Sydney Futures Exchange LTD v Australian Stock Exchange LTD

128 ALR 417
(1995) 56 FCR 236

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(Judgment by: Gummow J)

Between: SYDNEY FUTURES EXCHANGE LTD -
And: AUSTRALIAN STOCK EXCHANGE LTD and ANOTHER

Court:

Judges: Lockhart J

Gummow JLindgren J

Subject References:
Contract
Contracts
Corporations
Futures
Futures industry
Meaning of "commodity"
Option contracts
Securities
Whether a low exercise price option (LEPO) is a futures contract within s 72(1) of Law
Whether securities options are securities for purpose of s 92(1) of Law
Whether stock exchange precluded from trading in LEPOs
Whether underlying securities capable of delivery

Legislative References:
Corporations Law - s 9; ss 72(1); ss 92(1); s 1251

Case References:
Ainsworth v Criminal Justice Commission - (1992) 175 CLR 564; 106 ALR 11
Archibald Howie Pty Ltd v Commissioner of Stamp Duties (NSW) - (1948) 77 CLR 143
Borland's Trustee v Steel Brothers & Co Ltd - [1901] 1 Ch 279
Buckle v Josephs - (1983) 47 ALR 787
Carragreen Currencies Corp Pty Ltd v Corporate Affairs Commission of New South Wales - (1986) 7 NSWLR 705
Cochrane v Moore - (1890) 25 QBD 57
Cohns Industries Pty Ltd v DCT (Cth) - (1979) 24 ALR 658
Colonial Bank v Whinney - (1885) 30 Ch D 261
Colonial Bank v Whinney - (1886) 11 App Cas 426
Commissioner for Corporate Affairs v Shintoh Shohin Pty Ltd - (1987) Aust Sec Law Cases 76-134
Corin v Patton - (1990) 169 CLR 540; 92 ALR 1
Cuisenaire v Reed - [1963] VR 719
Dalton v AML Finance Corp Ltd (CA)(NSW) - 16 April 1982, unreported
E Bailey & Co Ltd v Balholm Securities Ltd - [1973] 2 Lloyd's Rep 404
Gamer's Motor Centre (Newcastle) Pty Ltd v Natwest Wholesale Australia Pty Ltd - (1987) 163 CLR 236
Inland Revenue Commissioners v Crossman - [1937] AC 26
Jenkins v NZI Securities Australia Ltd - (1994) 124 ALR 605
Laybutt v Amoco Australia Pty Ltd - (1974) 132 CLR 57; 4 ALR 482
Mackay v Wilson - (1947) 47 SR (NSW) 315
Marfani & Co Ltd v Midland Bank Ltd - [1968] 1 WLR 956
R v Gray; Ex parte Marsh - (1985) 157 CLR 351
Re Rose; Rose v Inland Revenue Commissioners - [1952] Ch 499
Ross, McConnel Kitchen & Co Pty Ltd v Lorbergs (SC)(NSW) - 31 March 1983, unreported
SCF Finance Co Ltd v Masri - [1986] 2 Lloyd's Rep 366
Shoreline Currencies (Aust) Pty Ltd v Corporate Affairs Commission - (1986) 11 NSWLR 22
Simonius Vischer & Co v Holt & Thompson - [1979] 2 NSWLR 322
Spiro v Glencrown Properties Ltd - [1991] Ch 537
Sydney Futures Exchange Ltd v Australian Stock Exchange Ltd - (1994) 126 ALR 209; 15 ACSR 206
University of New South Wales v Moorehouse - (1975) 133 CLR 1; 6 ALR 193
United Scientific Holdings Ltd v Burnley Borough Council - [1978] AC 904
Wilson, Smithett & Cope Ltd v Terruzzi - [1975] 1 Lloyd's Rep 642
YZ Finance Co Pty Ltd v Cummings - (1964) 109 CLR 395

Hearing date: 16, 20 December 1994
Judgment date: 3 March 1995

Sydney

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Judgment by:
Gummow J

Introduction

This appeal concerns the applicability of two regulatory schemes established by the Corporations Law (the Law) to the proposed conduct by the respondent, Australian Stock Exchange Ltd (ASX), of a market for a species of option contract to be known as a Low Exercise Price Option or "LEPO''.

Chapter 7 of the Law (ss 760-1119) is headed "Securities'' and Ch 8 (ss 1120-1273) is headed "The Futures Industry''. Chapter 1 (ss 1-111) contains a large number of definitions. Of particular importance for this case are definitions in ss 9, 72 and 92.

In essence, the dispute is whether the LEPO is to be classified as falling (the contention of ASX) within the regime for the regulation of securities exchanges established by Pt 7.2 of the Law, or as falling (the contention of the appellant, Sydney Futures Exchange Ltd (SFE)) within the regime established by Pt 8.2 for the control of futures markets. Neither side contends that the conduct by ASX of a market in LEPOs would fall within neither regulatory regime.

Each regulatory regime is enforced by penal provisions. These rely upon definitions in Ch 1 which have general application throughout the Law. As will appear, in many respects the definitions are ill suited to the use to which they must be put in order to resolve the issues which arise in the present case. Counsel pointed out in argument that the two regimes have distinct legislative antecedents, one beginning in federal law with the Securities Industry Act 1980 (Cth) and the other with the Futures Industry Act 1986 (Cth) (the 1986 Act). To some extent the difficulties of interpretation arise from the drawing of them together in the Law. The legislative history is analysed in detail by Lindgren J in his reasons for judgment.

Before turning to the terms of the legislation, it is useful to consider the characteristics which will be possessed by the LEPO. The legislation may then be considered with those characteristics in mind. The provisions which will govern LEPOs are found in amendments and proposed amendments to the business rules of the ASX (the Business Rules).

The LEPO

LEPOs usefully may be contrasted with conventional share options which are traded in Australia. Under a standard call option contract, the writer or grantor of the option agrees to sell to the taker or grantee of the option a certain number of shares of a particular type for a set price upon exercise of the option by the grantee. Thus, the grantee can call upon the grantor to sell. Such options have an "American'' style exercise, that is, they may be exercised at any time up until a certain date (the expiry date). The taker or grantee pays a premium for this right.

Another type of share option traded is what is known as a put option. Here the writer or grantor agrees to purchase shares for a given price upon exercise of the option by the grantee; the grantee may cause a purchase to be made by the grantor. The taker or grantee once again pays a premium for this agreement. In the case of a put option, the grantee can compel a purchase from him by the grantor, and in the case of a call option the grantee can compel a sale to him by the grantor.

