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Sydney Futures Exchange LTD v. Australian Stock Exchange LTD

128 ALR 417
(1995) 56 FCR 236

(Judgment by: Lockhart J)


Federal Court of Australia

Lockhart J

Gummow J

Lindgren J

Subject references:
Futures industry
Meaning of "commodity"
Option contracts
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


Judgment by:
Lockhart J


This appeal concerns a product called Low Exercise Price Option which, like almost everything else in the case, has an acronym, in this instance, LEPO. Jordan CJ's description of an option as "nearly always a ticklish thing'' ( Mackay v Wilson (1947) 47 SR (NSW) 315 at 318) is apt in the present case.

On 17 July 1994 Australian Stock Exchange Ltd (ASX) announced its intention to list LEPOs for trading on the Australian Options Market. Sydney Futures Exchange Ltd (SFE) seeks to prevent this. LEPOs have not yet been listed for trading by ASX. SFE is approved as a futures exchange under s 1126 of the Corporations Law, but ASX is not so approved.

SFE contends that LEPOs are futures contracts within the meaning of s 72(1) of the Corporations Law and that a market for the regular acquisition and disposal of LEPOs would be a "futures market'' within the meaning of the definition in s 9 of the Corporations Law. It is further contended by SFE that, assuming LEPOs are futures contracts, they are therefore excluded from the definition of "securities'' in s 92(1) and are subject to regulation under Ch 8 of the Corporations Law relating to the futures industry.

ASX contends that LEPOs are securities within the meaning of s 92(1) of the Corporations Law and regulated under Ch 7 relating to the securities industry.

The difference between the two regimes is important, primarily because it determines the exchange (stock exchange or futures exchange) upon which the product can be traded.

SFE claims declaratory and injunctive relief. ASX seeks a declaration in its cross-claim that LEPOs are securities within the meaning of s 92(1) of the Corporations Law.

Australian Securities Commission (ASC) intervened in the proceeding both at first instance and on appeal pursuant to s 1330 of the Corporations Law and made submissions on questions of law. It is therefore a party: s 1330(2).

The resolution of the controversy involves important questions of construction of the Corporations Law. Once these questions are resolved it is necessary to apply the relevant sections to the facts of the case, which requires a clear understanding of LEPOs, the proposed operation of the market for LEPOs, the options market and the futures market in Australia.

It is convenient to explain these markets and the characteristics of LEPOs.

The options market

Trading in options is controlled by the Australian Options Market (AOM). AOM is a wholly owned subsidiary of ASX. Options are bought and sold on the trading floor in Sydney which is administered by Options Clearing House (OCH). OCH serves as the clearing house for all option transactions. The responsibilities of OCH include registering all option contracts traded on AOM, calling of margins and deposits, and maintaining a depository for the lodgment of scrip and bank guarantees against sold call option positions in the market.

Trading on AOM is governed by the business rules of ASX. Clients are asked to sign a client agreement form in which they agree to abide by the rules. A client agreement form is available from clearing members of AOM. The rules of ASX require that a client must have an account approved by a clearing member before being permitted to buy or sell options. A clearing member is a member organisation of an exchange which has been admitted as a clearing member in accordance with Australian Stock Exchange Ltd Stock Option Trading Rules. The client's broker is required to obtain information concerning the client's investment objectives and financial situation, so that his suitability for trading in options can be assessed.

Investors themselves are not parties to option contracts. ASX member organisations that have been approved as clearing members under the ASX business rules enter into option contracts on behalf of their clients and take on responsibilities as principals both to the clearing member on the other side of the contract and OCH. To cover these obligations writers of options are normally required to lodge security through their clearing member with OCH.

Clients dealing in options place orders with their clearing member in the options market and are asked to specify whether or not the order is for an opening or closing transaction. The person selling a call option contract (known as the writer because he underwrites the obligation to deliver the underlying shares) gives to the buyer (or taker) of the call option the right to buy the underlying shares. The writer of a put option contract gives the taker the right to sell the underlying shares (the writer underwriting the obligation to accept the underlying shares). For these respective rights, the taker pays a premium.

The option contracts, in turn, are traded. The tradeability of options is achieved by the standardisation of the contract size, the expiry date and the exercise price. Rights and obligations of the contract are easily transferred from one party to another. If a trader buys (takes) an option as an opening transaction he may cancel his right to exercise by selling (writing) an identical option. This process is referred to as "closing out''. Similarly if a trader sells (writes) an option as an opening transaction he may cancel his obligations by buying (taking) an identical option. The premium or quoted price of an option is the only variable. In order to liquidate a position, it is essential that the client places the order with the clearing member through whom the opening transaction was made.

The taker of an option has the right to exercise until 5 pm Sydney time, on the last day of trading in that series. Exercising an option is achieved by the client notifying the clearing member that he wishes to do so. The clearing member informs OCH that the option is to be exercised and OCH selects at random a writer in the same series. In the case of a call option the writer must deliver shares covered by the exercised option to the taker by the fifth business day following the day on which the option was exercised.

Documentation relating to the registration of options traded on AOM is prepared by ASX. Whenever a trade is completed, the clearing member provides the client with a contract note detailing the transaction and its costs. An option is registered with OCH on the day on which it is traded and may be exercised on that same day. The taker of an option must pay the premium in full within 48 hours of the date of the transaction. Writers of options may be liable for margin payments from the date of registration onwards.

Option contracts have four components: contract size, expiry date, exercise price and premium. Contract size is standardised at present to 1000 shares of the underlying stock. The date on which all unexercised options in a particular series expires is known as the expiry date. A range of different expiry cycles is used on the AOM. Some options trade on a quarterly cycle which could be either January/February/July/October, February/May/August/November or March/June/September/December. In addition a current or "spot'' month is available for some stocks. There are longer term options listed over certain stocks with terms of up to three years. The expiry date for all stock options is the last Friday of the expiry month, provided that day is a business day. Trading in each series of stock options ceases at the close of trading on the last business day (usually a Thursday) prior to the expiry date. If either the Thursday or Friday is not a business day, the expiry date and last day for trading are brought forward. Options must be exercised by 5 pm on the last trading day, but can be exercised at any time from purchase until the date of expiry.

The exercise price of an option is the stipulated buying or selling price for the underlying shares, should the option be exercised. It is the range of exercise prices which provides investors with choices. The premium is the price of the option that is arrived at by negotiation between the taker and the writer and is the only variable. Option premiums are quoted on a per share basis. To obtain the full price for standard size options, a trader must multiply the quoted price by 1000. For example, a quoted premium of 16c represents the full premium cost of $160 (0.16 X 1000).

