses, discussions with potential bitcoin derivatives liquidity providers, and analyses of order and trade data across CME and CBOE to determine the plausibility of simultaneous liquidity collapses on both bitcoin future markets.
This commenter states that a commonly cited factor mitigating possible susceptibility to manipulation is the securities exchanges' own surveillance procedures, in addition to the futures exchanges' surveillance procedures and market surveillance and oversight by the Commodity Futures Trading Commission (“CFTC”). This commenter cites statements by the CFTC that it has the legal authority and means to police certain spot markets for fraud and manipulation through “heightened review” collaboration with exchanges, that exchanges will provide the CFTC surveillance team with trade settlement data upon request, and that the exchanges will enter into information-sharing agreements with spot market platforms and monitor trading activity on the spot markets. The commenter also states that the Gemini exchange has announced that it would use Nasdaq's market surveillance system to monitor its marketplace.
This commenter further asserts that market surveillance is generally a prerequisite to identifying potential market manipulation and discourages market manipulation. The commenter believes that the emergence of institutionalized market surveillance on both futures and spot markets is a positive sign for the long-term future of bitcoin markets.
The commenter suggests that the Commission, in coordination with the CFTC, self-regulatory organizations, bitcoin futures exchanges, and bitcoin spot market platforms, could gather market surveillance data to conduct an independent analysis of trade and settlement patterns and determine whether potentially manipulative trading practices occur on bitcoin spot and futures markets.
Unlike previous proposals for bitcoin-based ETPs,
the Exchange does not assert here that bitcoin prices or markets are inherently resistant to manipulation. Instead, the Exchange asserts that its existing surveillance procedures (including its ability to review activity by its members) and its ability to share surveillance information with U.S. futures exchanges are sufficient to meet the requirements of Exchange Act Section 6(b)(5).
One commenter also asserts that the exchange's own surveillance procedures, along with market surveillance and oversight by the CFTC, can mitigate manipulation.
While the Exchange would, pursuant to its listing rules, be able to obtain certain information regarding trading in the Shares and in the underlying bitcoin or any bitcoin derivative through registered market makers,
this trade information would be limited to the activities of market participants who trade on the Exchange. Furthermore, neither the Exchange's ability to surveil trading in the Shares nor its ability to share surveillance information with other securities exchanges trading the Shares would give the Exchange insight into the activity and identity of market participants who trade in bitcoin futures contracts or other bitcoin derivatives or who trade in the underlying bitcoin spot markets, where a substantial majority of trading, the Commission concluded in the Winklevoss Order, “occurs on unregulated venues overseas that are relatively new and that, generally, appear to trade only digital assets.” 
Thus, consistent with its determination in the Winklevoss Order,
and with the Commission's previous orders approving commodity-futures ETPs,
the Commission believes that the Exchange must demonstrate that it has in place a surveillance-sharing agreement with a regulated market of significant size related to bitcoin, because “[s]uch agreements provide a necessary deterrent to manipulation because they facilitate the availability of information needed to fully investigate a manipulation if it were to occur.” 
The Exchange represents that it is able to share surveillance information with CME and CBOE, which are bitcoin futures markets regulated by the CFTC, through membership in the Intermarket Surveillance Group.
Nonetheless, the Commission must disapprove the proposal, because there is no evidence in the record demonstrating that CME's and CBOE's bitcoin futures markets are markets of significant size.
The Order Instituting Proceedings sought comment on whether the CME and CBOE bitcoin futures markets are markets of significant size,
but the Exchange has not responded to any of the questions in the Order Instituting Proceedings, and the only analysis of the underlying futures markets the Exchange has provided in its proposed rule change are the generic statements that the market for bitcoin futures contracts “has limited trading history and operational experience” and that the liquidity of these markets will depend on the adoption of bitcoin and interest in the market for these futures.
Thus, there is no basis in the record on which the Commission can conclude that the bitcoin futures markets are markets of significant size. Publicly available data show that the median daily notional trading volume, from inception through August 10, 2018, has been 14,185 bitcoins on CME and 5,184 Start Printed Page 43918bitcoins on CBOE, and that the median daily notional value of open interest on CME and CBOE during the same period has been 10,145 bitcoins and 5,601 bitcoins, respectively.
But while these futures contract figures are readily available, meaningful analysis of the size of the CME or CBOE markets relative to the underlying bitcoin spot market is challenging, because reliable data about the spot market, including its overall size, are unavailable.
The Commission also notes that in recent testimony CFTC Chairman Giancarlo characterized the volume of the bitcoin futures markets as “quite small.” 
Additionally, the President and COO of CBOE recently acknowledged in a letter to the Commission staff that “the current bitcoin futures trading volumes on Cboe Futures Exchange and CME may not currently be sufficient to support ETPs seeking 100% long or short exposure to bitcoin.” 
These statements reinforce the Commission's conclusion that there is insufficient evidence to determine that the CME and CBOE bitcoin futures markets are markets of significant size.
Furthermore, according to the Notice, under normal market conditions, each Fund intends to obtain exposure to its target benchmark by investing in the Bitcoin Futures Contract as well as other Bitcoin Financial Instruments, which could be options on bitcoin or the Bitcoin Futures Contract and swaps on the Bitcoin Futures Contract.
The Funds' investments in Bitcoin Financial Instruments are used to produce economically “leveraged” or “inverse leveraged” investment results for the Funds.
The Notice does not establish any limit on the Funds' holdings of these other bitcoin-related derivatives; it provides no analysis of the size and liquidity of markets for those derivatives; 
and it does not discuss whether the Exchange has the ability to share surveillance information with the markets for these derivatives. Thus, as to what might be a substantial proportion of the Funds' portfolios, the Commission is unable to conclude that surveillance-sharing will be available, that the related markets are regulated, or that the related markets are of significant size.