Once the option contract has been formed, it is possible to trade the contract in the market. The market in these options has been established by the standardisation of the contract size (parcels of 1000 shares), the expiry date (which will be the same for all options in a particular series), and the exercise price. For a given type of underlying share, a limited range of exercise prices will be available in set intervals above and below the current trading price of the share.

The holder of an option contract may "close out'' the option by adopting the opposite position in the market. For example, a person who has granted a call option in respect of a given parcel of shares for $10 a share can obtain an option to buy an equivalent parcel of shares for $10 a share. That person is then removed from any further obligation or involvement in the market.

Options are exercisable "in the money'', "at the money'' or "out of the money''. An option is "in the money'' if there is some value for the holder in exercising it. Thus a call option will be in the money if the current market price of the underlying property is higher than the exercise price. The taker can exercise the option and then sell for a profit the shares acquired from the grantor of the option. An option is "at the money'' if the share price is the same as the exercise price. An option is "out of the money'' if a loss would result from the exercise of the option. In the latter case, one would expect the option to be left to expire unexercised and the holder of the option would lose whatever premium the holder had paid for the option.

There has been an options market in securities since 1976, and the rules governing trading are the Business Rules.

LEPOs will be a type of option with special characteristics. The exercise price, instead of being closely related to the current price of the shares, will be of nominal value only (1-10 cents). For example, the writer of a LEPO may agree, upon exercise of the LEPO, to sell a parcel of 1000 shares of a particular type for, say, one cent a share. LEPOs will have a "European'' manner of exercise, which means they are exercisable only on the last trading day before the expiry date. LEPOs are to be call options only. They will be written, taken and traded by and between brokers. Because of the very low exercise price, LEPOs will almost always expire "in the money''. Unless the share price falls below the nominal exercise price (ie somewhere between 1 and 10 cents) the LEPO will be of value and is therefore likely to be exercised.

As a further consequence of there being a low exercise price, the premium payable for the LEPO will bear a close relationship (and in practice should be slightly above) the current price of the share at the date of issue. The value of the LEPO will thereafter move in a manner very close to the movements in the underlying share price. Under the margining system adopted by the ASX, this premium payable for the LEPO will not immediately be paid over to the writer of the LEPO. Instead, the premium will be debited to the taker's account and credited to the writer's account. A risk margin will then be calculated for the position and paid by both taker and writer. The evidence includes an example in which the risk margin is calculated as 3% of the underlying value.

Thereafter, both the taker and writer are to be credited and debited with what is referred to as "mark to market''. On the first day, this will amount to a credit to the taker, and a debit to the writer, of the current market value of the LEPO. This will offset partially or totally the initial debit and credit in respect of the premium. Thereafter what will be debited and credited will be the daily movement in the price of the LEPO.

Upon sale or exercise of the LEPO, the "mark to market'' will work in the opposite manner to that on the first day. Practically speaking this will mean that the LEPO will be paid for by the taker at this point. Writers will not receive full value for their LEPOs until the expiry date (unless they close out their position earlier). The result is that the amount paid by the taker will only be the initial risk margin plus any downturns in the price of the LEPO; upturns will return a credit. LEPOs may be bought and sold and closed out in a similar way to other options.

These procedures are illustrated in the example provided in the evidence, a copy of which is the schedule to these reasons.

The Law provides authority for the maintenance by a company of an electronic share register: ss 209, 1306. The Business Rules will provide that the obligation to deliver the underlying securities shall not be settled by the delivery of a share certificate. This is important for the present case, given the terms of one of the basal definitions, "commodity'' in s 9. With an exception in respect of Pt 4.4, the term "commodity'' is defined as meaning:

(a)

any thing that is capable of delivery pursuant to an agreement for its delivery; or

(b)

without limiting the generality of paragraph (a), an instrument creating or evidencing a thing in action.

The primary judge (Sackville J) held that LEPOs were not contracts concerned with a commodity within the meaning of the definition. In his reasons for judgment, Lindgren J describes the CHESS and FAST systems under which securities are transferred electronically, without share certificates or transfers (CHESS), and by documentary transfer of uncertified shares (FAST). The decision of the primary judge is reported: Sydney Futures Exchange Ltd v Australian Stock Exchange Ltd (1994) 126 ALR 209; 15 ACSR 206. His Honour referred to the FAST and CHESS systems, and continued (126 ALR at 229):

The traditional form of settlement of a sale of shares involves the handing over of a transfer of shares, in registrable form, together with the share scrip. This is followed by registration of the transfer. Even if that traditional form of settlement can be regarded as "delivery'' of the shares, it is difficult to apply the same approach to shares underlying LEPOs, transferred through the FAST or CHESS systems. Not only is there no document which effects a transfer of the legal title when delivered or handed over, but there is no document at all handed over to the transferee. This is not simply because documents have been replaced by electronic messages. It is because a quite different process is utilised to effect settlement between brokers. Indeed, in the case of options, the writer and taker of the option are not regarded as principals to the transaction, the respective clearing house members accepting responsibilities as principals. In these circumstances, even if the traditional form of settlement of shares could be regarded as delivery for the purposes of para (a) of the definition of "commodity'', I do not think that the settlement of securities of the kind that can underlie LEPOs involves "delivery'' in a relevant sense. Such securities are therefore not capable of delivery within para (a).

Sackville J went on to hold (at ALR 229-30) that in a transaction effected under FAST system, there is no transfer between the brokers of shares corresponding precisely to a particular transaction and that the only document referable to the particular quantity of shares to be transferred is the security transfer form for validation by the broker of the transferor so as to result in an amendment to the register of the company. This, his Honour held, is simply a direction to the company to make entries in its register to record the transferee as the person legally entitled to the specified quantity of shares, the subject of the antecedent transaction; accordingly, it would not answer the description "of an instrument creating or evidencing a thing in action'' for the purposes of para (b) of the definition of "commodity''.

LEPOs may also be contrasted with futures contracts. A futures contract may be described as a contract to buy or sell a particular quantity of something at a particular date and a particular price. Currently, the procedure at the SFE is that futures contracts entered into between exchange members are novated, that is converted into, two contacts with the clearing house, ie the clearing house becomes the buyer to each seller, and the seller to each buyer. These contracts are freely traded on the exchange. Because the clearing house has become a party to each contract, it remains liable to perform the second contract even if the other party fails to perform the first contract.