The taker pays the premium to the writer, to obtain the right to exercise. The option writer keeps this premium whether the option is exercised by the taker or not. In this way the taker's maximum risk in the market is the amount of premium, should he decide to allow the option to lapse. On the other hand the writer's potential maximum income will be the premium amount. Option premiums reflect either or both of intrinsic value and time value. Accordingly, the premium will change during the life of the option as the price of the underlying shares moves (affecting intrinsic value) or as the factors affecting time value change. Intrinsic value is the difference between the exercise price of the option and the market price of the underlying shares. Options with intrinsic value are said to be "in-the-money''. This is because if the taker of the option exercises his right and immediately liquidates the resulting securities position, a profit would arise (disregarding the premium). When the exercise price of a call option is lower than the current share price, the taker of the call has the right to buy shares lower than the market price. When the exercise price of a put option is higher than the current share price, the taker of a put option has the right to sell shares higher than the market price. These options have intrinsic value and are referred to as "in-the-money''.

For options without intrinsic value the premium reflects only time value. These options are said to be "out-of-the-money'' (or "at-the-money'' if the current share price is equivalent to the exercise price).

Time value represents what investors are prepared to pay for the potential for profit in the future, should the market move in their favour. It reflects their views on a range of factors and is greatest for at the money options (where the exercise price equals the current share price).

All other things being equal, the more time until expiry the greater the chance the option will become profitable through a favourable movement in the share price. Therefore time value will be greater and the option premium will be greater. As time draws closer to expiry and the opportunities for the option to become profitable decline, time value declines. Time to pay is reflected in declining option premiums. Time value does not remain at a constant level, but becomes more rapid towards expiry.

Factors that affect time value are time to expiry (the greater the time to expiry, the higher the time value of the option) and volatility (in general the more volatile the market the higher will be the premium because theoretically the seller is exposed to potentially greater loss). Sellers are compensated for this added risk by receiving higher premium income.

Interest rates have a small effect on premiums. Payment of dividends tends to lower call option premiums and raise put option premiums because shares fall in price once they are no longer eligible for a dividend. Holders of option contracts who do not own the underlying securities do not receive dividends. The securities represented by options traded on the AOM are referred to as underlying securities or underlying shares. These securities must be listed on ASX and are subject to its listing requirements. Various criteria must be met by securities before they are selected as underlying securities to a listed option: the company must comply with the reporting requirements of the ASX; the underlying security must be represented by a substantial number of outstanding shares which are widely held and actively traded ie liquidity and large base of ownership of shares.

For an investor anticipating a significant move in a particular share price, the purchase of an option offers the opportunity to earn a highly leveraged profit with a known and limited risk. A call option gives the purchaser the right to buy the shares covered by the option at the exercise price at any time up until expiry. All things being equal, call option premiums rise as the underlying share price rises. For this reason the taker of a call option usually expects the underlying share price to rise strongly. A put option gives the taker the right to sell the shares. All things being equal, put option premiums rise as the underlying share price falls. For this reason the taker of a put option is likely to hold a market view that the underlying share price will fall significantly. For this right the taker of the put option pays the premium which is the maximum risk for the taker. It is not necessary for the taker of a put option to own the underlying shares. If the taker chooses to exercise a put option he is required to sell the underlying shares, at the exercise price, to a nominated writer of options in that series. However the taker also has the choice of liquidating his position by selling it on AOM; ie "closing out'' the position. If the taker choses to sell the option, a loss will be incurred if the option is sold for a premium lower than it was bought and a profit will occur if the option is sold for more than it was bought. At any time, value in the premium paid for the option will be lost if the option is exercised.

The writer of a call option agrees to sell to the taker of the call option the underlying shares at the exercise price, should the taker exercise the option any time before expiry (where the option is of the American style). The writer of a put option agrees to buy the shares if the put option is exercised. The decision to exercise the option rests entirely with the taker, therefore the option can be exercised at any time. However, this is most likely to occur when the option is in the money or has little time value left. A loss will be incurred if the option is bought for a premium higher than it was sold, and a profit will result if the option is bought for less than it was sold.

Because of the nature of the risks involved in selling options, OCH requires cover for those positions. In the case of calls the writer can either be a "scrip-covered'' writer or a "naked'' writer. The scrip-covered call writer owns all the shares underlying the options contract. The shares must be lodged with OCH through the clearing member. If the scrip-covered writer is "exercised against'', he has simply locked in the selling price of the shares at the exercise price. The "naked'' call option writer does not own the underlying shares. The risks involved for a "naked'' call writer are greater than for the scrip-covered call writer because any rise in the underlying share price increases the likelihood of exercise. Furthermore, if the "naked'' call writer is exercised against, he is required to purchase shares on the market at a higher price in order to satisfy the obligation to deliver, to the call taker, the shares.

If the put writer is "exercised against'' he will be required to accept (from the option taker) shares at the exercise price, presumably at a price higher than the current market. As well as the risk of exercise, the "naked'' call (put) writer will have to meet or pay margin calls in a rising market and therefore can sustain substantial losses.

The futures market

A futures market is a market in which people buy and sell things for future delivery. A futures contract generally involves an agreement to buy and sell a specified quantity of something at a specified future delivery date. The price is the variable, determined competitively by "open outcry'' on the trading floor or through a computer based market place. Futures markets perform the economic function of managing the price risk associated with holding the underlying commodity or having a future requirement to hold it. The futures market is a risk transfer mechanism whereby those exposed to risks shift them to someone else; the other party may be someone with an opposite physical market risk or a speculator. By contrast, securities markets facilitate the purchase and sale of equities or debt instruments. A small proportion of futures contracts results in the commodity or financial instrument underlying the contract being in fact sold or bought by the parties to the contract in satisfaction of their obligations under that contract. However, the economic function of this delivery mechanism is to ensure that the contract price converges with that of the physical or cash market at maturity. This is essential to the efficiency of the futures market in its role of risk transfer and risk management mechanism. The delivery aspect of future contracts is not designed to make them alternative primary investment or securities vehicles. Futures markets along with options and other similar markets are often described as "derivative markets'' in the sense that they are derived from the underlying instrument (for example, the cash securities markets).

There are basically two types of users of the futures market, hedgers and speculators. Hedgers typically deal in the physical commodity and use futures to manage price risks. Hedgers transfer risk to speculators. The futures market performs a price setting function, allowing a hedger to know in advance the price at which he will buy or sell and to plan for known costs and returns. The futures market achieves its purpose of setting a price in advance by providing profits or losses that balance losses and gains in the physical market respectively.