While one commenter suggests that the market for bitcoin derivatives other than exchange-traded futures appears to be developing—and that the offering of long and short bitcoin ETPs “raises the possibility that market makers in Bitcoin derivatives could make two-sided markets if interest in both the long and short ETFs is similar in magnitude” 
—these speculative statements do not provide a basis for the Commission to conclude that the non-exchange-traded bitcoin derivatives market is now, or may eventually be, of significant size.
The Commission therefore concludes that Exchange has not demonstrated that it has entered into a surveillance-sharing agreement with a regulated market of significant size related to bitcoin, or that, given the current absence of such an agreement, the exchange's own surveillance procedures described above would, by themselves, be sufficient to satisfy the requirement of Exchange Act Section 6(b)(5) that an exchange's rules be designed to prevent fraudulent and manipulative acts and practices.
While CME and CBOE are regulated markets for bitcoin derivatives, there is no basis in the record for the Commission to conclude that these markets are of significant size. Additionally, because bitcoin futures have been trading on CME and CBOE only since December 2017, the Commission has no basis on which to predict how these markets may grow or develop over time, or whether or when they may reach significant size.
Although the Exchange has not demonstrated that a regulated bitcoin futures market of significant size currently exists, the Commission is not suggesting that the development of such a market would automatically require approval of a proposed rule change seeking to list and trade shares of an ETP holding bitcoins as an asset. The Commission would need to analyze the facts and circumstances of any particular proposal and examine whether any unique features of a bitcoin futures market would warrant further analysis before approval.
C. Protecting Investors and the Public Interest
1. Comments Received
One commenter asserts that approval of the proposed ETPs would provide greater security in the cryptocurrency market, such as greater liquidity, transparency, and safe custody of assets.
Another commenter asserts that promoting the adoption of bitcoin will allow “paradigms within the cryptocurrency ecosystem,” such as initial coin offerings, to “break up the stranglehold cartels have on accruing and owning capital, as the funding model becomes democratized.” 
One commenter suggests that the Commission could address some of its concerns about the proposed ETPs by working with self-regulatory organizations, and in particular FINRA, to create bitcoin and cryptocurrency-related asset suitability requirements. In addition, this commenter suggests that targeted disclosure requirements could make investors aware of volatility, discourage retail investors from investing more than a small portion of their portfolio in cryptocurrency-related assets, and present historical scenarios to retail investors to demonstrate how an instrument such as a particular bitcoin ETP would have performed over time. This commenter believes that suitability requirements are less prescriptive than an effective ban on a class of product and that they could balance the Commission's interest in protecting retail investors against its interest in allowing cryptocurrency-related asset markets to continue to develop in regulated markets where the Commission can observe their performance closely.
Start Printed Page 43919
The Exchange asserts that approval of the proposal would enhance competition among market participants, to the benefit of investors.
One commenter asserts that approval of the proposal will provide greater security, transparency, and liquidity, as well as safe custody, for investors in cryptocurrencies.
And one commenter suggests that the Commission should seek to protect investors through disclosure requirements or suitability standards, rather than disapproving a bitcoin-ETP proposal.
The Commission acknowledges that, compared to trading in unregulated bitcoin spot markets, trading a bitcoin-based ETP on a national securities exchange may provide some additional protection to investors, but the Commission must consider this potential benefit in the broader context of whether the proposal meets each of the applicable requirements of the Exchange Act. Pursuant to Section 19(b)(2) of the Exchange Act, the Commission must disapprove a proposed rule change filed by a national securities exchange if it does not find that the proposed rule change is consistent with the applicable requirements of the Exchange Act—including the requirement under Section 6(b)(5) that the rules of a national securities exchange be designed to prevent fraudulent and manipulative acts and practices.
Thus, even if a proposed rule change would provide certain benefits to investors and the markets, the proposed rule change may still fail to meet other requirements under the Exchange Act. For the reasons discussed above, the Exchange has not met its burden of demonstrating an adequate basis in the record for the Commission to find that the proposal is consistent with Exchange Act Section 6(b)(5), and, accordingly, the Commission must disapprove the proposal.
D. Other Comments
Comment letters also addressed the intrinsic value of bitcoin 
; the desire of individuals to invest in a bitcoin-based ETP 
; the ways in which approval of the proposal would increase investor confidence 
; the ways in which promoting the adoption of bitcoin and other cryptocurrencies would ease inter-generational tension and wealth inequality and foster the confidence of younger generations in the economic system 
; the Commission's process for granting Exchange Act exemptive relief in connection with ETP approval 
; and the potential impact of Commission approval of the proposed ETPs on the price of bitcoin.
Ultimately, however, additional discussion of these tangential topics is unnecessary, as they do not bear on the basis for the Commission's decision to disapprove the proposal.
E. Basis for Disapproval
The record before the Commission does not provide a basis for the Commission to conclude that the Exchange has met its burden under the Exchange Act and the Commission's Rules of Practice to demonstrate that its proposed rule change is consistent with Exchange Act Section 6(b)(5).
For the reasons set forth above, the Commission does not find, pursuant to Section 19(b)(2) of the Exchange Act, that the proposed rule change is consistent with the requirements of the Exchange Act and the rules and regulations thereunder applicable to a national securities exchange, and in particular, with Section 6(b)(5) of the Exchange Act.
It is therefore ordered, pursuant to Section 19(b)(2) of the Exchange Act, that proposed rule change SR-NYSEArca-2018-02 is disapproved.
For the Commission, by the Division of Trading and Markets, pursuant to delegated authority.
Brent J. Fields,
[FR Doc. 2018-18577 Filed 8-27-18; 8:45 am]
BILLING CODE 8011-01-P