2020-24353
[Federal Register Volume 85, Number 227 (Tuesday, November 24, 2020)]
[Rules and Regulations]
[Pages 75112-75147]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 2020-24353]
[[Page 75111]]
Vol. 85
Tuesday,
No. 227
November 24, 2020
Part II
Commodity Futures Trading Commission
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17 CFR Part 41
Securities and Exchange Commission
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17 CFR Part 242
Customer Margin Rules Relating to Security Futures; Final Rule
Federal Register / Vol. 85 , No. 227 / Tuesday, November 24, 2020 /
Rules and Regulations
[[Page 75112]]
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COMMODITY FUTURES TRADING COMMISSION
17 CFR Part 41
RIN 3038-AE88
SECURITIES AND EXCHANGE COMMISSION
17 CFR Part 242
[Release No. 34-90244; File No. S7-09-19]
RIN 3235-AM55
Customer Margin Rules Relating to Security Futures
AGENCY: Commodity Futures Trading Commission and Securities and
Exchange Commission.
ACTION: Joint final rule.
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SUMMARY: The Commodity Futures Trading Commission (``CFTC'') and the
Securities and Exchange Commission (``SEC'') (collectively, the
``Commissions'') are adopting rule amendments to lower the margin
requirement for an unhedged security futures position from 20% to 15%
and adopting certain conforming revisions to the security futures
margin offset table.
DATES: This rule is effective December 24, 2020.
FOR FURTHER INFORMATION CONTACT:
CFTC: Melissa A. D'Arcy, Special Counsel and Sarah E. Josephson,
Deputy Director, Division of Clearing and Risk, at (202) 418-5430; and
Michael A. Penick, Economist at (202) 418-5279, and Ayla Kayhan,
Economist at (202) 418-5947, Office of the Chief Economist, Commodity
Futures Trading Commission, Three Lafayette Centre, 1155 21st Street
NW, Washington, DC 20581.
SEC: Michael A. Macchiaroli, Associate Director, at (202) 551-5525;
Thomas K. McGowan, Associate Director, at (202) 551-5521; Randall W.
Roy, Deputy Associate Director, at (202) 551-5522; Sheila Dombal
Swartz, Senior Special Counsel, at (202) 551-5545; or Abraham Jacob,
Special Counsel, at (202) 551-5583; Division of Trading and Markets,
Securities and Exchange Commission, 100 F Street NE, Washington, DC
20549-7010.
SUPPLEMENTARY INFORMATION:
I. Background
II. Final Rule Amendments
A. Lowering the Minimum Margin Level From 20% to 15%
1. The Commissions' Proposal
2. Comments and Final Amendments
B. Conforming Revisions to the Strategy-Based Offset Table
1. The Commissions' Proposal
2. Comments and the Re-Published Strategy-Based Offset Table
C. Other Matters
III. Paperwork Reduction Act
A. CFTC
B. SEC
IV. CFTC Consideration of Costs and Benefits and SEC Economic
Analysis (Including Costs and Benefits) of the Proposed Amendments
A. CFTC
1. Introduction
2. Economic Baseline
3. Summary of the Final Rules
4. Description of Costs
5. Description of Benefits Provided by the Final Rules
6. Discussion of Alternatives
7. Consideration of Section 15(a) Factors
B. SEC
1. Introduction
2. Baseline
3. Considerations of Costs and Benefits
4. Effects on Efficiency, Competition, and Capital Formation
5. Reasonable Alternatives Considered
V. Regulatory Flexibility Act
A. CFTC
B. SEC
VI. Other Matters
VII. Anti-Trust Considerations
VIII. Statutory Basis
I. Background
A security future is a futures contract on a single security or on
a narrow-based securities index.\1\ The Commodity Futures Modernization
Act of 2000 (``CFMA'') lifted the ban on trading security futures and
established a framework for the joint regulation of these products by
the Commissions.\2\ Among other things, the CFMA amended Section 7 of
the Securities Exchange Act of 1934 (``Exchange Act'') to establish a
margin program for security futures. Section 7(c)(2)(A) of the Exchange
Act provides that it shall be unlawful for any broker, dealer, or
member of a national securities exchange \3\ to, directly or
indirectly, extend or maintain credit to or for, or collect margin from
any customer on, any security future unless such activities comply with
the regulations prescribed by: (1) The Board of Governors of the
Federal Reserve System (``Federal Reserve Board''); or (2) the
Commissions jointly pursuant to authority delegated by the Federal
Reserve Board.
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\1\ See Section 1a(44) of the Commodity Exchange Act (``CEA'')
and Section 3(a)(55) of the Exchange Act (both defining the term
``security future''). A ``security future'' is distinguished from a
``security futures product,'' which is defined to include a security
future as well as any put, call, straddle, option, or privilege on a
security future. See Section 1a(45) of the CEA and Section 3(a)(56)
of the Exchange Act (both defining the term ``security futures
product''). Under Section 2(a)(1)(D)(iii)(II) of the CEA and Section
6(h)(6) of the Exchange Act, the Commissions may, by order, jointly
determine to permit the listing of options on security futures. The
Commissions have not exercised this authority. The amendments being
adopted in this release relate to margin requirements for security
futures and not for options on security futures. Most of the
discussion in this release relates to security futures. The term
``security futures products'' will be used when discussing security
futures and options on security futures.
\2\ See Appendix E of Public Law 106-554, 114 Stat. 2763 (2000).
Futures on security indexes that are not narrow-based are subject to
the exclusive jurisdiction of the CFTC.
\3\ A futures commission merchant (``FCM'') (as defined in
Section 1(a)(28) of the CEA) may be a member of a national
securities exchange, a clearing member of a clearinghouse, or a
customer of a clearing member of a clearinghouse.
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Section 7(c)(2)(B) of the Exchange Act provides that the customer
margin requirements for security futures products adopted by the
Federal Reserve Board or jointly by the Commissions, ``including the
establishment of levels of margin (initial and maintenance),'' must
satisfy four requirements. First, they must preserve the financial
integrity of markets trading security futures products.\4\ Second, they
must prevent systemic risk.\5\ Third: (1) They must be consistent with
the margin requirements for comparable options traded on any exchange
registered pursuant to Section 6(a) of the Exchange Act; \6\ and (2)
the initial and maintenance margin levels must not be lower than the
lowest level of margin, exclusive of premium, required for any
comparable exchange-traded options.\7\ Fourth, excluding margin levels,
they must be, and remain consistent with, the margin requirements
established by the Federal Reserve Board under 12 CFR part 220
(``Regulation T'').\8\
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\4\ See Section 7(c)(2)(B)(i) of the Exchange Act.
\5\ See Section 7(c)(2)(B)(ii) of the Exchange Act.
\6\ See Section 7(c)(2)(B)(iii)(I) of the Exchange Act. In this
release, this provision of the statute is sometimes referred to as
the ``consistent with restriction.''
\7\ See Section 7(c)(2)(B)(iii)(II) of the Exchange Act. In this
release, this provision of the statute is sometimes referred to as
the ``not lower than restriction.''
\8\ See Section 7(c)(2)(B)(iv) of the Exchange Act.
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On March 6, 2001, the Federal Reserve Board delegated its authority
under Section 7(c)(2)(A) of the Exchange Act to the Commissions.\9\
Pursuant to that delegation, the Commissions adopted rules in 2002
establishing a margin program for security futures.\10\
[[Page 75113]]
These rules require security futures intermediaries to collect margin
from their customers.\11\ A security futures intermediary is a
creditor, as defined under Regulation T, with respect to its financial
relations with any person involving security futures, and includes
registered entities such as brokers-dealers and FCMs.\12\
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\9\ See Letter from Jennifer J. Johnson, Secretary of the Board,
Federal Reserve Board, to James E. Newsome, Acting Chairman, CFTC,
and Laura S. Unger, Acting Chairman, SEC (Mar. 6, 2001) (``FRB
Letter''); see also Customer Margin Rules Relating to Security
Futures, Exchange Act Release No. 44853 (Sep. 26, 2001), 66 FR 50720
(Oct. 4, 2001) (``2001 Proposing Release'') (reprinting the FRB
Letter in Appendix B).
\10\ See Customer Margin Rules Relating to Security Futures,
Exchange Act Release No. 46292 (Aug. 1, 2002), 67 FR 53146 (Aug. 14,
2002) (``2002 Adopting Release''). See also 17 CFR 41.41 through
41.49 (CFTC regulations, hereinafter referred to as ``CFTC Rule
41.42'', ``CFTC Rule 41.43'' et seq.) and 17 CFR 242.400 through
242.406 (SEC regulations, hereinafter referred to as ``SEC Rule
400'', ``SEC Rule 401'' et seq.). CFTC regulations referred to
herein are found at 17 CFR chapter I, and SEC regulations referred
to herein are found at 17 CFR chapter II.