A pithy statement of a futures market was made by A L Valdex in his article "Modernizing The Regulation Of The Commodity Futures Market'', Harvard Journal on Legislation , Vol 13 No 1, December 1975, 35 in these terms at 40:

The primary purpose of futures trading is to enable producers, dealers, and processors of various commodities to shift the risk of price fluctuations to speculators through the process of hedging. Basically, hedging allows producers, dealers, and processors to make contracts in advance for the sale of their goods and to protect themselves against price fluctuations by buying or selling futures contracts for an equal quantity of their product or material of manufacture. The reduction in risk permits the producer to sell and the processor to buy at lower prices, which theoretically benefits the consumer by lowering the price of the finished product. The speculator is willing to accept the risk of price fluctuation for the sale of possible gain.

Speculators aim to profit from correctly anticipating the direction of price changes in a contract. In the futures market, speculators are people who try to make money by buying and selling futures (and options), by speculating that prices will change to their advantage. They usually do not intend ultimately to buy or sell the underlying commodities. Speculators are attracted to the futures market by the principle of leverage, which allows them to take advantage of price changes on a large amount of a traded commodity for a small initial outlay. Speculators play an essential economic role in any futures market by providing trading volume and liquidity and by taking on the risks which hedgers seek to avoid. Speculators play an important role in primary securities market, although in those markets they purchase the underlying instrument; and thus it is generally more difficult to obtain leverage than in derivative markets.

A hedger will use futures contracts to set the price for a future sale or purchase. Since the futures contract is a legally binding agreement to buy or sell a specified commodity, opening a futures position (that is entering into a futures contract) ensures the price the hedger will receive. Hedging can take two forms: hedging existing physical market investments or anticipatory hedging. If a hedger holds an open bought or long futures contract then he will profit in the event that the price of the futures contract rises and lose in the event that the price falls. Conversely, if a hedger holds an open, sold or short contract then he will profit in the event of the futures contract price falling and lose if it rises. Hedging can take an anticipatory form as in the example of a portfolio holder who expects to receive funds in (say) six months time and who will use those funds to increase his portfolio investment. In the meantime the sharemarket dips and the portfolio holder's opinion is that it is cheaper now than it will be in six months time when the funds will be received. By buying futures the investor can take advantage of current depressed prices.

From the point of view of a speculator, the buying or selling of a futures contract will depend upon his opinions about future price trends. Speculators aim to profit from correctly anticipating the direction of price changes in a contract. If the speculator believes that price of a particular commodity (for example, wool) is going to rise then he will buy the relevant futures contract now, and once the price has risen, close out the position by selling the futures contract at the higher price and thus making a profit. Similarly, if the speculator believes that the price is going to fall he will sell futures contracts now and close out the position by buying futures contract at the lower price and thus making a profit.

In the case of SFE, futures contracts may be traded by the process of "open outcry'' on the futures exchange trading floor or via electronic screen dealing system.

Futures exchanges operate on the basis that contracts traded on the exchange are registered with a clearing house. The clearing house may be a division or subsidiary of SFE or may be independent of it. Clearing houses have their own membership and only members are entitled to have futures and options contracts registered with that clearing house. Consequently those market users who are not members must have their contract cleared by a member.

The primary function of a clearing house is:

 to process, account for and settle all futures contracts registered with it;
 to become a party to all contracts traded on the exchange through a process of novation; this enhances the negotiability of such contracts and thus overall market liquidity; and
 to guarantee performance of all futures and option contracts to clearing members.

Once a futures contract is registered by a clearing house, the original contract which existed between two exchange members is novated by two contracts with the clearing house, that is the clearing house becomes the buyer to each seller and the seller to each buyer. Since the clearing house becomes a party to each registered contract, it continues to be liable to perform under those contracts even if another member fails to perform its contract to the clearing house. This is a method by which the clearing system enhances financial performance in the market. This system means that members generally enter into contracts on the futures exchange without concern for counterparty credit risk to other members. It also means that the original counterparties to the contract do not necessarily have to negotiate with each other in order to liquidate the contract, but can deal with any other buyer or seller through the futures exchange. These features of the clearing system are essential to the liquidity of the futures market.

The futures contract can be registered in the clearing member's books on behalf of a broker who was in turn acting on behalf of a client. Indeed, there may be a chain of brokers between the clearing member and ultimate client. Clearing members may also have contracts registered on their own behalf as principals. Clearing houses generally value contracts registered with them at a final closing or settlement price each day. The clearing house then settles all resulting profits and losses with its members the next day. Similarly clearing members and brokers settle with their clients. This process is generally referred to as "marking to market''. Somehow clearing houses do this more frequently than once daily.

Sydney Futures Exchange Clearing House (SFECH) the clearing house for the SFE, settles its contracts to market as opposed to marking to market. Under this process all open contracts at the end of each trading day are deemed to be closed or liquidated at the settlement price and replaced by identical open contracts at the same price.

Apart from this daily marking or settlement to market, the primary means by which clearing houses manage the risk under their performance guarantee is to require lodgment of performance deposits, normally referred to as initial margins. SFECH clearing members are required to pay initial margins in respect of the net contract open position which they have with the clearing house. The initial margin is usually set at a level which the clearing house deems appropriate to cover the risk of a single day's loss on a member's portfolio. Similarly, brokers are required to hold initial margins on behalf of their customers.

Holders of open futures contracts may terminate such contracts by different means. The great majority of futures contracts on SFE are terminated by liquidation on SFE. Holders of a bought or long position may sell the contract. Conversely, holders of a sold or short position may buy it back. If futures contracts are not liquidated on the market but are left open at the maturity date of the contract, then (in the case of "deliverable contracts'') the obligation of each party under the contract is either to take or give delivery of the specified amount and grade of thing the subject of the contract. Holders of short positions must give delivery, whilst holders of long positions must take delivery. Such deliveries are processed and guaranteed by the clearing house. In the case of cash settled markets, futures contracts which are left open at the maturity time are settled at an official settlement price struck at the time trading closes.

SFE currently has various types of futures contracts listed (as well as futures options), that is, options to buy or sell futures contracts at or before a set date, namely:

 wool futures contracts
 90-day bank accepted bill futures contracts
 three year and 10 year treasury bond futures contracts
 share price index (SPI) futures contracts
 individual share futures (ISF) contracts.


As mentioned earlier, LEPOs have not yet been listed for trading by ASX. LEPOs will be extremely deep in the money call options. They typically will have an exercise price of between 1 and 10 cents and have a European expiry, that is, they can only be exercised on the last trading day. This is in contrast to an American expiry whereby an option can be exercised at any time up to the date of its expiry. LEPOs will be deliverable contracts usually covering 1000 shares of the underlying stock. If the taker elects to exercise at expiry he will be taking delivery of those 1000 shares from the writer at the strike price. Deliverable contracts are contracts that are settled by delivery of the underlying commodity.