The SFE currently has eight types of futures contracts listed, as well as options to buy or sell futures contracts at or before a set date. The futures contracts include individual Share Futures Contracts (ISFs), which are contracts involving parcels of 1000 shares. With the exception of the 90 day bank accepted bill futures contracts, all futures are currently cash settled (ie no commodities change hands). A 90 day bank accepted bill futures contract is an agreement to buy or sell a $500,000 90 day accepted bank bill at a specific future settlement date; the bill is deliverable.

The present dispute

Section 1123 of the Law (in Ch 8) states that a person must not establish or conduct "an unauthorised futures market''. Contravention of this prohibition is an offence which attracts the general penalty provisions of s 1311 of the Law. A "futures market'' is defined in s 9 as meaning "a market, exchange or other place at which, or a facility by means of which, futures contracts are regularly acquired or disposed of''. The term "futures contract'', to which it will be necessary to return in dealing with this appeal, has a lengthy meaning set out in s 72 of the Law. An "unauthorised futures market'' is given by s 9 the meaning of a futures market which is neither a futures market of a "futures exchange'' nor an exempt futures market.

The expression "futures exchange'' itself is defined in s 9 in such a fashion as to include a body corporate in relation to which there is in force an approval by the minister under s 1126. The appellant, SFE, is such a body corporate. Therefore its activities cannot contravene the prohibition of s 1123; it conducts an authorised futures market. The respondent, ASX, does not hold an approval under s 1126 as a futures exchange.

It is necessary to refer briefly to the basic provisions which establish the regulatory scheme for the conduct of securities exchanges. ASX is defined in s 9, as the "Exchange''. As a result of further definitions in s 9, ASX is a "securities exchange''. Section 767 (in Ch 7) of the Law forbids the establishment or conduct of "an unauthorised stock market''. This may be compared with s 1123, dealing with an unauthorised futures market. Section 767 is the first provision in Pt 7.2, headed "Securities Exchanges''. Section 1123 is the first provision in Pt 8.2, headed "Futures Exchanges, Clearing Houses and Futures Associations''. As with s 1123, contravention of s 767 is an offence wiih attracts the general penalty provisions of s 1311.

The phrase "an unauthorised stock market'' is so defined in s 9 as to mean a stock market that is not a stock market of a securities exchange. The phrase "stock market'' includes, with a qualification to which I will refer, a market, exchange or other place at which, or a facility by means of which, to put it broadly, offers to sell, purchase or exchange "securities'' are regularly made or accepted. The qualification in the definition of "stock market'' is that it is expressed as being "subject to section 97''. This states:

97. In determining whether a market, exchange, place or facility is a stock market, regard shall not be had to the making at that market, exchange or other place, or by means of that facility, as the case may be, of futures contracts.

In May 1994, ASX announced that it proposed to establish a market for a species of contract to be known as a Low Exercise Price Option or "LEPO''. SFE contends that the establishment of a market in LEPOs would involve the establishment and then the conduct by ASX of an unauthorised futures market within the meaning of s 1123. This would be because the LEPOs would be futures contacts within the meaning of s 72. It follows, says SFE, that ASX proposes to engage in conduct which would constitute a contravention of the Law.

The ASX's position is that the trading in LEPOs on the Exchange (i) would be within the scope of what is permitted it under Ch 7 of the Law as a securities exchange and (ii) would not contravene the requirement of Ch 8 (s 1126) for an approval to conduct a futures exchange.

Section 1324 of the Law provides that the court may, on the application of a "person whose interests have been, are or would be affected'' by the conduct complained of, grant an injunction restraining engagement in that conduct. On that footing, SFE instituted a proceeding in this court on 26 August 1994. It sought an injunction under s 1324, on a quia timet basis, to restrain ASX from establishing or conducting a market for the trading of LEPOs. Declaratory relief also was sought, pursuant to the general powers of the court under s 21 of the Federal Court of Australia Act 1976 (Cth).

The matter came on for trial early in October and judgment was delivered on 2 November 1994. Sackville J dismissed the application by SFE. On a cross-claim by ASX, his Honour noted that while this sought a declaration in relation to future events, no submission was made that if the case were otherwise made out by ASX it should not have the declaration. Accordingly, he made the declaration as sought. This was to the effect that a financial instrument to be designated by ASX as being a Low Exercise Price Option "is a security'' within the meaning of the definition in s 92(1) of the Law.

The practical effect of what was decided was two-fold. First, the primary judge held that LEPOs would not be futures contracts within the meaning of s 72 of the Law, so that ASX would not be conducting an unauthorised futures market for the purposes of Ch 8. This meant that ASX would not be trespassing upon the ground reserved under regulatory schemes established by the Law to bodies corporate (such as SFE) holding an approval under s 1126 to operate a futures exchange. Secondly, the significance of the declaration was that it indicated that in acting as it proposed, ASX would be operating within the domain permitted to it under Ch 7 of the Law as an approved stock exchange.

At this stage, it is appropriate to refer to the role in this litigation of the Australian Securities Commission (the ASC). Section 1330 provides that the ASC may intervene in any proceeding relating to a matter arising under the Law, and that when it does so the ASC shall be deemed to be a party to the proceeding. The ASC intervened at the trial and appeared on the appeal. One of the submissions made by the ASC was that "from a regulatory point of view'', Chapter 7 of the Law would provide "a level of investor protection'' in respect of LEPOs as appropriate and as adequate as that which might be provided by Ch 8.

In its submissions the ASC fixed upon the necessary connection between LEPOs and the electronic share transfer and registration systems. The ASC supported the proposition that uncertificated shares, those being the subject of LEPOs, would not answer the description of "commodity'' in s 9 of the Law, whilst certificated shares would, in particular, fall within para (b) of that definition.

The consequence, the ASC submitted, was that (i) the chain of definitions led to the conclusion that LEPOs would not be futures contracts within the meaning of s 72 and thus might be traded on the ASX without the requirement of an approval as a futures exchange under s 1126 of the Law, and (ii) LEPOs would be "option contracts'' and thus securities within s 92, with the result that the projected activities of the ASX would be those of an authorised stock market.

The ASC also made submissions as to the position with trading in options over certificated shares. It contended that (a) these were option contracts and so securities and (b) they "may also'' be traded on the SFE, being in respect of a "commodity'', and thus "eligible commodity agreements'' and so futures contracts within the meaning of s 72. What was not explained was whether, in respect of such activities, it would be an answer to a claim of contravention of s 767, forbidding the establishment or conduct of an unauthorised stock market, that the defendant held an approval under s 1126 as a futures exchange. Would an approval under s 1126 meet a claim of contravention of s 767? One answer would be the holding of the necessary authority under both of the regulatory regimes, but that may be a theoretical rather than a practical possibility. Another answer might be legislation to clarify the situation.