\11\ See CFTC Rule 41.45 and SEC Rule 403. See also CFTC Rule
41.43(a)(29) and SEC Rule 401(a)(1)(29) (both defining the term
``security futures intermediary'' to include a broker-dealer and an
FCM). The term ``security futures intermediary'' includes FCMs that
are clearing members or customers of clearing members. As of
September 18, 2020, the Options Clearing Corporation (``OCC'') was
the only clearinghouse for U.S. exchange-traded security futures.
\12\ Because a security future is both a security and a future,
customers who wish to buy or sell security futures must conduct the
transaction through a person registered both with the CFTC as either
an FCM or an introducing broker (``IB'') and with the SEC as a
broker-dealer.
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The Commissions' rules include requirements governing: Account
administration; type, form, and use of collateral; calculation of
equity; withdrawals from accounts; and the treatment of undermargined
accounts. The Commissions stated that ``the inclusion of these
provisions in the final rules satisfies the statutory requirement that
the margin rules for security futures be consistent with Regulation
T.'' \13\
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\13\ See 2002 Adopting Release, 67 FR at 53155. As indicated
above, Section 7(c)(2)(B)(iv) of the Exchange Act requires that
margin requirements for security futures (other than levels of
margin), including the type, form, and use of collateral, must be
consistent with the requirements of Regulation T.
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The Commissions' rules contemplate that all security futures
intermediaries will pay to or receive from their customers a daily
variation settlement (i.e., the daily net gain or loss on a security
future) as a result of all open security futures positions being marked
to current market value by the clearing organization where the security
futures are cleared.\14\ In addition, the Commissions' rules establish
minimum initial and maintenance margin levels for unhedged security
futures equal to 20% of their ``current market value.'' \15\
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\14\ See CFTC Rules 41.43(a)(32), 41.46(c)(1)(vi) and
(c)(2)(iii), and 41.47(b)(1), and SEC Rules 401(a)(32),
404(c)(1)(vi) and (c)(2)(iii), and 405(b)(1).
\15\ See CFTC Rule 41.45(b)(1) and SEC Rule 403(b)(1). See also
CFTC Rule 41.43(a)(4) and SEC Rule 401(a)(4) (defining the term
``current market value'').
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The Commissions' rules permit a ``self-regulatory authority''
(``SRA''),\16\ as that term is defined in the rules, to set initial and
maintenance margin levels lower than 20% of the current market value
for certain strategy-based offsetting positions involving security
futures and one or more related securities or futures.\17\ The SRA
rules must meet the four criteria set forth in Section 7(c)(2)(B) of
the Exchange Act and must be effective in accordance with Section
19(b)(2) of the Exchange Act and, as applicable, Section 5c(c) of the
CEA.\18\ In connection with these provisions governing SRA rules, the
Commissions published a table identifying offsets for security futures
that were consistent with the offsets permitted for comparable
exchange-traded options (``Strategy-Based Offset Table'').\19\ SRAs
have adopted margin rules that permit strategy-based offsets between
security futures and related positions based on the Strategy-Based
Offset Table.\20\
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\16\ The Commissions' rules define the term ``self-regulatory
authority'' to mean a national securities exchange registered under
Section 6 of the Exchange Act, a national securities association
registered under Section 15A of the Exchange Act, a contract market
registered under Section 5 of the CEA or Section 5f of the CEA, or a
derivatives transaction execution facility registered under Section
5a of the CEA. See CFTC Rule 41.43(a)(30) and SEC Rule 401(a)(30).
The term ``SRA'' as used in this release refers to self-regulatory
organizations (``SROs'') registered under the Exchange Act and self-
regulatory authorities registered under the CEA. The term
``securities SRO'' as used in this release refers only to SROs
registered under the Exchange Act.
\17\ See CFTC Rule 41.45(b)(2) and SEC Rule 403(b)(2). See also
2002 Adopting Release, 67 FR at 53158-61. The initial margin level
is the required amount of margin that must be posted when the trade
is executed. The maintenance margin level is the required amount of
margin that must be maintained while the contract is open.
\18\ Section 19(b)(2) of the Exchange Act governs SRA rulemaking
with respect to SEC registrants, and Section 5c(c) of the CEA
governs SRA rulemaking with respect to CFTC registrants.
\19\ See 2002 Adopting Release, 67 FR at 53158-61.
\20\ See, e.g., FINRA Rule 4210(f)(10) and Cboe Rule 10.3(k).
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The Commissions' rules also enumerate specific exclusions from the
margin requirements for security futures, and those exclusions will
continue under the final rule amendments.\21\ For example, margin
requirements that derivatives clearing organizations (``DCOs'') or
clearing agencies impose on their clearing members are not subject to
the 20% margin level requirement.\22\
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\21\ See CFTC Rule 41.42(c)(2)(i) through (v) and SEC Rule
400(c)(2)(i) through (v).
\22\ See CFTC Rule 41.42(c)(2)(iii) and SEC Rule 400(c)(2)(iii).
The OCC is registered with the SEC as a clearing agency pursuant to
Section 17A of the Exchange Act and registered with the CFTC as a
DCO pursuant to Section 5b of the CEA.
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There also is an exclusion providing that the required 20% initial
and maintenance margin levels do not apply to financial relations
between a customer and a security futures intermediary to the extent
that they comply with a portfolio margining system under rules that
meet the four criteria set forth in Section 7(c)(2)(B) of the Exchange
Act and that are effective in accordance with Section 19(b)(2) of the
Exchange Act and, as applicable, Section 5c(c) of the CEA.\23\
Subsequent to the adoption of the Commissions' rules, and consistent
with this exclusion, two securities SROs implemented portfolio
margining rules that permit a broker-dealer to combine certain of a
customer's securities and security futures positions in a securities
account in order to compute the customer's margin requirements
(``Portfolio Margin Rules'').\24\ As discussed in more detail below,
the Portfolio Margin Rules established a 15% margin level for unhedged
exchange-traded options on an equity security or narrow-based equity
index (sometimes referred to herein as ``exchange-traded equity
options'').\25\ The 15% margin level also applies to unhedged security
futures held in a securities account that is subject to Portfolio
Margin Rules. There is no comparable portfolio margining system for
security futures held in a futures account.\26\ These same unhedged
security futures positions, if held in a futures account, are subject
to the required 20% initial and maintenance margin levels set forth in
the Commissions' rules.
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\23\ CFTC Rule 41.42(c)(2)(i) and SEC Rule 400(c)(2)(i).
\24\ See FINRA Rule 4210(g) and Cboe Rule 10.4. The broker-
dealer would need to be registered with the CFTC (as an FCM) to
include security futures in the securities account. See also 2019
Proposing Release, 84 FR 36437, n.36. FINRA Rule 4210 (Margin
Requirements) was adopted as part of a new consolidated rulebook
effective permanently on December 2, 2010, after the pilot program
was approved and made available on August 1, 2008. Cboe rules on
portfolio margining became effective permanently on July 8, 2008,
after they were approved under a pilot program on April 2, 2007.
\25\ The amendments adopted in this release were motivated, in
part, by changes made to margin requirements for certain exchange-
traded options pursuant to securities SRO pilot programs offering
risk-based portfolio margining rules. Those pilot programs were
later made permanent after review and approval by the SEC. See 2019
Proposing Release, 84 FR 36437, n.34-36.
\26\ For purposes of this rulemaking a ``futures account'' is an
account that is maintained in accordance with the requirements of
Sections 4d(a) and 4d(b) of the CEA. See also 17 CFR 1.3 (CFTC Rule
1.3).
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2019 Proposing Release
In July 2019, the Commissions proposed amending the security
futures margin rules to lower the required initial and maintenance
margin levels for an unhedged security futures position from 20% to 15%
of its current
[[Page 75114]]
market value.\27\ The Commissions sought to align margin requirements
for security futures held in futures accounts and customer securities
accounts that are not subject to the Portfolio Margin Rules with
security futures and exchange-traded options held in customer
securities accounts subject to the Portfolio Margin Rules (``Portfolio
Margin Account'').\28\ The Commissions also proposed certain conforming
revisions to the Strategy-Based Offset Table.\29\ Because the
Commissions' proposal solely related to the reduction in ``levels of
margin'' for security futures, the Commissions stated a preliminary
belief that they did not implicate the requirement of Section
7(c)(2)(B)(iv) of the Exchange Act that the Commissions' rules be
consistent with Regulation T.\30\
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\27\ See Customer Margin Rules Relating to Security Futures,
Exchange Act Release No. 86304 (July 3, 2019), 84 FR 36434 (July 26,
2019) (``2019 Proposing Release''). OneChicago, LLC (``OneChicago'')
filed a rulemaking petition requesting that the minimum required
margin for unhedged security futures be reduced from 20% to 15%. See
Letter from Donald L. Horwitz, Managing Director and General
Counsel, OneChicago, to David Stawick, Secretary, CFTC, and Nancy M.