LEPOs will be traded as call options only. LEPOs will have a delta of near 1, hence the taker will hold a position similar to buying the underlying share and the writer to selling the underlying share. LEPOs will not be an exact substitute for ownership of the underlying shares because the option holder will not receive dividend, income or voting rights.

With conventional options, for each expiry month there will be a selection of exercise prices available. For example, a $10 stock may have listed a $9.50, $10, $10.50 etc series for trading in June. LEPOs will have only one exercise price listed per month with that price set to a very low or nominal amount.

It is proposed that LEPOs will be traded on the Australian Stock Exchange Derivatives (ASXD). ASXD is a committee to which the board of ASX has delegated the power to make and amend the rules of ASX relating to derivatives (ie markets derived from underlying commodities or securities). The margining practices adopted by ASXD using the Theoretical Intermarket Margining System (TIMS) allows the value of the premium to be paid by the taker of a LEPO to be offset by a credit equivalent to the value of the option at current market prices. This means that the net payment on the opening of a LEPO will be the sum of the current mark to market plus risk margin. The result is that the net payment will be less than the premium amount for the LEPO.

Standard Exchange Traded Options have a selection of exercise prices trading at any one time, and therefore some series will expire worthless. Because LEPOs will be deep in the money call options with nominal exercise prices, it is likely that they will always expire in the money.

LEPOs will be highly leveraged securities which will compliment an investor's existing equity and equity option trading. They will allow investors to gain leveraged exposure to future share price movement, without physically buying or selling shares. Investors will save on initial capital outlay because they will not have to fund the full price of the shares, but through the netting process effectively pay only an initial margin (which acts as a "performance bond'') to open a contract. Because of the small initial commitment of capital, investors can potentially enjoy highly leveraged returns on their invested funds.

The taker of a LEPO will have the right to exercise and buy the underlying shares at expiry and thereby take advantage of further expected gains in the share price or future dividend returns. On the other hand, because LEPOs will be European-styled, the writer will not have to worry about the risk of early exercise.

By using the TIMS margining system for both exchange traded options and LEPOs, which will be simply exchange traded options with a nominal strike price, full offset for options within the same class will be available. This can mean significant savings on margin requirements for investors trading both instruments. Collateral arrangements will be the same for LEPOs and exchange traded options, which means investors will not have to lodge cash to cover their requirements, but may elect to lodge other securities accepted by OCH.

LEPOs may be used for a variety of reasons: they may be used as hedges or "insurance policies'' which lock in a future buying or selling price of shares. Investors with a particular market value (usually speculators) may use them as an alternative to buying or selling shares. Investors may trade either a bullish or bearish market view, and if the investor's view proves to be correct, highly leveraged gains may be made. Investors may trade LEPOs through their share brokers who are authorised to give advice on equities and equity derivative products.

Leverage is a powerful investment tool. It allows investors to gain exposure to a large amount of shares for a relatively small initial outlay (initial margin). Because each LEPO will cover 1000 of the underlying shares, for each $1 movement in the share price, each LEPO contract will move by an amount approximately equal to $1000. This means investors can potentially make profits and losses during the life of the LEPO on the same basis as if they traded the underlying shares. If the share price rises by $1 the taker will have an unrealised profit of $1000 while the writer will have an unrealised loss of $1000. The reverse will be true if the share price falls. As with all options, the maximum loss for the taker will be the premium paid for the option contract. In the event that the price of the underlying share falls dramatically, the possible loss on a LEPO may be large. This is because LEPOs will have a low exercise price which means that the full premium amounts will be closer to the full share price than for a normal Exchange Traded Option. LEPOs will be a potentially high risk, high reward investment.

The same people who currently trade Exchange Traded Options will trade LEPOs, namely, institutional investors, private clients, registered traders and arbitrageurs.

LEPOs will use the existing tracing and administrative infrastructure of the ASXD. The contracts would trade at the same station and in the same manner as other options for that class, expiry months matching the existing Exchange Traded Option. Standard market making facilities will apply. Trades will be cleared through OCH as with Exchange Traded Options.

LEPOs may be used in much the same way as Conventional Equity Options for both hedging purposes and speculation. If LEPOs are used for hedging purposes, that is locking in a buying or selling price of the underlying shares, the investor may engage in an anticipatory buying hedge or selling hedge for protecting a portfolio. For example, if an investor wishes to purchase 1000 shares in stock X at today's price of $10 a share, it requires $10,000 which he does not have available until say three months time and he is concerned that the share price will rise in the meantime and the investor will have to pay more for the shares at that time. In order to lock in the buying price today he may decide to take one LEPO with the right, but not the obligation, to exercise and buy the X company shares. If the X company shares rise in price the LEPO contract will also rise by a similar amount. The investor has the choice of selling the LEPO and using the profits to offset the increased cost of the shares or alternatively to wait until expiry and exercise in order to buy the shares. If the X company shares fall in value the LEPO contract will also fall by a similar amount, that is the investor will incur a loss on the position. If the investor still wishes to purchase the shares, he can either sell the LEPO and buy the shares more cheaply in the market or alternatively exercise at expiry and take delivery of the shares. However, the investor may decide not to purchase shares in the falling market and may sell the LEPO contract prior to expiry. Any loss incurred on liquidating the LEPO will be in effect an "insurance'' cost.

An investor may, however, wish to protect the portfolio by a selling hedge. For example, if an investor has a portfolio of X company shares and is concerned about a fall in the price of those shares, instead of selling the shares which may rise in value, he may write a LEPO with the obligation of selling the shares at expiry if the taker exercises. If the X company shares fall in value the LEPO will also fall in price by a similar amount. If the investor's shares decline in value, however, there will be an offsetting profit on the LEPO. If the investor decides not to sell the X company shares, the position can be closed out by buying back the LEPO prior to expiry, thus cancelling the delivery obligation and realising the profit. This profit offsets the loss in value of the X company shares. In other words it enables an investor to continue holding his portfolio when the sharemarket values are declining.

Alternatively, the writer may decide to hold the position until expiry, when the LEPO may be exercised and the share delivery will take place. If the X company shares rise in price over the term of the LEPO, the LEPO will rise in value by a similar amount. The investor's shares will have increased in value, but there will be an unrealised loss on the LEPO. At expiry it is likely that the taker will exercise the LEPO, at which time the investor will be obliged to deliver the stock. Alternatively, the writer may decide to close the position prior to expiry, accept the loss on the LEPO but allow the shares to fully appreciate in value.

The second use for LEPOs will be as a speculative investment, whereby the investor profits from an expected market move if the view proves to be correct. In this way his strategy will be to take a LEPO for a low price and sell it for a higher price or, alternatively, to write high in the first instance and to buy it back at a lower price.