Thus, the ASC attached critical importance to the factual circumstance that LEPOs would operate in respect of one rather than the other system of share transfer and registration. The ASC also supported a degree of overlapping between the two regulatory regimes, but without an immediate answer to the difficulties this might cause.

Will LEPOs be securities?

The scheme of the legislation is that the range of possible contracts is to be divided into those that are securities, those that are futures contracts and those that are neither and not regulated. However, the manner of the division is not clearly specified.

As I have indicated, the term "futures contract'' is given a meaning spelled out in s 72. A concern to put futures contracts to one side is apparent in the definition of "securities'' in s 92(1). This, as it stands after amendment by Sch 1, Pt 1 of the Corporate Law Reform Act 1994 (Cth), states:

92(1) Subject to this section, "securities'' means:

(a)

debentures, stocks or bonds issued or proposed to be issued by a government; or

(b)

shares in, or debentures of, a body; or

(c)

prescribed interests; or

(d)

units of such shares or of prescribed interests; or

(e)

an option contract within the meaning of Chapter 7;

but does not include a futures contract or an excluded security.

...

[Emphasis supplied.]

The reference in the words of exclusion at the end of s 92(1) to "a futures contract'' is to the definition in s 72. This is because "futures contract'' is said (in s 9) to have "the meaning given by section 72''.

Section 92(2) states what is meant by "securities'' when used in relation to a body; again the list is followed by the phrase "but does not include a futures contract or an excluded security''.

Section 9 states:

... "option contract'' in Chapter 7, means:

(a)

a contract under which a party acquires from another party an option or right exercisable at or before a specified time, to buy from, or to sell to, that other party a number of specified securities, or of a specified class of securities, being securities of a kind referred to in paragraph 92(1)(a), (b), (c) or (d) at a price specified in, or to be determined in accordance with, the contract; or

(b)

a contract entered into on a stock market of a securities exchange or on an exempt stock market, being a contract under which a party to the contract acquires from another party to the contract an option or right, exercisable at or before a specified time:

(i)

to buy from, or to sell to, that other party an amount of a specified foreign currency, or a quantity of a specified commodity, at a price specified in, or to be determined in accordance with, the contract; or

(ii)

to be paid by that other party an amount of money to be determined by reference to the amount by which a specified number is greater or less than the number of a specified index, being the Australian Stock Exchanges All Ordinaries Price Index or a prescribed index, as at the time when the option or right is exercised.

[Emphasis supplied.]

The submission of ASX is that the LEPO will fall within para (a) of the above definition and so will answer the description "an option contract within the meaning of Chapter 7'' given in s 92(1)(e); therefore it will be a "security'', trading in which will be regulated by Ch 7 and thus within the domain of the ASX. The contrary submission of SFE is that whatever might otherwise be the case, effect must be given to the final provision of s 92(1). It then is said that the LEPO is a "futures contract'', with the meaning given by s 72, and therefore is taken outside the definition of "securities'' in s 92(1), even though it answers the description in s 92(1)(e), "an option contract within the meaning of Chapter 7''.

The dispute largely turns upon the effect of the drafting form adopted in s 92(1), whereby it is said that a term "means A, B, C, but does not include X''. The relationship in a statutory definition between "means'' and "includes'' is capable of much discussion with copious illustration from decided cases. To adapt what was said by Kitto J in YZ Finance Co Pty Ltd v Cummings (1964) 109 CLR 395 at 401-2, "means'' may have an exclusive force of its own, indicating that its object is the whole of its subject. That, in my view, is the case with s 92(1)(a)-(e). The term "includes'' may be used as a term of enlargement of what otherwise are the contents of the class which has been so identified: Cuisenaire v Reed [1963] VR 719 at 727-8 Cohns Industries Pty Ltd v DCT (Cth) (1979) 24 ALR 658 at 660; Buckle v Josephs (1983) 47 ALR 787 at 792-3, 795-6; R v Gray; Ex parte Marsh (1985) 157 CLR 351 at 364-5; 62 ALR 17.

Here, "includes'' is used in the negative rather than the positive sense. In my view, the phrase "but does not include ...'' is employed in respect of futures contracts to indicate that there is to be no enlargement of the class identified by paras (a)-(e). In that sense, it is used for more abundant caution and to underline the point that the Law is so designed that the regulation of those dealings which answer the description "futures contract'' are outside the province of Ch 7, and within Ch 8.

It may be that it is possible to conceive of facts which involve a dealing which falls within one or more of s 92(1)(a)-(e), and also within the definition in s 72 of futures contract. As I have indicated, the submissions of the ASC as to options over certificated shares appear to have that result. But in my view the dealing would not cease to bear the former character simply because it also bore the latter; both, not one, regulatory regime would apply according to the terms of each of them.

The phrase "but does not include ...'' also applies to "an excluded security''. This term is defined in s 9, to put it shortly, so as to refer to the special subject of interests in retirement village schemes. Dealings in interests therein might be thought to have been dealings in "prescribed interests'' within s 92(1)(c) and thus to be "securities''. But the definition of "prescribed interests'' in s 9, contemplates that interests in retirement village schemes may be exempted from Ch 7 by regulation. This has been done: Corporations Regulations reg 7.12.04. Here again, the phrase in s 92(1), "does not include'', operates for more abundant caution. This is to make it clear that paras (a)-(e) operate exhaustively in respect of the subject "securities''.

The construction I would give to the concluding words of s 92(1) in relation to futures contracts is supported by reference to other provisions which apparently are designed to avoid treatment of futures contracts as securities. These include s 93(7) and s 97 of the Law. I have set out the text of s 97 earlier in these reasons, when discussing the definition of "stock market''. Section 93 is concerned to define the phrase "securities business''; s 93(7) states that an act or acts done by the person that constitutes or together constitute a dealing by that person in a futures contract shall be disregarded in determining whether or not that person deals in securities or carries on a securities business, and in determining what constitutes the carrying on of such a business.