Morris, Secretary, SEC (Aug. 1, 2008) (``OneChicago Petition''), at
2.
\28\ See 2019 Proposing Release, 84 FR at 36437.
\29\ See 2019 Proposing Release, 84 FR at 36441-43.
\30\ See 2019 Proposing Release, 84 FR at 36440. As discussed
above, Section 7(c)(2)(B)(iv) of the Exchange Act requires that
margin requirements for security futures (other than levels of
margin), including the type, form, and use of collateral, must be
consistent with the requirements of Regulation T (emphasis added).
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The Commissions received a number of comment letters in response to
the proposal.\31\ As discussed below, after considering the comments,
the Commissions are adopting, as proposed, the amendments to the
security futures margin rules to lower the required initial and
maintenance margin levels for an unhedged security futures position
from 20% to 15%. The Commissions also are publishing a revised
Strategy-Based Offset Table as proposed.
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\31\ The comment letters are available at https://www.sec.gov/comments/s7-09-19/s70919.htm and https://comments.cftc.gov/PublicComments/CommentList.aspx?id=3013. The Commissions address
these comments in section II below (discussing the final rule
amendments), and in section IV (including the CFTC's consideration
of the costs and benefits of the amendments and the SEC's economic
analysis (including costs and benefits) of the amendments).
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Subsequent to the issuance of the 2019 Proposing Release,
OneChicago, the only exchange listing security futures in the U.S.,
discontinued all trading operations on September 21, 2020. At this
time, there are no security futures contracts listed for trading on
U.S. exchanges. The final rule amendments in this release, however,
would apply to customer margin requirements for security futures if an
exchange were to resume operations or another exchange were to launch
security futures contracts.
II. Final Rule Amendments
A. Lowering the Minimum Margin Level From 20% to 15%
1. The Commissions' Proposal
As discussed above, the current minimum initial and maintenance
margin levels for an unhedged long or short position in a security
future are 20% of the current market value of the position,\32\ unless
an exclusion applies.\33\ For context, as discussed when adopting the
margin requirements for security futures in 2002, the 20% margin levels
were designed to be consistent with the margin requirements then in
effect for an unhedged short at-the-money exchange-traded option held
in a customer account where the underlying instrument is either an
equity security or a narrow-based index of equity securities.\34\ In
this case, the margin requirement was 100% of the exchange-traded
option proceeds, plus 20% of the value of the underlying equity
security or narrow-based equity index.\35\ This margin requirement on
options continues to apply if the exchange-traded option is held in a
securities account that is not subject to the Portfolio Margin
Rules.\36\
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\32\ See CFTC Rule 41.45(b) and SEC Rule 403(b).
\33\ See CFTC Rule 41.42(c)(2)(i) through (v) and SEC Rule
400(c)(2)(i) through (v).
\34\ See 2002 Adopting Release, 67 FR at 53157 (``The
Commissions believe that a security future is comparable to a short,
at-the-money option . . .''); 2001 Proposing Release, 66 FR at
50725-26 (``The Commissions propose that the initial and maintenance
margin levels required of customers for each security future carried
in a long or short position be 20 percent of the current market
value of such security future because 20 percent is the uniform
margin level required for short, at-the-money equity options traded
on U.S. options exchanges.'') (footnote omitted). In 2002, the
margin requirement for a long exchange-traded equity option with an
expiration exceeding nine months was 75% of the contract's in-the-
money amount plus 100% of the amount, if any, by which the current
market value of the option exceeded its in-the-money amount,
provided the option is guaranteed by the carrying broker-dealer and
has an American-style exercise provision. Otherwise, long exchange-
traded options were not margin eligible and the customer needed to
pay 100% of the purchase price. These requirements remain in place
for long options contracts. See FINRA Rule 4210 and Cboe Rule 10.3.
\35\ This release generally discusses security futures on
underlying equity securities and narrow-based equity security
indexes because, while permitted, no exchange has listed security
futures directly on one or more debt securities. See CFTC Rule
41.21(a)(2)(iii), 17 CFR 41.21(a)(2)(iii), and SEC Rule 6h-2, 17 CFR
240.6h-2 (both providing that a security futures may be based upon a
security that is a note, bond, debenture, or evidence of
indebtedness or a narrow-based security index composed of such
securities).
\36\ See FINRA Rule 4210 and Cboe Rule 10.3.
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However, as a result of the more recent Portfolio Margin Rules, an
unhedged short at-the-money exchange-traded equity option held in a
Portfolio Margin Account is now subject to a lower margin level. More
specifically, under the Portfolio Margin Rules, a broker-dealer can
group options, security futures, long securities positions, and short
securities positions in a customer's account involving the same
underlying security and stress the current market price for each
position at ten equidistant points along a range of positive and
negative potential future market movements using a theoretical option
pricing model that has been approved by the SEC.\37\ In the case of an
option on an equity security or narrow-based equity securities index,
the ten equidistant stress points span a range from -15% to +15% (i.e.,
-15%, -12%, -9%, -6%, -3%, +3%, +6%, +9%, +12%, +15%).\38\ The gains
and losses of each position in the portfolio are allowed to offset each
other to yield a net gain or loss at each stress point.\39\ The stress
point that yields the largest potential net loss for the portfolio is
used to determine the aggregate margin requirement for all the
positions in the portfolio.\40\
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\37\ See FINRA Rule 4210(g) and Cboe Rule 10.4.
\38\ This range of price movements (+/-) 15% is consistent with
the prescribed 15% haircut for most proprietary equity securities
positions under the SEC's net capital rule for broker-dealers. See
17 CFR 240.15c3-1(c)(2)(vi)(J).
\39\ For example, at the -6% stress point, XYZ Company stock
long positions would experience a 6% loss, short positions would
experience a 6% gain, and XYZ Company options would experience gains
or losses depending on the features of the options. These gains and
losses are added up resulting in a net gain or loss at that point.
\40\ Because options are part of the portfolio, the greatest
portfolio loss (or gain) would not necessarily occur at the largest
potential market move stress points ((+/-) 15%). This is because a
portfolio that holds derivative positions that are far out-of-the-
money would potentially realize large gains at the greatest market
move points as these positions come into the money. Thus, the
greatest net loss for a portfolio conceivably could be at any market
move stress point. In addition, the Portfolio Margin Rules impose a
minimum charge based on the number of derivative positions in the
account and that applies if the minimum charge is greater than the
largest stress point charge.
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Under the Portfolio Margin Rules, the margin requirement for a
short at-the-money exchange-traded equity option generally would be 15%
if there were no other products in the account eligible to be grouped
with the option position to form a portfolio (i.e., an unhedged
position). Consequently, the Commissions proposed to lower the required
initial and maintenance margin levels for unhedged security futures
[[Page 75115]]
from 20% to 15%.\41\ In doing so, the Commissions preliminarily viewed
unhedged exchange-traded equity options as comparable to security
futures that may be held alongside the exchange-traded equity options
in a Portfolio Margin Account.\42\ The Commissions stated that Congress
did not instruct the Commissions to set the margin requirement for
security futures at the exact level as the margin requirements for
exchange-traded equity options. Rather, pursuant to Section 7(c)(2)(B)
of the Exchange Act, the Commissions must establish margin requirements
that are ``consistent'' with the margin requirements for ``comparable''
exchange-traded equity options and set initial and maintenance margin
levels that are not lower than the lowest level of margin for the
comparable exchange-traded equity options.
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\41\ See 2019 Proposing Release, 84 FR at 36438-40.
\42\ See 2019 Proposing Release, 84 FR at 36439 (``The
Commissions are proposing to decrease the margin requirement for
unhedged security futures from 20% to 15% in order to reflect the
comparability between unhedged security futures and exchange-traded
options that are held in risk-based portfolio margin accounts.'').
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Under the proposal, unhedged security futures held in futures
accounts and securities accounts that are not Portfolio Margin Accounts
would be subject to the same initial and maintenance margin levels as
unhedged security futures held in Portfolio Margin Accounts (i.e.,
15%). Thus, the proposed 15% initial and maintenance margin levels for
unhedged security futures would bring security futures held in futures
accounts and securities accounts that are not Portfolio Margin Accounts
into alignment with the required margin level for unhedged security
futures held in Portfolio Margin Accounts. At the same time, the
amendments would not lower the required margin levels for unhedged
security futures below the lowest required margin level for unhedged
exchange-traded equity options (i.e., 15%). As discussed below, margin
levels for exchange-traded equity options are prescribed in rules
promulgated by securities SROs.\43\
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\43\ See 12 CFR 220.12(f); FINRA Rule 4210; Cboe Rule 10.3. See
also infra note 56 and accompanying text (noting securities SROs
typically set margin levels for exchange-traded equity options
through rule filings with the SEC under Section 19(b) of the
Exchange Act).