Assume an investor is confident that the price of the X company shares will rise in the short term, that they are currently trading at $10 per share, but that the investor does not wish to fund the full stock purchase and would rather use only part of his available funds. He decides to take one LEPO with the view that if the market does rise during its life, leveraged returns can be made. If the market declines, however, the investor accepts the potential risks. If the X company shares rise, the LEPO will also rise in value, and the taker can liquidate the position prior to expiry and realise a profit. If in the meantime his funds become available for the purchase of the stock he can elect to exercise on expiry. If the X company shares fall in price the LEPO will also fall. The taker will have losses on a one for one basis with the underlying shares until the position is closed out and the loss realised.

An investor may take advantage of a bearish market bias by writing a LEPO. In this way if the market declines he can liquidate the position at a lower price and realise a profit. The writer must be prepared however to accept losses in the event the share price rises over the life of the LEPO. In this case the profit and loss profile is the reverse of the taker, that is the bullish market view.

For more experienced traders LEPOs may be used in conjunction with equities and other Exchange Traded Options to construct "sophisticated spread and synthetic strategies at varying levels of risk''.

A LEPO may be exercised or abandoned (that is left to expire) only on the option expiry date known as the European-expiry. If a LEPO is abandoned the taker will be liable to make a net payment equal to the difference between the premium and accrued mark to market amount.

LEPOs will be margined along with existing Exchange Traded Options via the TIMS system. Whilst LEPOs will have a high premium value, the TIMS methodology with regard to the calculation of the liquidation value of each option will result in cashflows for LEPOs that defer the effect of the full premium posting. The following is a summary of how LEPOs will be margined:

 the premium will be debited to the taker's account and credited to the writer's account on registration. TIMS will calculate the projected liquidation value of each position which for a taker will be a credit at the current market price and for a writer will be a debit at the current market price;
 an initial margin will be calculated for the position and paid by both taker and writer;
 any remaining credit will be used to offset other debit premium margins or other risk margins.

The total margin payable for a class of options (company X) will be the net margin of all option positions for that class including LEPOs. In other words, the margin for a written X company LEPO can be offset against margins for taken positions in other options of the same class and visa versa.

A LEPO will be an option contract cleared by the OCH; margin liabilities for LEPO transaction may be covered by cash or approved collateral (which will include approved listed shares, bank guarantees and approved fixed interest securities).

LEPO transactions will be processed with all other options traded on the ASXD and details will appear on all existing documents (contract notes, liquidation advices etc). LEPOs are to be traded using the existing trading and administrative infrastructure of the ASXD. In general the establishment of a market for options will be achieved by standardisation of contract size, expiry date and exercise price.

ASX rules for LEPOs

Various requirements are established by the amended ASX business rules relating to LEPOs. To be eligible as underlying securities for LEPOs, the securities must be quoted on the stock exchange and must be characterised by a substantial number of outstanding shares or stock units which are widely held and actively traded in the primary market: r 7.1.9(b). In addition the securities must be "FAST eligible securities'' or "CHESS approved securities''. I will say something about FAST and CHESS shortly. The market capitalisation of the underlying securities must ordinarily exceed $2 billion: r 7.1.9(d). Delivery of the underlying securities upon the exercise of an option and payment of the total exercise price is to be in accordance with the Securities Clearing House Business Rules. The Securities Clearing House is ASX Settlement and Transfer Corporation Pty Ltd which is approved under s 779B of the Corporations Law as the clearing house for transactions in CHESS Approved securities. On exercise of a call option the relevant clearing member is to make full cash payment of the exercise price or procure his client to do so. Upon allocation of an exercise notice, the clearing member is to deliver the underlying securities in accordance with the SCH Business Rules.

Where a put option is exercised, the clearing member is also to deliver the underlying securities in accordance with the SCH Business Rules: r 7.1.17(3). The obligation of the clearing member to deliver underlying securities upon the exercise of a LEPO cannot be settled by the delivery of a share certificate: r 7.1.17(3)(d). Accordingly, on the exercise of a LEPO no share certificate changes hands as part of the settlement process.

FAST stands for Flexible Accelerated Security Transfer System. FAST involves an uncertificated register maintained by the company itself. The system is regulated by the ASX Business Rules. Under the FAST system the ASX provides a transaction setting service, whereby the obligations of brokers to deliver and make payments are netted off. Broker to broker transactions are replaced, through a process of novation, with contracts between the selling broker and the clearing house company (TNS Clearing Pty Ltd) and between the buying broker and the company, replacing broker to broker obligations. A delivery netting service nets off a particular broker's obligation to deliver (or entitlement to receive) securities to (or from) other brokers. Similarly, payment obligations or entitlements are netted off. There is therefore ordinarily no transfer between brokers corresponding to the number of shares involved in a particular transaction.

The FAST system was not the subject of explanatory evidence before the primary judge, but his Honour observed that it seems that the selling broker (not the transferor) validates a transfer form, which provides authority to the company to alter its register to rescind the transaction. Where a broker duly completes the form and adds the appropriate stamp, the broker is deemed to have given statutory warranties relating to the entitlement of the transferor to sell or dispose of the securities: s 1105 of the Corporations Law; Sch 2.

CHESS stands for Clearing House Electronic Subregister System. This system is governed by the SCH Business Rules, a booklet entitled "Legal Issues in CHESS Phase 1'', 2nd ed, 1992 describes the characteristics of CHESS Phase 1 as follows:

2.1 CHESS provides an electronic subregister for uncertificated holdings of each class of CHESS approved securities. Each CHESS subregister is administered by the Securities Clearing House (SCH) and forms part of the issuer's relevant securities register for the purposes of the Corporations Law.

2.2 The electronic subregister facilitates the registration of transfers of securities. In the paper environment, transfers are registered by the issuers securities registry upon delivery of a paper transfer and (except where the securities are held in uncertificated form under the FAST system) the relevant securities certificate. There is therefore an inevitable delay between settlement of a transaction and registration of a transfer to reflect the transaction.

2.3 The CHESS subregister is electronically linked to the issuer and CHESS participants, with the consequence that for all practical purposes, delay between settlement and registration is eliminated.

2.4 CHESS is being introduced in two phases. Phase 1 implements the subregister concept and permits electronic transfer of CHESS approved securities. However, broker/broker settlements will continue through the existing BBS [broker/broker settlement] system operated by the ASX.

The CHESS system builds on the changes already made through the FAST system. Phase 1 of the CHESS system continues the netting off practices implemented in relation to broker to broker settlement. However CHESS involves an electronic subregister and adjustments to the subregister take place electronically. The primary judge noted that this is recognised in the Corporations Law which defines "document'' for presently relevant purposes as including in the case of an "SCH-regulated transfer'' an electronic message: s 1097(1). The authority for a company maintaining an electronic register is also contained in the Corporations Law: ss 209 and 1306. The "transfer document'' attracts statutory warranties by the member organisation whose identification code shows that it has effected the transfer: Corporations Law s 1109E(1).