It is appropriate to refer also to para (b) of the definition of "option contract''. The definition has been set out above. It identifies certain contracts entered into on a stock market of a securities exchange, or on an exempt stock market. One integer in the definition of "futures contract'' in s 72 is "eligible exchange-traded option''. This is defined in s 9 in such a way that, save for the identification of the market as the futures market of a futures exchange, the content is virtually the same as that of para (b) of the definition of "option contract''. The point is that it is the identity of the market which brings about classification under Ch 7 (securities) or Ch 8 (futures).

In my view, LEPOs will fall within para (a) of the definition of "option contract'', which in turn will bring them within para (e) of the definition of "securities'' in s 92(1), and thus within the scheme of Ch 7. I accept the submission of ASX that they would not cease to have that character by reason of the concluding phrase of s 92(1).

Will LEPOs be futures contracts?

However, even if this submission were rejected, LEPOs would still have to fall within the definition of "futures contract'' in s 72, for SFE to succeed in its submission that what ASX proposes requires compliance with the regulatory regime of Ch 8. I turn to consider this branch of the case. Section 72 relevantly is as follows:

72(1) A futures contract is:

(a)

a Chapter 8 agreement that is, or has at any time been, an eligible commodity agreement or adjustment agreement;

(b)

a futures option; or

(c)

an eligible exchange-traded option;

...

Of these possible alternatives, only para (a) was relied upon by SFE. A "Chapter 8 agreement'', put simply, is almost any conceivable agreement. The term "Chapter 8 agreement'' is defined in s 9 to mean:

(a)

a relevant agreement;

(b)

a proposed relevant agreement; [or]

(c)

a relevant agreement as varied, or as proposed to be varied ...

[Emphasis supplied.]

The term "relevant agreement'' is defined by s 9 to mean:

an agreement, arrangement or understanding:

(a)

whether formal or informal or partly formal and partly informal;

(b)

whether written or oral or partly written and partly oral; and

(c)

whether or not having legal or equitable force and whether or not based on legal or equitable rights;

LEPOs clearly amount to such an agreement. The question then is whether a LEPO is an "eligible commodity agreement''. SFE did not rely upon the term "adjustment agreement''. An "eligible commodity agreement'' is defined to mean:

A commodity agreement (in this definition called the "relevant agreement''), where, at the time when the relevant agreement:

(a)

unless paragraph (b) applies - is entered into; or

(b)

if the relevant agreement is not a commodity agreement at the time when it is entered into - becomes a commodity agreement;

it appears likely, having regard to all relevant circumstances (other than the respective intentions of the person in the sold position, and the person in the bought position, under the relevant agreement), including, without limiting the generality of the foregoing:

(c)

the provisions of any agreement;

(d)

the rules and practices of any market; and

(e)

the manner in which the respective Chapter 8 obligations of persons in sold positions, and persons in bought positions, under agreements of the same kind as the first-mentioned agreement are generally discharged;

that:

(f)

the Chapter 8 obligation of the person in the sold position under the relevant agreement to make delivery in accordance with the relevant agreement will be discharged otherwise than by the person so making delivery;

(g)

the Chapter 8 obligation of the person in the bought position under the relevant agreement to accept delivery in accordance with the relevant agreement will be discharged otherwise than by the person so accepting delivery; or

(h)

the person in the sold position, or bought position, under the relevant agreement will assume an offsetting bought position, or offsetting sold position, as the case may be, under an agreement of the same kind as the relevant agreement.

In order for a contract to be a "eligible commodity agreement'', it is necessary that it be a "commodity agreement''. The term "commodity agreement'' is defined in s 9 to mean:

... a standardised agreement the effect of which is that:

(a)

a person is under a Chapter 8 obligation to make delivery ; or

(b)

a person is under a Chapter 8 obligation to accept delivery ;

at a particular future time of a particular quantity of a particular commodity for a particular price or for a price to be calculated in a particular manner , whether or not:

(c)

the subject matter of the agreement is in existence;

(d)

the agreement has any other effect; or

(e)

the agreement is capable of being varied or discharged before that future time.

[Emphasis supplied.]

There is no dispute that LEPOs amount to standardised agreements. The term "Chapter 8 obligation'' is defined in s 55 simply as an obligation whether or not enforceable at law or in equity. A Ch 8 obligation is to be distinguished from a Ch 8 agreement.

The definition of commodity

Much of the submissions on the appeal were concerned with whether shares were a "commodity'' for the purposes of the definition of "commodity agreement''. I have referred to the submissions of the ASC. The legislative basis for the electronic transfer and settlement systems was first provided by the amendments to the Law effected by Pt 5 (ss 126-173) of the Corporate Law Reform Act 1992 (Cth); this in turn is relevantly amended by Sch 2 to the Corporations Legislation Amendment Act 1994 (Cth). It would be a curious result if the operation of the regulatory scheme in Ch 8, built upon the term "commodity'', now depended upon the circumstance that uncertificated shares fell outside it and the certificated shares fell within it. Why should the mischief against which the regulatory scheme seeks to protect the public turn upon such a criterion?

I have set out the terms of the definition of "commodity'' earlier in these reasons. This gives the term a meaning "except in Part 4.4''. Part 4.4 (ss 399-408) is headed "Investment Companies'' and s 405 is headed "Investment Company Not to Speculate in Commodities''. However, s 109D(3) of the Law states that each heading to a section is taken not to be part of the Law. This is curious because the term "commodities'' does not otherwise seem to appear in Pt 4.4. Section 405 imposes a prohibition upon an investment company, for the purpose of profit, buying, selling or dealing in any raw materials or manufactured goods, whether in existence or not'', otherwise than by investment in companies trading in such materials or goods.

In this awkward fashion, there is perhaps some support given to the proposition that outside Pt 4.4, "commodity'' may mean more than raw materials, manufactured goods, or the like which are capable of delivery.

Nevertheless, it would be an odd use of language to describe a share or other item of incorporeal property such as a share, or a copyright, as "capable of delivery''. It is a hallmark of a chose in possession, as distinguished from a chose in action, that title may be transferred by delivery, in the technical sense of that term: Cochrane v Moore (1890) 25 QBD 57 at 72-3; Gamer's Motor Centre (Newcastle) Pty Ltd v Natwest Wholesale Australia Pty Ltd (1987) 163 CLR 236 at 244-7, 255, 260-3, 273-4; 72 ALR 321. Hence, in my view, the operation of para (b) of the definition to bring in as a commodity "an instrument creating or evidencing a thing in action''. A bearer debenture, bill of lading or negotiable instrument may be fairly said to be an instrument which "creates'' a thing in action. Thus, damages for conversion of a cheque are given on the basis that the chattel, being the paper on which the cheque is written, was goods converted by the wrongdoer, but with a value given it by the law of negotiable instruments: Marfani & Co Ltd v Midland Bank Ltd [1968] 1 WLR 956 at 970-1, per Diplock LJ.