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2. Comments and Final Amendments
One commenter stated that the proposed amendments would harmonize
margin requirements, be simpler to administer and risk manage, and
better align with customer use of security futures.\44\ This commenter
stated that it has long supported securities portfolio margining and
has found the 15% margin level for unhedged positions sufficiently
robust for intermediaries to risk manage their customer positions.\45\
Other commenters, however, raised concerns with the proposal, as
discussed below.
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\44\ Letter from Walt Lukken, President & Chief Executive
Officer, Futures Industry Association (Aug. 26, 2019) (``FIA
Letter'') at 2.
\45\ FIA Letter at 2.
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Addressing Commenters' Concerns That the Proposal Is Inconsistent With
Section 7(c)(2)(B) of the Exchange Act
When proposing these amendments, the Commissions stated a
preliminary belief that they would be consistent with Section
7(c)(2)(B) of the Exchange Act.\46\ The Commissions noted that, under
that section, customer margin requirements, including the establishment
of levels of margin (initial and maintenance) for security futures,
must be consistent with the margin requirements for comparable options
traded on any exchange registered pursuant to Section 6(a) of the
Exchange Act.\47\ The Commissions stated a preliminary belief that
``[c]ertain types of exchange-traded options, no matter what type of an
account they are in, are comparable to security futures'' and therefore
the ``margin requirements for comparable exchange-traded options and
security futures must be consistent.'' \48\ Finally, the Commissions--
in proposing to lower the margin level for security futures from 20% to
15%--used the margin level for an unhedged exchange-traded equity
option held in a Portfolio Margin Account to ``establish a consistent
margin level for security futures held outside'' of a Portfolio Margin
Account.\49\
---------------------------------------------------------------------------
\46\ See 2019 Proposing Release, 84 FR at 36439-40.
\47\ Id.
\48\ Id.
\49\ Id. at 36440.
---------------------------------------------------------------------------
Some commenters stated that the 15% margin level in a Portfolio
Margin Account is prudent, given the requirements for these accounts
(e.g., risk management, account approval process, and minimum equity
required).\50\ However, these commenters stated that minimum margin
levels for security futures held outside of a Portfolio Margin Account
do not govern the levels of margin applicable for security futures held
in a Portfolio Margin Account and, similarly, that the rules governing
levels of margin for exchange-traded equity options held outside of a
Portfolio Margin Account do not govern the levels of margin for
exchange-traded equity options held in a Portfolio Margin Account. In
the commenters' view, Section 7(c)(2)(B) of the Exchange Act requires
initial and maintenance margin levels for security futures held outside
of a Portfolio Margin Account to remain at 20% because the initial and
maintenance margin levels for exchange-traded equity options held
outside a Portfolio Margin Account are 20%.
---------------------------------------------------------------------------
\50\ Letter from Angelo Evangelou, Chief Policy Officer, Cboe
Global Markets, Inc. and Shelly Brown, EVP, Strategic Planning &
Operations, MIAX Exchange Group (Aug. 26, 2019) (``Cboe/MIAX
Letter'') at 4-7.
---------------------------------------------------------------------------
Some commenters stated that the proposal ``may not be in line with
the spirit or letter'' of the CFMA and asked the Commissions to outline
how the proposal to lower the required initial and maintenance margin
levels from 20% to 15% is consistent with the CFMA.\51\
---------------------------------------------------------------------------
\51\ Letter from the Honorable Mike Bost and Rodney Davis, U.S.
Congress (Nov. 13, 2019) (``Bost/Davis Letter'') at 1.
---------------------------------------------------------------------------
Other commenters, while fully supportive of harmonizing margin
requirements, urged the Commissions to reconsider the proposal or
provide for a corresponding change to margin levels for exchange-traded
equity options to ensure any final rule is consistent with Section
7(c)(2)(B) of the Exchange Act.\52\ In making these comments, these
commenters agreed with (or did not state a disagreement with) the
Commissions' view that security futures are comparable to exchange-
traded equity options in terms of their risk characteristics and uses.
---------------------------------------------------------------------------
\52\ Letter from the Honorable Jerry Moran, Thom Tillis, and M.
Michael Rounds, U.S. Senate (Nov. 22, 2019) (``Moran/Tillis/Rounds
Letter'') at 1-2.
---------------------------------------------------------------------------
After considering these comments, the Commissions continue to
believe that it is appropriate to seek to align the required margin
levels for unhedged security futures held in a futures account (or in a
securities account that is not subject to Portfolio Margin Rules) with
the 15% margin level for unhedged exchange-traded equity options held
in a Portfolio Margin Account.\53\ The primary benefit to customers of
holding positions in a Portfolio Margin Account is the lower margin
requirements (i.e., margin levels less than 15%) that can result from
grouping and recognizing the risk-reducing offsets between positions
involving the same underlying equity security or narrow-based equity
securities index. These lower margin requirements also can increase the
amount of leverage available to customers who use Portfolio Margin
[[Page 75116]]
Accounts to trade equity positions. To address the lower margin
requirements and increased leverage that may result from grouping risk
reducing equity positions, Portfolio Margin Accounts are subject to
additional requirements, as compared to non-Portfolio Margin
Accounts.\54\
---------------------------------------------------------------------------
\53\ See 2019 Proposing Release, 84 FR at 36439.
\54\ For example, in order to open a Portfolio Margin Account, a
customer must be approved for writing uncovered options and meet
minimum equity requirements (generally ranging from $100,000 to
$500,000). In addition, Portfolio Margin Accounts are subject to
enhanced risk management procedures and additional customer
disclosure requirements. See FINRA Rule 4210(g) and Cboe Rule 10.4;
see also FINRA Portfolio Margin FAQ, available at www.finra.org.
---------------------------------------------------------------------------
An exchange-traded equity option that cannot be grouped with any
other risk reducing offsetting equity positions in a Portfolio Margin
Account (i.e., an unhedged position) does not receive the benefit of a
lower margin requirement and is subject to a 15% margin level.
Therefore, the greater leverage that can be achieved by grouping
offsetting positions is not available to the customer in the case of an
unhedged position. Given the absence of risk-reducing offsetting
positions, the risk of the unhedged position held in a Portfolio Margin
Account generally is no different than if the unhedged position was
held outside of a Portfolio Margin Account. The same is true with
respect to an unhedged security futures position held in a Portfolio
Margin Account as compared to an unhedged security futures position
held outside of a Portfolio Margin Account.
Moreover, there is no comparable portfolio margin system for
security futures held in a futures account. Therefore, an unhedged
security futures position held in a futures account is subject to the
required 20% margin level even though the risk of the position is
generally no different than if the position was held in a Portfolio
Margin Account, given the absence of risk-reducing offsetting
positions. In addition, as discussed above, in 2002, securities SROs
had not yet proposed portfolio margin rules for exchange-traded
options. With the adoption of the Portfolio Margin Rules, the lower 15%
margin level for unhedged security futures and exchange-traded options
held in Portfolio Margin Accounts became available as an alternative.
For these reasons, it is appropriate to use the margin level for an
unhedged exchange-traded equity option held in a Portfolio Margin
Account to establish a consistent margin level for security futures
held outside of a Portfolio Margin Account.
In addition, as discussed above, Section 7(c)(2)(B) of the Exchange
Act provides that: (1) The margin requirements for security futures
must be consistent with the margin requirements for comparable options
traded on any exchange registered pursuant to Section 6(a) of the
Exchange Act; and (2) the initial and maintenance margin levels for
security futures must not be lower than the lowest level of margin,
exclusive of premium, required for any comparable exchange-traded
options. The statute requires that the Commissions establish customer
margin requirements that are ``consistent'' with the margin
requirements for ``comparable'' exchange-traded options. This provides
the Commissions with some flexibility in establishing the margin levels
for security futures, provided those margin requirements do not set
initial and maintenance margin levels for security futures lower than
the lowest level of margin, exclusive of premium, required for any
comparable exchange-traded options.
Further, Section 7(c)(2)(B)(iii)(II) of the Exchange Act provides
that the initial and maintenance margin levels for security futures
must not be lower than the lowest level of margin required for any
comparable exchange-traded option. It does not specify that the initial
and maintenance margin levels must not be lower than the lowest level
of margin required with respect to a given type of account. Therefore,
it is appropriate to consider the lowest level of margin for an
unhedged exchange-traded equity option held in a Portfolio Margin
Account when setting initial and maintenance margin levels for security
futures held outside of a Portfolio Margin Account (i.e., held in a
futures account or a securities account that is not a Portfolio Margin
Account).