The statutory regime

The Corporations Law prohibits a person from establishing or conducting an "unauthoried futures market'': s 1123. An "unauthoried futures market'' means a futures market that is neither a futures market of a futures exchange nor an exempt futures market: s 9, the interpretation section. A futures market is a market or exchange or other place at which, or a facility by means of which, futures contracts are regularly acquired or disposed of: s 9. A futures exchange means, so far as presently relevant, a body corporate in relation to which an approval to conduct a futures exchange has been given by the minister under s 1126 of the Corporations Law: s 9. The ASX is not a body to which an approval of this kind has been given, nor does it conduct an exempt futures market.

Central to the case is the meaning of the expression "futures contract'', an expression defined by s 72(1) of the Corporations Law in these terms:

72(1) A futures contract is:

 a Chapter 8 agreement that is, or has at any time been, an eligible commodity agreement, or adjustment agreement;
 a futures option; or
 an eligible exchange-traded option;
 other than
 a Chapter 8 agreement:
 that is:
 a currency swap;
 an interest rate swap;
 a forward exchange rate contract; or
 a forward interest rate contract; and
 to which an Australian bank, or a merchant bank ... is a party; or
 a Chapter 8 agreement that, when entered into, is in a class of agreement prescribed for the purposes of this paragraph.

The expression "Chapter 8 agreement'' means (s 9):

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

A "relevant agreement'' means (s 9) an agreement, arrangement or understanding:

 whether formal or informal or partly formal and partly informal;
 whether written or oral or partly written and partly oral; and
 whether or not having legal or equitable force and whether or not based on legal or equitable rights

The next expression used in s 72(1)(a) that is defined by s 9 is "eligible commodity agreement''. Its definition is:

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

 unless paragraph (b) applies - is entered into; or
 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:
 the provisions of any agreement;
 the rules and practices of any market; and
 the manner in which the respective Chapter 9 obligations of persons in sold positions, and persons in bought position, under agreements of the same kind as the first-mentioned agreement are generally discharged;
 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;
 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
 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.

"Commodity agreement'' means (s 9):

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

 a person is under a Chapter 8 obligation to make delivery; or
 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:
 the subject matter of the agreement is in existence;
 the agreement has any other effect; or
 the agreement is capable of being varied or discharged before that future time.

"Commodity'' is also defined by s 9 and it means:

 any thing that is capable of delivery pursuant to an agreement for its delivery; or
 without limiting the generality of paragraph (a), an instrument creating or evidencing a thing in action.

A "standardised agreement'' means (s 9) a Ch 8 agreement that is one of two or more Ch 8 agreements each of which is a Ch 8 agreement of the same kind as the other, or as each of the others, as the case may be.

"Chapter 8 obligation'' is defined by s 55(1) in the following terms:

A Chapter 8 obligation, or a Chapter 8 right, is an obligation or right, as the case may be, whether or not enforceable at law or in equity.

An "adjustment agreement'' is defined by s 9 as meaning a standardised agreement, the effect of which is that a person will be under a Ch 8 obligation to pay or receive money depending on a particular future "state of affairs'', including a state of affairs that relates to fluctuations in the value or price of a commodity or other property or in an index or other factor.

The expression "futures option'' referred to in s 72(1)(b) is defined in s 9 as follows:

... 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.

The expression "bought position'' in relation to a commodity agreement or futures contract which is a commodity agreement is defined by s 9 as meaning:

... the position of a person who, by virtue of the agreement is under a Chapter 8 obligation to accept delivery in accordance with the agreement.

"Sold position'' is also defined in s 9 in relation to a commodity agreement or futures contract which is a commodity agreement as meaning:

... the position of a person who, by virtue of the agreement, is under a Chapter 8 obligation to make delivery in accordance with the agreement.

The term "eligible exchange-traded option'' in s 72(1)(c) is defined in s 9 as follows:

... a contract that is entered into on a futures market of a futures exchange and under which a party acquires from another party an option or right, exercisable at or before a specified time:

 to purchase from, or to sell to, that other party a specified quantity of a specified commodity at a price specified in, or to be determined in accordance with, the contract; or
 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.

SFE contends that a contract, arrangement or understanding upon the terms of a LEPO would constitute a "futures contract'' within the meaning of s 72(1) (in particular, because a LEPO is an "eligible commodity agreement''); that the market for the regular acquisition and disposal of LEPOs would be a "futures market'' within the meaning of the definition of that expression in s 9; and therefore ASX is proposing to conduct an unauthorised future market in contravention of s 1123 of the Corporations Law.

The contention is made in support of two propositions. The first proposition is that, because a LEPO is an eligible commodity agreement and therefore a futures contract, ASX cannot deal in LEPOs because they can be traded, relevantly, only on a futures exchange and that ASX does not have an approval to conduct such an exchange. The second proposition is based on s 92(1) of the Corporations Law. The Corporations Law (Ch 7) prohibits a person from establishing or conducting an unauthorised stock market: s 767. A "stock market'' is defined by s 9 to mean a market or exchange at which, inter alia, offers to sell, purchase or exchange securities are regularly made or accepted. The word "securities'' is important; it is defined by s 92(1) in these terms:

Subject to this section, "securities'' means:

 shares in, or debentures of, a body; or
 prescribed interests; or
 an option contract within the meaning of Chapter 7;
 but does not include a futures contract ...

SFE contends that the concluding words of the definition of "securities'' in s 92(1) exclude futures contracts from the definition of "securities'', with the consequence that they cannot be dealt with in a stock market (as defined in s 9) and cannot be taken into account in determining whether a market is a stock market, because s 97 provides that in determining whether a market is a stock market regard shall not be had to the making at that market of futures contracts.

I conclude this regrettably lengthy, but necessary, recitation of definitions with the definition of the expression "option contract'' in s 92(1)(e) which is defined in s 9 in these terms:

Option contract means:

  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(i)(a), (b), (c) or (d), at a price specified in, or to be determined in accordance with the contract ; or
 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:
 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
 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.

It should be noted that para (b) of the definition of "option contract'' is in almost identical terms to the definition of the expression "eligible exchange-traded option'' (s 72(1)(c) previously recited), the essential difference being that a transaction relating to an option contract takes place on a stock market of a securities exchange whereas the transaction in relation to an eligible exchange-traded option takes place in a futures market.

The principal contention of SFE is that a LEPO falls within the definition of a futures contract in s 72(1) of the Corporations Law and is excluded from the definition of "securities'' in s 92(1). It was contended that a LEPO is a "Chapter 8 agreement'', namely, an "eligible commodity agreement'' within the meaning of para (a) of the definition of the expression "futures contract'' in s 72(1).