A share certificate issued in accordance with s 1087(1) of the Law is prima facie evidence of the title of the member to the shares in question: s 1087(2). The "title'' referred to in this provision is the legal title. The beneficial title may be elsewhere. The shares may be assets of a settlement. Again, if a donor has executed and delivered a transfer and share certificate to the donee with the intention of transferring title to the shares and has placed the donee in a position to secure the legal title by registration, subject to the exercise by the directors of any discretion to register, the donor cannot recall the gift or invoke the aid of the court to prevent registration; this is because the donor has parted with the beneficial interest and has become a constructive trustee for the donee: Re Rose; Rose v Inland Revenue Commissioners [1952] Ch 499; Corin v Patton (1990) 169 CLR 540 at 559-60; 92 ALR 1. In such cases, by itself the share certificate neither creates nor evidences the thing in action constituted by the beneficial interest in the shares.

The above matters suggest the apparent force in the submissions for the ASC that the definition of "commodity'' can have no application to uncertificated share dealings, the incorporeal property being incapable of delivery within para (a) and there being no instrument creating or evidencing it.

"Commodity agreement''

However, in my view, that is not the end of the matter. The definition of "commodity'' is relevant to the present case because it is a component in the further definition "commodity agreement''. It may be conceded that a share certificate evidences a thing in action, being the subject shares. However, the result is that it is that instrument which is a "commodity''. It is important to note that para (b) of the definition treats as the commodity not the thing in action but the instrument which creates or evidences it.

A "commodity agreement'' is so defined as to fix upon an agreement to make or accept delivery "at a particular future time of a particular quantity of a particular commodity for a particular price ...''. The price is to be paid for the particular commodity in a particular quantity of that commodity. In my opinion, that would not be so where the price is being paid for a particular number of shares albeit title thereto is evidenced by the share certificate delivery of which will take place on settlement.

In the result, the position is that (i) uncertificated share transactions could not fall within the definition of "commodity'' and for that sufficient reason the definition of "commodity agreement'' could not apply, and (ii) whilst a certificated share transaction might involve a commodity, the share certificate evidencing a thing in action, the definition of "commodity agreement'' would not apply because the subject of that transaction is something different, namely the underlying incorporeal property, the shares, which are not a "commodity''.

Further, in any event, in respect of LEPOs there is no relevant obligation to attract the definition of "commodity agreement''. The obligation referred to therein is of a specific nature, to make or accept delivery at a particular future time of a particular quantity of a particular commodity "for a particular price . . .''.

Is there an obligation to make delivery upon exercise of the call option being a LEPO? Counsel for the ASX submits that a LEPO is an option and thus any obligation in the specific terms spelled out in the definition of "commodity agreement'' is conditional upon payment of the exercise price.

We were referred to authorities (particularly Laybutt v Amoco Australia Pty Ltd (1974) 132 CLR 57 at 71-2; 4 ALR 482 per Gibbs J) dealing with the question whether an option is in truth a conditional contract to sell or a contract to keep an offer open. The House of Lords has since given support to the latter characterisation, in United Scientific Holdings Ltd v Burnley Borough Council [1978] AC 904. However, in Spiro v Glencrown Properties Ltd [1991] Ch 537, Hoffmann J exposed a further dimension of the dispute. (The references to the considerable academic discussion the case has provoked are collected in the Note, All ER Rev 1991 at 200.) After discussing various authorities, his Lordship stressed the importance of the context, particularly the statutory context, in which the question of characterisation arises. He said (at 544):

The purchaser's argument requires me to say that "irrevocable offer'' and "conditional contract'' are mutually inconsistent concepts and that I must range myself under one or other banner and declare the other to be heretical. I hope that I have demonstrated this to be a misconception about the nature of legal reasoning. An option is not strictly speaking either an offer or a conditional contact. It does not have all the incidents of the standard form of either of these concepts. To that extent it is a relationship sui generis. But there are ways in which it resembles each of them. Each analogy is in the proper context a valid way of characterising the situation created by an option. The question in this case is not whether one analogy is true and the other false, but which is appropriate to be used in the construction of s 2 of the Law of Property (Miscellaneous Provisions) Act 1989.

In the present case, the type of obligation required is specified in the statutory definition. It is not present in the case of a LEPO.

Indeed, the true nature of the obligation is to be found in the Business Rules of the ASX. Rule 7.1.3(3), which applies to LEPOs, is headed "General Rights and Obligations of Takers and Writers'', and is as follows:

Subject to the provisions of the Rules of Options Clearing House the Taker of an Option has the right, beginning at the time such Option is registered and expiring in accordance with the Articles of Association and Rules of the Exchange and the Rules of Options Clearing House, in the case of a Call Option to purchase from the Writer ( or from such substituted person as the Exchange may from time to time appoint to perform the Option ), and in the case of a Put Option to require the Writer to purchase from him at the Exercise Price the Standard Quantity of the Underlying Securities represented by such option, all in accordance with the Articles of Association and Rules of the Exchange and the Rules of Options Clearing House. The Writer of an Option has the obligation upon the allocation to him of an Exercise Notice in respect of such Option, in the case of a Call Option to sell and deliver the Standard Quantity of the Underlying Securities represented by such Option to such person as the Exchange may from time to time appoint against payment of the Exercise Price , and in the case of a Put Option to purchase the Standard Quantity of the Underlying Securities represented by such Option from such person, all in accordance with the Articles of Association and Rules of the Exchange and the Rules of Options Clearing House. [Emphasis supplied.]

It is apparent that it is impossible to say that the writer of the LEPO has, at the moment of writing, an obligation to make delivery at a particular future time of a particular quantity of a particular commodity. Such an obligation may arise, but only after payment of the exercise price and receipt of the exercise notice. Nor, in my view, is there a proposed agreement to that effect. The option agreement is made, not proposed. The point is that the agreement does not contain such an obligation.

The definition of "eligible commodity agreement'' does, in para (b) of the definition, accommodate the situation where an agreement becomes a commodity agreement at some later stage. However, a LEPO does not become a commodity agreement upon exercise. The definition of "commodity agreement'' requires that there be an obligation to make or accept delivery "at a particular future time''. Upon exercise of a LEPO, the relevant obligation is immediate, not future.