As discussed above, commenters requested that the Commissions
provide for a corresponding change to margin levels for exchange-traded
equity options to ensure any final rule is consistent with Section
7(c)(2)(B) of the Exchange Act. This comment is outside the scope of
this rulemaking, which is focused on margin levels for security
futures. Margin levels for exchange-traded equity options are set forth
in securities SRO rules.\55\ Securities SROs typically set margin
levels for exchange-traded equity options through rule filings with the
SEC under Section 19(b) of the Exchange Act.\56\
---------------------------------------------------------------------------
\55\ See 12 CFR 220.12(f); FINRA Rule 4210; Cboe Rule 10.3.
\56\ Under Section 19(b) of the Exchange Act, securities SROs
generally must file proposed rule changes with the SEC for notice,
public comment, and SEC approval, prior to implementation. 15 U.S.C.
78s(b). Section 19(b)(1) of the Exchange Act requires each
securities SRO to file with the SEC ``any proposed rule or any
proposed change in, addition to, or deletion from the rules of . . .
[a] self-regulatory organization.'' 15 U.S.C. 78s(b)(1).
---------------------------------------------------------------------------
Some commenters that raised concerns about the proposal's
consistency with Section 7(c)(2)(B) of the Exchange Act also stated
that the proposal would create a competitive advantage for security
futures over exchange-traded equity options through preferential margin
treatment for security futures held outside of a Portfolio Margin
Account.\57\
---------------------------------------------------------------------------
\57\ Cboe/MIAX Letter at 6.
---------------------------------------------------------------------------
These commenters noted that the Commissions recognized in 2001 that
security futures can compete with, and be an economic substitute for,
equity securities, such as equity options, and stated that the CFMA was
specifically designed to avoid regulatory arbitrage between security
futures and exchange-traded options.\58\ These commenters believed that
the proposal implies that exchange-traded options and security futures
are not competing products and that the analysis in the proposal
unfairly underestimates the utility of options.\59\ They also stated
that synthetic futures strategies are an important segment of today's
options market, and could be used to compete with security futures.
They stated that in June 2019 there were over 700,000 contracts traded
on their exchanges that replicate long and short security futures.\60\
---------------------------------------------------------------------------
\58\ Cboe/MIAX Letter at 6. See also 2001 Proposing Release, 66
FR 50721 at n.10.
\59\ Cboe/MIAX Letter at 6.
\60\ Cboe/MIAX Letter at 7.
---------------------------------------------------------------------------
The Commissions acknowledge that security futures and exchange-
traded equity options can have similar economic uses.\61\ However,
reducing the margin level for an unhedged security future held outside
of a Portfolio Margin Account to 15% should not result in a competitive
disadvantage for exchange-traded equity options, if security futures
trading resumes. First, reducing the required margin levels for
unhedged security futures to 15% will result in more consistent margin
requirements between futures and securities accounts. Second, subject
to certain requirements, customers may hold exchange-traded equity
options in a Portfolio Margin Account, in which case the margin level
for an unhedged position is 15%.
---------------------------------------------------------------------------
\61\ For example, commenters noted that to create a synthetic
long (short) futures contract, which requires two options, an
investor would buy (sell) a call option and sell (buy) a put option
on the same underlying security with the same expiration date and
strike price. Cboe/MIAX Letter at 6-7.
---------------------------------------------------------------------------
Finally, customers can hold security futures in a Portfolio Margin
Account, in which case the required margin level is 15% for an unhedged
position. Nonetheless, the vast majority of
[[Page 75117]]
security futures traded in the U.S. were held in futures accounts
subject to required initial and maintenance margin levels of 20% for
unhedged positions.\62\ Therefore, the relative advantage of a required
15% margin level as compared to a required 20% margin level did not
cause customers to migrate their security futures trading to Portfolio
Margin Accounts.
---------------------------------------------------------------------------
\62\ In its petition, OneChicago stated that ``because of
operational issues at the securities firms, almost all security
futures positions are carried in a futures account regulated by the
CFTC and not in a securities account. The proposed joint rulemaking
would permit customers carrying security futures in futures accounts
to receive margin treatment consistent with that permitted under the
[portfolio] margining provisions of CBOE.'' See OneChicago Petition
at 2 and 2019 Proposing Release 84 FR at 36440, n.67.
---------------------------------------------------------------------------
Some commenters that opposed lowering the required margin levels
from 20% to 15% stated that industry solutions and rule changes that
optimize the portfolio margining of security futures and exchange-
traded equity options, including the portfolio margining of security
futures in both securities and futures accounts, would be a more
appropriate solution.\63\
---------------------------------------------------------------------------
\63\ Cboe/MIAX Letter at 5. More specifically, to the extent
securities accounts are not operationally optimal for security
futures, the options exchanges support industry efforts to make
improvements. Id.
---------------------------------------------------------------------------
As discussed above, lowering the required margin levels from 20% to
15% is appropriate, consistent with Section 7(c)(2)(B) of the Exchange
Act, and should not disadvantage exchange-traded equity options markets
if security futures trading resumes. Moreover, the Commissions remain
committed to continuing to coordinate on issues related to harmonizing
portfolio margining rules and requirements, as well as increasing
efficiencies in the implementation of portfolio margining. Further, to
the extent securities accounts are not operationally suited for holding
security futures, the Commissions support industry efforts to address
this issue. Finally, the realization of any potential harmonization
efforts or operational improvements with respect to portfolio margining
will depend on firms offering such programs to their customers.
Response to Commenters' Request To Use Risk Models To Calculate Margin
In response to the Commissions' request for comments in the 2019
Proposing Release,\64\ some commenters stated that the Commissions'
rules should permit the use of risk models to calculate required
initial and maintenance margin levels for security futures \65\--
similar to how DCOs calculate margin requirements for futures and the
OCC calculates margin requirements for its clearing members.\66\ One of
these commenters--OneChicago--believed that the required margin levels
for security futures and the proposal to modify them were too
conservative.\67\ OneChicago characterized the Commissions' proposal
as--``at best''--``a first-step towards the risk-based margining that
is needed in the [security futures] marketplace.'' \68\ It further
stated that 92% of the security futures traded on its exchange were
``margined at a level greater than is set by the clearinghouse for
comparable products, which are equity swaps'' and that, under the
proposal, 84% would still be margined at a greater level.\69\ According
to OneChicago's analysis, the Commissions' proposal to lower the
required margin levels from 20% to 15% would have resulted in a 25%
reduction in the value of margin collected (from $540 million to $410
million) for the period between September 1, 2018, and August 1, 2019;
whereas using a margin model would have resulted in a 61% reduction
(from $540 million to $210 million).\70\
---------------------------------------------------------------------------
\64\ The Commissions asked, ``[a]re there any other risk-based
margin methodologies that could be used to prescribe margin
requirements for security futures? If so, please identify the margin
methodologies and explain how they would meet the comparability
standards under the Exchange Act.'' 2019 Proposing Release, 84 FR at
36441.
\65\ For purposes of this final rule, any references to using
``risk models'' or a ``risk model approach'' to calculate required
initial margin levels is intended to mean the same thing. While
there are different risk-based margin models, a key component of all
such margin regimes is the use of modeling to generate expected
potential future exposures that adjust over time in response to
market conditions, credit risk, and other inputs.
\66\ Letter from Thomas G. McCabe, Chief Regulatory Officer,
OneChicago (Aug. 26, 2019) (``OneChicago Letter''); Letter from
Thomas G. McCabe, Chief Regulatory Officer, OneChicago (Oct. 7,
2019) (``OneChicago Letter 2''); Letter from Thomas G. McCabe, Chief
Regulatory Officer, OneChicago (Apr. 27, 2020) (``OneChicago Letter
3''); OneChicago, April 27, 2020 OneChicago Comment Letter Summary
(``OneChicago Letter 3 Summary''); Letter from Mike Ianni,
individual (Aug. 29, 2019) (``Ianni Letter''); Letter from Scott A.
La Botz, individual (Dec. 4, 2019) (``La Botz Letter'').
\67\ OneChicago Letter at 1.
\68\ OneChicago Letter at 1.
\69\ OneChicago Letter at 1. In this release, the term
``clearinghouse'' may refer to a clearing organization or a clearing
agency.
\70\ OneChicago Letter at 14. However, as discussed in more
detail in section IV of this release, it is possible that under
certain circumstances the margin requirement under a risk-based
margin model may exceed the 15% of the current market value that is
required under the final rules.
---------------------------------------------------------------------------
OneChicago believed that the ``margin regime in place today and the
proposed margin regime incentivizes market participants to transact in
other environments.'' \71\ OneChicago stated that the trading volume on
its exchange ``has been plummeting in recent years.'' \72\ In the
exchange's view, these issues would be addressed if the Commissions
adopted a risk model approach to calculate required margin levels for
security futures. As a more limited alternative, OneChicago suggested
the Commissions could adopt a risk model approach for a class of
security futures paired transactions executed on its exchange and known
as ``securities transfer and return spreads'' (``STARS'').\73\
---------------------------------------------------------------------------
\71\ OneChicago Letter at 2.