The initial, and in my opinion, the principal question that arises from the contention is whether the shares which underlie a LEPO are a "commodity'' within the meaning of that expression in s 9. There are two limbs to the definition of "commodity'' (previously recited). I turn to the first limb which raises the question whether the shares that are the subject of a LEPO answer the description of "any thing that is capable of delivery pursuant to agreement for its delivery''.

In considering the first limb regard must be had also to the second limb because it is introduced with the words "(b) without limiting the generality of paragraph (a), ...'' which on one interpretation of "commodity'' would mean that words that follow, namely, "an instrument creating or evidencing a thing in action'' are intended to be encompassed within the framework of the first limb.

In one sense shares that are the subject of LEPOs are "things''; but the word "things'' is part of the composite expression in s 9(a) "any thing that is capable of delivery pursuant to an agreement for its delivery'' and must not be construed in isolation from that statutory context. Are shares that underlie LEPOs "[things] capable of delivery pursuant to [the] agreement for [their] delivery''?

A share is a right to a specified amount of the share capital of a company, carrying with it rights and liabilities when the company is a going concern and in the course of its winding up. A share is a chose in action entitling its holder to the rights and subjecting him to the liabilities provided by the memorandum and articles of association and by legislation. In Borland's Trustee v Steel Brothers & Co Ltd [1901] 1 Ch 279 Farwell J described the nature of a share in the terms at 288:

A share is the interest of a shareholder in the company measured by a sum of money, for the purpose of liability in the first place, and of interest in the second, but also consisting of a series of mutual covenants entered into by all the shareholders interest in accordance with s 16 of the Companies Act 1862. The contract contained in the articles of association is one of the original incidents of the share. A share ... is an interest measured by a sum of money and made up of various rights contained in the contract, including the right to a sum of money of a more or less amount.

This passage was approved by Lord Russell of Killowen in Inland Revenue Commissioners v Crossman [1937] AC 26 at 66.

The rights attaching to a share include the right to participate in dividends whilst the company is a going concern and the right to participate in the distribution of assets available for the shareholders upon a winding up. They also include the right to receive capital in excess of the company's wants which the company resolves to distribute upon a reduction of capital: Archibald Howie Pty Ltd v Commissioner of Stamp Duties (NSW) (1948) 77 CLR 143 at 156 per Williams J.

In Colonial Bank v Whinney (1885) 30 Ch D 261 at 286-7 Fry LJ said:

What, then is the character of a share in a company? Is it in its nature a chose in possession, or a chose in action? Such a share is, in my opinion, the right to receive certain benefits from a corporation, and to do certain acts as a member of that corporation; and if those benefits be withheld or those acts be obstructed, the only remedy of the owner of the share is by action. Of the share itself, in my view, there can be no occupation or enjoyment; though of the fruits arising from it there may be occupation, enjoyment and manual possession. Such a share appears to me to be closely akin to a debt which is one of the most familiar of choses in action; no action is required to obtain the right to the money in the case of the debt, or the right to the dividends or other accruing benefits in the case of the share; but an action is the only means of obtaining the money itself or the other benefits in specie, the right to which is called in one case a debt and in the other case a share. In the case alike of the debt and of the share, the owner of it has, to use the language of Blackstone, a bare right without any occupation or enjoyment. A debt, no doubt differs from a share in one respect, that it confers generally a more limited right to the share, and once paid it is at an end, but this distinction appears to me immaterial for the purpose now in hand.

Although Fry LJ was in dissent in the Court of Appeal, the judgment of the majority was reversed by the House of Lords and reported as Colonial Bank v Whinney (1886) 11 App Cas 426.

Under the Corporations Law a share is personal property and is transferable or transmissible as provided by the articles, and, subject to the articles, is capable of devolution by will or by operation of law: s 105(1).

Thus, shares in a company are personal property; but they are choses in action, not choses in possession. Personal property may of course be partly in possession and partly in action, for example, promissory notes and bills of exchange. The note or bill itself is a chose in possession, but the debt secured by it is a chose in action.

I agree with the following passage from Halsbury's Laws of England , 4th ed, vol 35 in para 1205:

For general purposes, however, the expression "chose in action'' is now used in order to distinguish those chattel interests which, unlike choses in possession, are incapable of transfer by delivery of the subject matter in the manner described subsequently [ie para 1253 et sec].

The buyer of shares does not obtain legal title to the shares until the buyer's name is entered in the share register; but in the meantime the buyer may acquire equitable interests in shares, enforceable by specific performance: s 1085(2)(b) of the Corporations Law, Ford's Principles of Corporations Law , (6th ed, 1992) 823.

Legal title to personal property may be conveyed otherwise than by physical delivery of the property itself. As the primary judge observed (1994) 126 ALR 209 at 227 an example is the legislation governing the sale of goods where property passes when the parties intend that it should pass, a with the exception that unascertained goods are subject in the case of uncertain goods to the goods being ascertained: Sale of Goods Act 1923 (NSW) ss 21 and 22.

Delivery is an important element in transferring possession of and title to goods: see Pollock and Wright Possession in the Common Law (1990 ed), at 46, 57.

We were referred to dictionary definitions of the word "commodity''. In Shoreline Currencies (Aust) Pty Ltd v Corporate Affairs Commission (1986) 11 NSWLR 22 at 30-1 Lee J recited two definitions of the word from the Oxford English Dictionary:

a thing of "commodity'', a thing of use or advantage to mankind; esp. in plural, useful products, material advantages, elements of wealth;

[a] kind of thing produced for use or sale; an article of commerce, an object of trade; in plural, goods, merchandise, wares, produce

The word "commodity'' can therefore bear a wide meaning; but in my view, in the context of the definition of "commodity'' in the Corporations Law, for there to be a thing "capable of delivery'' it means capable of delivery in the sense of the physical delivery of tangible property or possibly a document evidencing title to the property. The concept of delivery involves the transfer of legal title. It is not apposite to include within that concept a share in a corporation.

The primary judge reached the same conclusion and said that he was reinforced in his view by an examination of the development of the regulatory legislation. I agree with his Honour's view. The present definition of "commodity'' was introduced for the first time into the Futures Industry Act 1986 (Cth) and the Futures Industry Codes of the States. That same legislation also introduced a broader definition of "futures contracts'' than the definition that had previously applied in the State legislation. The Futures Markets Act 1979 (NSW) contained no definition of "commodity''. It contained a definition of a "commodity futures contract'', namely, a contract whereby one party agrees to deliver to the other party at a specified future time a specified quantity of a particular commodity at a specified price. A definition of "commodity'' was inserted in 1982 by the Futures Markets (Amendment) Act 1982 (NSW) Sch 1, cl 1(a); but, as the primary judge observed, this included "a bill of exchange'' and anything prescribed as a "commodity''. A unit of foreign currency was prescribed as a "commodity'' in 1984 by the Futures Markets (Foreign Currency) Regulations 1984 (NSW). I agree with the primary judge (at ALR 228) that:

... the scope of the legislation governing the futures industry has been expanded, independently of the wording or construction of the definition of "commodity'' or "commodity agreement''.