The reference in r 7.1.3(3), which I have set out above, to such persons as the ASX may from time to time appoint to perform the option, and the Rules of Options Clearing House are references to r 7.3 which, inter alia, provides (r 7.3.12) as follows:

"Set off''

(a)

If a Clearing Member is registered as both Writer and Taker in respect of the same number of Options in an Option Series and such Clearing Member requests in the manner determined by Options Clearing House a set off in respect thereof:

(i)

he shall thereupon be deemed to have ceased to be a party to such Options;

(ii)

the registration thereof by Options Clearing House shall thereupon be deemed to have ceased; and

(iii)

the other Clearing Members in whose names such Options are registered shall thereupon be deemed to have contracted with each other (subject to these Rules) and in pursuance of Rule 7.3.1 shall accept by way of novation such other party as Options Clearing House may appoint.

Paragraph (e) of the definition of "commodity agreement'' provides that the effect of the standardised agreement must be that a person is under a Ch 8 obligation to make or accept delivery at a particular future time. This requirement must be satisfied despite (or in terms of para (e) of the definition "whether or not'') the agreement being capable of discharge before that time. It may be that the effect of a closing out under the "Set-Off'' provision of r 7.3.12(a) is to bring about what might be called a discharge by novation. Even if this be so, the definition still requires the agreement to satisfy the requirement described above. For the reasons I have given, in my view this is not the case.

The definition of "commodity agreement'' fixes upon agreements "the effect'' of which is that a person is under a Ch 8 obligation either to make delivery or to accept delivery. With respect to the obligation to accept delivery, the only obligation pointed to by SFE is one stemming from economic imperative. The argument is that LEPOs always expire "in the money'' so that it would be foolish not to exercise them. A Ch 8 obligation need not be enforceable at law or in equity: s 55.

Counsel for the ASX submits, in my view correctly, that although the concept of "obligation'' is broad and one is looking to "the effect'' of the commodity agreement, it is difficult to see how self-interest may amount to an obligation; this particularly is so where what would be involved in the legislative scheme, as in the present case, would be the imposition of serious legal consequences upon factual likelihoods. It is, after all, possible that a share price could fall below the exercise price prior to exercise, an event which would remove the alleged obligation.

With respect, I agree with the conclusion expressed as follows by the primary judge (126 ALR at 231):

The effect of the agreement is to be judged by its terms. The terms give the taker of the option the legal entitlement to choose whether or not to exercise the option. The terms no doubt create a state of affairs in which the taker has a powerful, ordinarily irresistible motive to exercise the option. But that motive does not in my view involve any duty or commitment to the writer of the option such as would make the word "obligation'' appropriate to describe the taker's position. Indeed, as was pointed out in argument, the writer of the option ordinarily would be delighted if the option were not exercised. If this happy state of affairs were to eventuate he or she would retain the premium and the shares.

Carragreen

Some of the above conclusions conflict with holdings in Carragreen Currencies Corp Pty Ltd v Corporate Affairs Commission of New South Wales (1986) 7 NSWLR 705. One issue in that case was whether an option contract in respect of foreign currency answered the definition of "commodity agreement'' which appeared in the Futures Industry (NSW) Code; this statute adopted with certain modifications the 1986 Act. Save that the definition spoke to "an obligation'' rather than "a Chapter 8 obligation'', it was in the same terms as the definition in the Law.

Hodgson J concluded (at 716):

On the whole, I think the view is that the contract in this case does have the effect that the plaintiff is under an obligation to make delivery of a particular quantity of a particular commodity for a particular price. The circumstance that such obligation is conditioned upon the exercise of an option and also payment in full of the selling price does not prevent it from being an obligation, in the sense in which that word is used in the definition of commodity agreement.

In the present case, the primary judge construed rather differently the reasoning in Carragreen . His Honour (126 ALR at 222-3) said:

Hodgson J held that obligations must include conditional obligations. It was true that an option was not necessarily to be regarded as a conditional contract (cf Laybutt v Amoco Australia Pty Ltd (1974) 132 CLR 57 at 71-6; 4 ALR 482, per Gibbs J), but might be characterised as an irrevocable offer. But the definition of agreement for the purposes of the Futures Industry (NSW) Code included a "proposed agreement''. In his Honour's view, an option granted to enter an agreement amounted at least to a proposed agreement. Thus the fact that the obligation was conditional on the exercise of the option and the payment of the price did not prevent it being an "obligation'' . [Emphasis supplied.]

In my view, this reasoning, being inconsistent with the conclusions I have expressed above, should not govern the result in the present case.

Counsel for the ASC submitted that a difficulty in not following Carragreen is that there would be left unregulated off-market trading in commodity options. Not being securities options, they do not fall within para (a) of the definition of "option contracts''. Not being traded on any exchange they do not come within para (b) of the definition of option contracts, or within the definition of "eligible exchange-traded options''.

The term "futures option'' means (s 9):

... an option or Chapter 8 right to assume, at a specified price or value and within a specified period, a bought position, or a sold position, in relation to an eligible commodity agreement or in relation to an adjustment agreement.

In Carragreen (at 718-19) Hodgson J held that the subject contract was not an adjustment agreement and, as I understand it, it was not sought in the present case to depart from that holding. Nor, in my view, is there a "futures option'' on the footing that there is an option or Ch 8 right to assume "at a specified price or value and within a specified period'' a bought position or a sold position in relation to an eligible commodity agreement. One of the requirements in the definition of "commodity agreement'' is an obligation to make or accept delivery "at a particular future time''. In the case of a LEPO, once the option is exercised, as I have indicated, the obligation will be immediate.

Counsel for the SFE submitted that, in any event, the consequence to which the ASC pointed was one within the contemplation of the legislature. He pointed to the explanatory memorandum circulated by the Attorney-General to the House of Representatives upon the bill for what became the 1986 Act. Paragraph 10 thereof, under the heading "Overlap with [Securities Industry Act]'' states:

10. In order to provide an appropriate framework for the various "products'' traded on futures and securities exchanges, it is proposed that the following regime will apply:

(a)

The Futures Industry Bill will:

(i)

apply to futures contracts, options over futures contracts, and to commodity options traded on a futures exchange (it should be noted that, at this stage, the Futures Industry Bill will not apply to deliverable commodity options not traded on a futures exchange);

(ii)

adopt appropriate [Securities Industry Act] provisions (eg prohibition on insider trading) to cover futures contracts where the underlying instrument is a security.