\72\ OneChicago Letter at 14.
\73\ OneChicago Letter at 19; see also Memorandum from the SEC's
Division of Trading and Markets regarding a July 16, 2019, meeting
with representatives of OneChicago.
---------------------------------------------------------------------------
Risk models calculate margin requirements by measuring potential
future exposures based on statistical correlations between positions in
a portfolio. For example, the OCC's risk model--known as the System for
Theoretical Analysis and Numerical Simulations (``STANS'')--calculates
a clearing member's margin requirement based on full portfolio Monte
Carlo simulations.\74\ The margin requirements in place today for
exchange-traded equity options do not use risk models to calculate
margin requirements for customer positions.\75\ Rather, current rules
prescribe margin requirements as a percent of a value or other amount
of a single position or combinations of offsetting positions or, in the
case of the Portfolio Margin Rules, stress groups of related positions
across a preset range of potential percent market moves (e.g., market
moves of -15%, -12%, -9%, -6%, -3%, +3%, +6%, +9%, +12%, +15% in the
case of exchange-traded equity options).
---------------------------------------------------------------------------
\74\ More information about the OCC's STANS model is available
at https://www.theocc.com/risk-management/Margin-Methodology/.
\75\ See, e.g., FINRA Rule 4210 and Cboe Rule 10.3.
---------------------------------------------------------------------------
The Commissions' required initial and maintenance margin levels for
security futures (i.e., 20% of the current market value) are based on
the margin requirements for exchange-traded equity options and are
designed to be consistent with those requirements in accordance with
Section 7(c)(2)(B) of the Exchange Act.\76\ Consequently, implementing
a risk model approach to calculate required margin levels for security
futures would substantially alter how the required margin is calculated
(or would be calculated under these amendments) and would substantially
deviate from how customer margin requirements are calculated for
exchange-traded equity options. It also could result in required
[[Page 75118]]
initial and maintenance margin levels for unhedged security futures
that are significantly lower than the 20% margin level for unhedged
exchange-traded equity options held outside a Portfolio Margin Account
as well as the 15% margin level for unhedged exchange-traded equity
options held in a Portfolio Margin Account.
---------------------------------------------------------------------------
\76\ See 2002 Adopting Release, 67 FR at 53156-61.
---------------------------------------------------------------------------
For these reasons, implementing a risk model approach to calculate
margin for security futures would be inconsistent with how margin is
calculated for exchange-traded equity options at this time and may
result in margin levels for unhedged security futures positions that
are lower than the lowest level of margin applicable to unhedged
exchange-traded equity options (i.e., 15%). Consequently, because no
exchange-traded equity options are subject to risk-based margin
requirements, adopting a risk model approach at this time for security
futures would conflict with the requirements of Section 7(c)(2)(B) of
the Exchange Act that: (1) The margin requirements for security futures
must be consistent with the margin requirements for comparable options
traded on any exchange registered pursuant to Section 6(a) of the
Exchange Act; and (2) the initial and maintenance margin levels must
not be lower than the lowest level of margin, exclusive of premium,
required for any comparable exchange-traded options.\77\
---------------------------------------------------------------------------
\77\ In this adopting release, the Commissions are considering
OneChicago's proposed alternative risk model approach for margining
security futures. However, as the discussion herein reflects, this
alternative is not a viable one because the Commissions are not
persuaded that it would satisfy the requirements of Section
7(c)(2)(B) of the Exchange Act at this time.
---------------------------------------------------------------------------
To address the conflict between a risk model approach and Section
7(c)(2)(B) of the Exchange Act, OneChicago argued that the Commissions
could adopt a risk model approach because Section 7(c)(2)(B) of the
Exchange Act can be read to require that the level of protection
provided to the marketplace by the margin requirements for security
futures must be consistent with the level of protection provided by the
margin requirements for exchange-traded options.\78\ Similarly,
OneChicago argued that the statute can be construed to require that the
level of protection provided by the margin requirements for security
futures (rather than the margin levels) must not be lower than the
lowest level of protection provided by the margin requirements for
exchange-traded options.
---------------------------------------------------------------------------
\78\ See OneChicago Letter at 30-35.
---------------------------------------------------------------------------
OneChicago pointed out that Section 7(c)(2)(B)(iii)(I) of the
Exchange Act provides that ``margin requirements'' for a security
future product must be consistent with the margin requirements for
comparable option contracts traded on any exchange registered under the
Exchange Act. OneChicago further noted that Section 7(c)(2)(B)(iv) of
the Exchange Act also uses the phrase ``margin requirements'' but then
qualifies it by excluding ``levels of margin'' from its provisions
regarding consistency with Regulation T. Thus, OneChicago concluded
that the phrase ``margin requirements'' in Section 7(c)(2)(B)(iii)(I)
of the Exchange Act can be read to mean all aspects of margin
requirements, including margin levels and the type, form, and use of
collateral for security futures products.
OneChicago also argued that futures-style margining includes daily
pay and collect variation margining, and options-style margining--in
its view--does not include variation margining.\79\ Consequently,
OneChicago believed that, if Section 7(c)(2)(B)(iii)(I) of the Exchange
Act is read to relate to levels of margin, the Commissions would be
required to implement a daily pay and collect variation margin feature
for options (or to eliminate this feature from the security futures
margin requirements) in order to achieve the consistency required by
the statute. OneChicago argued that this does not make sense and,
therefore, the better reading of the statute is that it requires the
level of protection provided by the security futures margin
requirements to be consistent with and not lower than the lowest level
of protection provided by the margin requirements for comparable
exchange-traded options. And, according to OneChicago, in analyzing the
level of protection provided by futures-style margining, the
Commissions can consider the daily pay and collect variation margin
feature to find that a risk model approach to calculating margin would
be consistent with Section 7(c)(2)(B)(iii) of the Exchange Act.
---------------------------------------------------------------------------
\79\ For purposes of this discussion, the Commissions understand
the phrase ``futures-style margining'' to refer to initial margin
requirements based on the use of risk models, as well as the daily
settlement of variation margin based on marking open positions to
market. ``Options-style margining'' will refer to initial and
maintenance margin requirements for exchange-traded equity options
under the Exchange Act.
---------------------------------------------------------------------------
The Commissions agree with OneChicago that the phrase ``margin
requirements'' in Section 7(c)(2)(B)(iii)(I) of the Exchange Act refers
to all aspects of margin requirements, including margin levels and the
type, form, and use of collateral for security futures products.
However, the Commissions do not agree that the ``consistent with'' and
``not lower than'' restrictions in the statute do not apply to levels
of margin. Section 7(c)(2)(B)(iii)(II) of the Exchange Act states, in
pertinent part, that ``initial and maintenance margin levels for a
security future product [must] not be lower than the lowest level of
margin, exclusive of premium, required for any comparable option
contract traded on any exchange'' registered under the Exchange Act
(emphasis added).\80\
---------------------------------------------------------------------------
\80\ The prefatory text of Sections 7(c)(2)(B)(iii)(I) and (II)
of the Exchange Act also uses the term ``levels of margin.'' In
particular, it provides that the Federal Reserve Board or the
Commissions, pursuant to delegated authority, shall prescribe
``regulations to establish margin requirements, including the
establishment of levels of margin (initial and maintenance) for
security futures products under such terms, and at such levels,'' as
the Federal Reserve Board or the Commissions deem appropriate
(emphasis added).
---------------------------------------------------------------------------
Moreover, the legislative history of the CFMA includes an earlier
bill.\81\ In that earlier bill, the provisions governing the setting of
margin requirements for security futures did not include the
``consistent with'' and ``not lower than'' restrictions in Sections
7(c)(2)(B)(iii)(I) and (II) of the Exchange Act, respectively.\82\
Instead, the earlier bill would have required that the margin
requirements for security futures must ``prevent competitive
distortions between markets offering similar products.'' \83\ The
Senate Report on the earlier bill explained that ``[u]nder the bill,
margin levels on [security future] products would be required to be
harmonized with the options markets.'' \84\ Thus, while the text of the
earlier bill was not as explicit in terms of articulating the
``consistent with'' and ``not lower than'' restrictions, the Senate
Report indicates that the objective was to harmonize margin levels
between security futures and options to prevent competitive
distortions. This objective was clarified in the text of Section
7(c)(2)(B) of the Exchange Act, as enacted. In light of this statutory
text and the legislative history, the best reading of the statute is
that the ``consistent with'' and ``not lower than'' restrictions apply
to levels of margin.
---------------------------------------------------------------------------
\81\ See S. Report 106-390 (Aug. 25, 2000).
\82\ See id. at 39-40.
\83\ Id. at 39.
\84\ Id. at 5 (emphasis added).