What I have said thus far applies to shares generally; but it seems to me to be incorrect to say that shares that are the subject of LEPOs are capable of delivery in the meaning of the first limb of the definition of "commodity''. Nor is a share certificate delivered upon settlement of such transactions. Also the settlement of dealings must take place under either the FAST or CHESS systems. The transferor does not execute a transfer or hand over anything to the transferee under either system. What takes place is a netting off process which settles the obligations between the brokers themselves. The transfer of the particular parcels of shares is achieved by recording the relevant information contained in the transfer form from electronic communication. The FAST or CHESS systems do not involve the customary or traditional form of settlement of the sale of shares, namely, the handing over of a transfer of shares in registrable form together with the share scrip, which is followed by registration of the transfer. There is no document which comes into being to achieve a transfer of the legal title to the shares. Indeed, no document at all comes into existence which is given to the transferee. The reason for this is the process of settling transactions between brokers is fundamentally different to the traditional transaction of settling sales and purchases of shares. The settlement of transactions with respect to shares of the kind that are the subject of LEPOs does not involve delivery in any relevant sense, so the shares themselves are not capable of being delivered within the first limb of the definition of "commodity''.

Strong reliance was placed by SFE in argument before us (not an argument advanced before the primary judge) that s 1251 of the Corporations Law recognises that the subject of a "commodity agreement'' may be "security'' of a body corporate. Section 1251 relevantly provides that, for the purposes of Div I of Pt 8.7 relating to the offence of inside trading, a futures contract concerns a body corporate if and only if:

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

But s 1251 does not provide that all securities are commodities. It applies only to securities which are commodities. Plainly some securities may be commodities. Bearer bonds provide an example. Section 1251 does not assist the argument of counsel for SFE.

In support of its contention that the Corporations Law recognises that shares can be capable of delivery, counsel for SFE referred to certain sections of the Corporations Law. Section 235(1)(d) requires a corporation to keep a register including particulars of certain contracts under which a person has the right "to call for or to make delivery of shares''. Section 846(3)(d)(ii) contains an exception against a prohibition on short selling of securities where certain specified conditions are satisfied. They include the case where arrangements have been made before the time of sale that will enable "delivery of securities of the class sold'' to be made within three business days of the transaction effecting the sale. Section 262(3) refers to a charge on a personal chattel as including "a charge on any article capable of complete transfer by delivery'' other than certain things including a "marketable security''. It was argued that this suggests or implies that a marketable security is regarded as capable of being transferred by delivery.

Counsel for SFE said that the relevant market itself recognises that shares are capable of delivery by pointing to the business rules of ASX and the explanatory booklet on LEPOs published by ASXD. This lastmentioned booklet refers to LEPOs as "deliverable contracts''. The business rules of ASX refer to the obligation of a broker to "deliver non-CHESS Securities'' (r 4.1D) and they provide for the situation where securities "remain undelivered'': r 4.4(4)(a). Although I concede the attractiveness at first sight of this argument, it must be remembered that the source of ss 235(1)(d) and 262(3) is the earlier Companies Codes and the source of s 846(3)(d) is the earlier Securities Industry Code. The definition of "commodity'' was derived from the Futures Industry Code. Hence, the sections to which counsel pointed are derived from different legislative streams.

I accept that the language of commerce and the sections just mentioned refer to the delivery of shares; but in my opinion, the word "commodity'' in the context of something that is capable of delivery pursuant to an agreement for its delivery has a different and narrower meaning, derived from the context in which it appears and from the history of the relevant legislation.

I turn to the argument advanced on behalf of SFE in the alternative in reliance upon the second limb (para (b)) of the definition of "commodity''. As mentioned earlier, that definition refers to "an instrument creating or evidencing a thing in action''. I said before that in transactions effected under the FAST or CHESS system no transfer is executed by the transferor or handed over to the transferee. There is a netting off procedure to settle the obligations as between the brokers of shares, a procedure which is not conducted on a transaction by transaction basis, but is confined to the net total amount due from one broker to the other. The only relevant document (whether a paper form or an electronic signal is used) is the security transfer form which must be validated by the transferor's broker and which is used to effect an amendment to the company's register.

The security transfer form is not the subject of the agreement for sale and purchase of the shares. It is merely the means chosen to give effect to the transaction which has already been made or entered into. It is a direction to the company to record in its register the transferee as the person legally entitled to the specified quantity of shares. The company may act on that direction: s 1091(1). As mentioned earlier, the transferor does not execute the transfer form; its only purpose is to permit the transferee to secure registration of the shares that have been the subject of the prior transaction. The transfer is not therefore "an instrument creating or evidencing a thing in action'' within the meaning of para (b) of the definition of "commodity''.

For these reasons, in my opinion the definition of "commodity'' does not include shares that are the subject of a LEPO or an instrument that creates or evidences such shares. They cannot therefore be the subject of a "commodity agreement'' and still less an "eligible commodity agreement''.

The agreement that underlies the LEPO is not a futures contract within the meaning of s 72(1) and the concluding words of s 92(1). The foundation of SFE's case therefore fails and the appeal must be dismissed.

This leaves the cross-claim of ASX that LEPOs are securities within the meaning of s 92(1) of the Corporations Law.

Plainly LEPOs fall within para (a) of the definition of "option contract'' in s 9 as a contract under which a party acquires from another party an option exercisable at or before a specified time to buy from or to sell to that other party a number of specified "securities'', being "securities'' of the kind referred to in s 92(1)(b), at a price specified in or to be determined in accordance with the contract. Section 92(1)(b) includes "shares in ... a body'' within the meaning of "securities''.

LEPOs are therefore "securities'' within the meaning of s 92(1)(e) and hence may be traded within the regulatory framework of Ch 7.

The declaration

The primary judge made a declaration in favour of ASX, the terms of which are set out in Gummow J's reasons for judgment. I agree, for the reasons given by Gummow J, that the declaration should be set aside. I add that counsel for ASX did not press strongly to maintain the declaration.


I would set aside the declaration made by the primary judge, but otherwise dismiss the appeal with costs.

Case Judgement
Table of contents
  Judgment by Lockhart J
  Judgment by Gummow J
  Judgment by Lindgren J.

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