(b)

There will be no regulation of physical commodity sales or of sale of commodity options not traded on a stock or futures exchange.

(c)

The [Securities Industry Act] will apply to:

(i)

securities and commodity options traded on a stock exchange (but not options over futures);

(ii)

the marketing of discretionary accounts or of a right to participate in a commodity pool.

Note: A dealing in a futures contract will not be a dealing in securities for the purposes of the [Securities Industry Act] (see cl 12 of the Companies and Securities Legislation Amendment (Futures Industry) Bill 1986).

(d)

The [Companies Act 1981] will apply to the offering of a right to participate in a commodity pool.

Section 1251

There remains reliance placed by SFE upon s 1251 of the Law. Reference to this provision was not made in the submissions below. It will be recalled that the primary judge held that uncertificated shares are not within the definition of "commodity'', and that for that reason could not be the subject to a commodity agreement. I have expressed agreement with that view. Reliance is placed upon s 1251 because it is said to recognise that the subject matter of a commodity agreement may be "securities'' of a body corporate.

As I have indicated, Chapter 8 of the Law is headed "The Futures Industry''. Part 8.7 is headed "Offences'' and Div 1 (ss 1251-1257) is headed "Insider Dealing''. Section 1253 creates an offence whereby a person is precluded on a particular day from dealing in "a futures contract concerning a body corporate'' if, to put it shortly, the person has inside information in relation to that futures contract. Section 1255 confers an exemption from that preclusion in favour of a person holding a futures brokers licence, if certain conditions are met. The purpose of s 1251 is to explain when, for the purposes of Div 1, a "futures contract concerns a body corporate''. This is said to be so only if the futures contract "is a commodity agreement'' and the commodity to which it relates is "securities of the body''. The insider dealing provisions, as they apply to futures contracts, are concerned only with futures contracts which are, within the definition, commodity agreements or (and nothing turns upon this) adjustment agreements.

Division 1 of Pt 8.7 may be compared with Div 2A of Pt 7.11 (ss 994-1015). Division 2A (ss 1002-1002U) is headed "Insider Trading''. It contains in s 1002A(1) a definition of "securities'' which differs from that in s 92. There is no special definition of "securities'' for the purposes of Pt 8.7. However, the form taken by s 1251 makes this unnecessary. It states:

1251. For the purposes of this Division, a futures contract concerns a body corporate if, and only if:

(a)

the futures contract is a commodity agreement and a commodity to which it relates is securities of the body; or

(b)

the futures contract is an adjustment agreement and the state of affairs to which it relates concerns the price of securities of the body, or the prices of a class of securities that includes securities of the body, at a particular time.

It will be observed that s 1251 is concerned with the expression "securities'' used in relation to a body corporate, the phrase being "securities of the body''. Hence the applicable definition is not that in s 92(1). The matter is directly dealt with in s 92(2). This states:

92(2) The expression "securities'', when used in relation to a body, means:

(a)

shares in the body;

(b)

debentures of the body;

(c)

prescribed interests made available by the body; or

(d)

units of such shares or prescribed interests;

but does not include a futures contract or an excluded security.

The definition is narrower than that in s 92(1) and, in particular, there is no equivalent of para (e), "an option contract within the meaning of Chapter 7''.

Section 1251 operates only for the purposes of Div 1 of Pt 8.7. Its effect is to render a futures contract one which concerns a body corporate, if the futures contract (a) is a commodity agreement and (b) that agreement relates to a commodity being securities of that body corporate within the definition in s 92(2). The effect is to expand what otherwise might have been the limitations in the definition of "commodity'' by bringing within it, for this special purpose, the definition in s 92(2). It is true that that definition, like s 92(1), ends with the phrase "but does not include a futures contract ...'', but the effect of this, in the present operation of the legislation, is to avoid any suggestion of circularity whereby a futures contract was identified in s 1251 in terms of itself.

It follows, in my view, that s 1251 is of no assistance in construing the provisions of Ch 8 outside Div 1 of Pt 8.7.

That there is a special regime which operates within Div 1 of Pt 8.7 in the way described, is not surprising. The subject of the Division is insider trading and typically that may be thought to occur in relation to shares.

The declaration

The only remaining issue concerns the declaration which was made in favour of ASX on its cross-claim. The declaration was as follows:

The court declares that a financial instrument to be known as and designated by the [ASX] as a Low Exercise Price Option, being an instrument to be regulated in accordance with the Business Rules of the [ASX] in the form of the document referred to as DJW5 in the affidavit of David John White sworn 10 October 1994, is a security within the meaning of s 92(1) of the Corporations Law.

Counsel for SFE submits that the declaration is hypothetical. There is force in that submission. The declaration concerns a legislative definition, not the operation of a particular section, which incorporates the definition, upon specified circumstances. As counsel submits, it is not possible to identify any particular factual premises upon which the declaration is dependent. The content of the Business Rules may change. Not all the then proposed amendments in respect of LEPOs had come into effect when ASX filed its cross-claim. The Business Rules might be expected to change again from time to time.

The court should be careful in avoiding the inapt use of the judicial power of the Commonwealth in making hypothetical declarations: see, particularly, the authorities referred to in Ainsworth v Criminal Justice Commission (1992) 175 CLR 564 at 581-2; 106 ALR 11, and Jenkins v NZI Securities Australia Ltd (1994) 124 ALR 605 at 616-18.

ASX should be able sufficiently to gauge where it stands from study of the reasons for judgment on the appeal.

I would set aside the declaration made 2 November 1994, and dismiss the cross-claim by ASX but otherwise dismiss the appeal. The costs should be paid by SFE.

THE SCHEDULE

An investor takes a BHO LEPO.

*In this example risk margin is calculated as 3% of underlying value.

On day 1, the investor takes a BHP LEPO contract with a premium value of $16,000 and in addition pays a risk margin of $465. Since the market closed at $16.50 he is credited with a mark to market of $16,500 but the net daily settlement is only $35cr.

On day 2, the market weakens resulting in a mark to market debit of $1000. However, as the physical market has also weakened the risk margin required is now only $35, therefore he is credited with $30.

On day 3, the market strengthens and the investor decides to realise the profit from his position. This is done by selling (writing) a BHP LEPO. The sold premium is posted in full, previous mark to market postings are reversed and the risk margin of $435 is returned.

A profit of $250 is made on this LEPO transaction (excluding costs) ie the investor has bought st $16 and sold at $16.25.