---------------------------------------------------------------------------
Consequently, the levels of margin for unhedged security-futures
must be consistent with the margin levels for comparable unhedged
exchange-traded equity options, and not lower than the lowest level of
margin for comparable unhedged exchange-traded equity options.
Currently, the margin levels for comparable unhedged exchange-traded
[[Page 75119]]
equity options are determined through a percent of a value. Therefore,
using a risk model approach for security futures would be inconsistent
with how margin levels are currently determined for comparable
exchange-traded equity options. Further, at this time, the lowest level
of margin for comparable unhedged exchange-traded equity options is
15%. Accordingly, the margin levels for unhedged security futures
cannot be lower than 15%.
OneChicago also cited legislative history to support its reading of
the statute.\85\ First, OneChicago cited statements that it believed
demonstrated that ``Congress intended to prevent the market for
security futures from being ceded to overseas competitors'' and that
``Congress wanted to ensure that U.S. exchanges had the potential to
compete with these product offerings in overseas markets.'' \86\
However, these statements do not bear on whether Sections
7(c)(2)(B)(iii)(I) and (II) of the Exchange Act apply to levels of
margin. Rather, if OneChicago's view of Congressional intent is
correct, it would support the notion that the CFMA was designed to
establish a U.S. market for security futures to compete with overseas
markets.\87\ Further, Sections 7(c)(2)(B)(iii)(I) and (II) require a
comparison of security futures margin requirements to U.S. exchange-
traded option margin requirements--not to requirements of overseas
security futures markets. For these reasons, these statements do not
support OneChicago's reading of the statute or conflict with the
Commissions' reading of the statute.
---------------------------------------------------------------------------
\85\ OneChicago Letter at 30-32.
\86\ OneChicago Letter at 30. The Commissions address comments
relating to the competition with foreign securities markets in
section IV below (including the CFTC's consideration of the costs
and benefits of the amendments and the SEC's economic analysis,
including costs and benefits, of the amendments).
\87\ The CFMA ended the prohibition on trading security futures
in the United States at a time when this product was traded in
overseas markets.
---------------------------------------------------------------------------
Second, OneChicago cited statements that it believed demonstrated
``[t]here was concern, especially from options industry participants
that [security futures] would directly compete with options and
Congress wanted to make sure that participants did not migrate between
futures and options for regulatory reasons'' and that ``Congress wanted
to avoid regulatory arbitrage.'' \88\ It cited the following statements
in support of this view:
---------------------------------------------------------------------------
\88\ OneChicago Letter at 30.
[T]he bill requires that margin treatment of stock futures must
be consistent with the margin treatment for comparable exchange-
traded options. This ensures that margin levels will not be set
dangerously low and that stock futures will not have an unfair
competitive advantage vis-a-vis stock options.\89\
---------------------------------------------------------------------------
\89\ See 146 Cong. Rec. H12497 (daily ed. Dec. 15, 2000)
(Commodity Futures Modernization Act of 2000, speech of Rep.
Dingell, Dec. 15, 2000) (emphasis added).
---------------------------------------------------------------------------
Our bill would also provide for joint jurisdiction with each
agency maintaining its core authorities over the trading of single-
stock users. The legislation would further require that margin
levels on these products be harmonized with the options market.\90\
---------------------------------------------------------------------------
\90\ See S. 2697--The Commodity Futures Modernization Act of
2000, Joint Hearing Before the Committee on Agriculture, Nutrition,
and Forestry United States Senate and the Committee on Banking,
Housing, and Urban Affairs, (June 21, 2000) (``Senate Hearing'') at
3, statement of Sen. Lugar (emphasis added).
---------------------------------------------------------------------------
The SEC has always been charged with protecting investors and
providing full and fair disclosure of corporate market information
and preventing fraud and manipulation. The CFTC regulates commercial
and professional hedging and speculation in an institutional
framework. CFTC cannot regulate insider trading. Margin requirements
are different. I hate to see investors shopping as to which
instrument to use or to buy for that reason. So neither regulation
nor the lack of it should pick winners and losers among products or
exchanges and fair competition should.\91\
---------------------------------------------------------------------------
\91\ See Senate Hearing at 28, statement of Sen. Schumer.
OneChicago argued that these statements indicated that ``[b]ill
sponsors made a point to emphasize that they wanted market forces and
not margin levels to determine winners and losers'' and that ``[m]argin
needed to be set at a level that prevented it from impacting a market
participant's decision on what products to trade.'' \92\ However, the
Congressional concerns and statements identified by OneChicago--that
security futures should not have an unfair competitive advantage over
exchange-traded options--support a reading of Sections
7(c)(2)(B)(iii)(I) and (II) of the Exchange Act that is consistent with
the approach the Commissions are adopting here, namely that the margin
levels for security futures must be consistent with and not lower than
the lowest level of margin for comparable exchange-traded options.
---------------------------------------------------------------------------
\92\ OneChicago Letter at 30-31.
---------------------------------------------------------------------------
Contrary to OneChicago's view, the statute does not provide a
mechanism that would permit the Commissions to recalibrate margin
requirements for security futures to foster greater use of the product.
Rather, it contains restrictions that were designed to ensure that the
margin requirements for these products were consistent with the margin
requirements for comparable exchange-traded options, and not lower than
the lowest level of margin for comparable exchange-traded options. This
reading of the statute is supported by the following statement from the
legislative history of the CFMA that OneChicago did not cite:
A provision in the bill directs that initial and maintenance
margin levels for a security future product shall not be lower than
the lowest level of margin, exclusive of premium, required for any
comparable option contract traded on any exchange registered
pursuant to section 6(a) of the Exchange Act of 1934. In that
provision, the term lowest is used to clarify that in the potential
case where margin levels are different across the options exchanges,
security future product margin levels can be based off the margin
levels of the options exchange that has the lowest margin levels
among all the options exchanges. It does not permit security future
product margin levels to be based on option maintenance margin
levels. If this provision were to be applied today, the required
initial margin level for security future products would be 20
percent, which is the uniform initial margin level for short at-the
money equity options traded on U.S. options exchanges.\93\
---------------------------------------------------------------------------
\93\ See 146 Cong. Rec. E1879 (daily ed. Oct. 23, 2000)
(Commodity Futures Modernization Act of 2000, speech of Rep. Markey,
Oct. 19, 2000) (emphasis added). As discussed above, the Commissions
implemented the CFMA establishing 20% initial and maintenance margin
levels for security futures.
Further, implementing a risk model approach in order to lower the
margin requirements to levels in the way OneChicago suggested could
create an incentive for market participants to trade security futures,
if security futures trading resumes, rather than exchange-traded
options precisely because of the more favorable margin treatment.
Based on the text of Section 7(c)(2)(B) of the Exchange Act and the
legislative history (including the legislative history cited by
OneChicago), the better reading of the statute is that it applies to
levels of margin, and requires that initial and maintenance margin
levels for security futures be: (1) Consistent with margin levels for
comparable exchange-traded options; and (2) not lower than the lowest
level of margin for comparable exchange-traded options. Currently, the
lowest level of margin for an unhedged exchange-traded equity option is
15%. Consequently, a 15% margin level is the lowest level of margin
permitted for an unhedged security future.\94\
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\94\ OneChicago argued that the Commissions could compare
unhedged security futures to unhedged long option positions. See
OneChicago Letter at 35. In its view, the initial and maintenance
margin requirement for a long option is 0% and, therefore, a margin
level for security futures that is lower than 15% would be
appropriate. As discussed earlier, the margin level is 75% for
certain long unhedged options with maturities greater than 9 months.
However, this margin requirement relates to financing the purchase
of a long option position. Unlike the case with an unhedged short
option, the margin does not serve as a performance bond to secure
the customer's obligations if the option is assigned to be
exercised. Initial margin for a security future serves as a
performance bond. See, e.g., OneChicago Letter at 4. Long options
that do not meet the requirements to be subject to the 75% margin
level must be paid in full. Thus, from a financing perspective, they
have a 100% margin requirement (i.e., they cannot be purchased
through an extension of credit by the broker-dealer). For these
reasons, the margin requirements for unhedged long exchange-traded
options are not comparable to the margin requirements for security
futures.
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[[Page 75120]]
OneChicago argued further that ``the margins have not been
harmonized and are not consistent'' because security futures ``have
variation pay/collect while options do not, which makes a strict
comparison of initial margin percentages inappropriate.'' \95\
OneChicago stated that the concept of daily variation margin plays a
critical role in the margin framework for security futures, and it
believed that the failure to take variation margin into account biases
the Commissions' margin rule against security futures.\96\ OneChicago
believed that variation margin rather than minimum initial and
maintenance margin levels more effectively protects customers.\97\
OneChicago argued that ``the level of initial and maintenance margin
should be considered not lower than comparable options when it provides
a level of protection against default that is not lower than comparable
options'' and that this ``reading would support the Commissions
considering variation margin when looking at the appropriate level of
initial margin.'' \98\
---------------------------------------------------------------------------
\95\ OneChicago Letter at 31.
\96\ OneChicago at 4-5; OneChicago Letter 2 at 5-6.
\97\ OneChicago Letter at 7.
\98\ OneChicago Letter at 34.
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The Commissions, when adopting the margin requirements for security
futures in 2002, modified the proposal to incorporate the concept of
daily pay and collect variation margining into the final rules.\99\
Variation settlement is any credit or debit to a customer account, made
on a daily or intraday basis, for the purpose of marking-to-market a
security future issued by a clearing agency or cleared and guaranteed
by a DCO.\100\ Therefore, in prescribing the required initial and
maintenance margin levels for security futures, the Commissions' rules
also account for daily variation margining.\101\
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\99\ See CFTC Rules 41.43(a)(32), 41.46(c)(1)(vi) and
(c)(2)(iii), and 41.47(b)(1), and SEC Rules 401(a)(32),
404(c)(1)(vi) and (c)(2)(iii), and 405(b)(1).
\100\ See CFTC Rule 41.43(a)(32) and SEC Rule 401(a)(32).
\101\ See 2002 Adopting Release, 67 FR at 53157. See also FRB
Letter (``The authority delegated by the Board is limited to
customer margin requirements imposed by brokers, dealers, and
members of national securities exchanges. It does not cover
requirements imposed by clearing agencies on their members.'') and
2019 Proposing Release, 84 FR at 36435 at n.6 (describing variation
settlement and maintenance margin).
---------------------------------------------------------------------------
The variation margin component of the futures and security futures
margining regimes settles the mark-to-market gains or losses on the
positions on a daily basis with FCMs collecting payments from their
customers and DCOs collecting payments from FCMs. The margin
requirements for exchange-traded equity options also account for daily
mark-to-market gains or losses on an option position. In particular,
margin rules for exchange-traded equity options require that a customer
maintain a minimum level of equity in the account (i.e., an amount that
equals or exceeds the maintenance margin requirement). A mark-to-market
gain will increase account equity and a loss will decrease account
equity potentially generating a requirement for the customer to post
additional collateral to maintain the minimum account equity
requirement (i.e., the maintenance margin requirement). In this way,
the margin requirements for exchange-traded equity options cover the
broker-dealer's exposure to the credit risk that arises when the
customer's position incurs a mark-to-market loss, just as daily pay and
collect variation margining protects the security futures intermediary.
Further, if a customer's security futures position has a mark-to-
market gain, the clearing agency or DCO will pay the amount of the gain
to the security futures intermediary. This is the pay feature of
futures-style variation margining. However, if that variation margin
payment remains in the customer's account at the security futures
intermediary, the customer continues to have credit risk exposure to
the intermediary. Similarly, if a customer's exchange-traded equity
option has a mark-to-market gain that results in the account having
equity above the maintenance margin requirement, the customer will have
credit exposure to the broker-dealer with respect to the excess equity
in the account.
For these reasons, the Commissions do not believe that the
variation margin requirements for futures and security futures are a
unique feature that is absent from the margin requirements for
exchange-traded options insomuch as both requirements address mark-to-
market changes in the value of the positions.\102\ Further, there is no
basis to conclude that the variation settlement process for security
futures when coupled with a risk model approach to calculating required
initial and maintenance margin levels for security futures would be
consistent with the margin requirements for exchange-traded equity
options. The margin requirements for exchange-traded equity options
also account for changes in the mark-to-market value of the options,
but they do not use risk models to calculate initial and maintenance
margin levels.
---------------------------------------------------------------------------
\102\ See, e.g., SEC, Self-Regulatory Organizations;
Philadelphia Stock Exchange, Inc.; Order Approving Proposed Rule
Change and Amendments Thereto, Exchange Act Release No. 22189 (June
28, 1985) at n.10 (``Maintenance margin in the securities industry
and variation margin in the commodities industry are basically
intended to serve the same purposes'').
---------------------------------------------------------------------------
Moreover, as acknowledged by OneChicago, a risk model approach to
calculating required initial and maintenance margin levels for unhedged
security futures could result in margin levels that are significantly
lower than the 20% margin level for exchange-traded equity options held
outside a Portfolio Margin Account as well as the 15% margin level for
exchange-traded equity options held inside a Portfolio Margin
Account.\103\ Consequently, given the ``not lower than restriction'' of
Section 7(c)(2)(B)(iii)(II) of the Exchange Act, it would not be
appropriate to set initial and maintenance margin levels for security
futures using a risk model approach insofar as exchange-traded equity
options are not permitted to rely upon a risk model approach.
---------------------------------------------------------------------------
\103\ See, e.g., OneChicago Letter at 1 and 14.
---------------------------------------------------------------------------
As an alternative to the statutory construction argument discussed
above, OneChicago stated that ``the Commissions can recognize that the
concern at the time of the CFMA, that options and [security futures]
would trade interchangeably, was unfounded as options and [security
futures] are not comparable products.'' \104\ Consequently, Section
7(c)(2)(B)(iii)--in OneChicago's view--``was written into the Exchange
Act in case the products proved comparable; because they have proven to
not be comparable, it no longer needs to bind upon financial markets.''
\105\ Relatedly, OneChicago also argued that there are no exchange-
traded options that are comparable to security futures and, therefore,
the ``consistent with'' and ``not lower than'' restrictions of Section
7(c)(2)(B)(iii) of the Exchange Act are not implicated.
---------------------------------------------------------------------------
\104\ See OneChicago Letter at 35.
\105\ Id.
---------------------------------------------------------------------------
The Commissions stated a preliminary belief when proposing the
reduction of the required margin levels from 20% to 15% that an
unhedged
[[Page 75121]]
security future was comparable to an unhedged exchange-traded equity
option held in a Portfolio Margin Account.\106\ This belief was
grounded on the Commissions' view--when adopting the margin
requirements for security futures--that an unhedged short at-the-money
exchange-traded equity option is comparable to a security future.\107\
---------------------------------------------------------------------------
\106\ See 2019 Proposing Release, 84 FR at 36435, 36438-40.
\107\ See 2002 Adopting Release, 67 FR at 53157; 2001 Proposing
Release 66 FR at 50725-26.
---------------------------------------------------------------------------
OneChicago stated that security futures products are not comparable
to exchange-traded equity options because the latter have different
risk profiles than security futures, including dividend risk, pin risk,
and early assignment risk.\108\ Further, OneChicago stated that
security futures are used for different purposes than exchange-traded
equity options.\109\ In this regard, OneChicago noted that security
futures are delta one derivatives used in equity finance transactions
and that they compete with other delta one transactions such as total
return swaps, master security lending agreements, and master security
repurchase agreements.\110\ OneChicago commented that equity financing
transactions can be used to provide customers with synthetic (long)
exposure to a notional amount of a security, while the financing
counterparty pre-hedges the position by accumulating an equivalent
position in the underlying shares.\111\
---------------------------------------------------------------------------
\108\ OneChicago Letter at 2, 9; OneChicago Letter 2 at 1-2.
\109\ OneChicago Letter at 2-3.
\110\ Delta one derivatives are financial instruments with a
delta that is close or equal to one. Delta measures the rate of
change in a derivative relative to a unit of change in the
underlying instrument. Delta one derivatives have no optionality,
and therefore, as the price of the underlying instrument moves, the
price of the derivative is expected to move at, or close to, the
same rate. See also 2019 Proposing Release, 84 FR 36435, at n.14.
\111\ OneChicago Letter at 2.
---------------------------------------------------------------------------
OneChicago also provided statistical data and analysis to support
its contention that security futures are not comparable to exchange-
traded equity options.\112\ In particular, OneChicago provided
statistical data comparing trade size (number of contacts and notional
value) between options and security futures and comparing security
futures delivery rates with options exercise rates.\113\ OneChicago
stated that the delivery data makes ``clear'' that the ``markets view
and use the products differently.'' \114\ OneChicago also provided
statistical data on correlations between open interest in security
futures and equity options.\115\ OneChicago stated that the data
results show no correlation between changes in open interest in
security futures and options.\116\
---------------------------------------------------------------------------
\112\ The Commissions address the statistical data and analysis
provided by OneChicago in more detail in section IV of this release.
In addition to the statistical data and analysis discussed below,
OneChicago provided statistical data and analysis on possible
correlations between changes in price of the underlying security and
changes in trading activity in security futures and equity options
(i.e., sensitivity to underlying price moves). OneChicago Letter 3
at 12-13. OneChicago stated that the results of this analysis were
ambiguous. OneChicago Letter 3 Summary at 1.
\113\ OneChicago Letter 3 at 9-11.
\114\ OneChicago Letter 3 Summary at 1.
\115\ OneChicago Letter 3 at 14-15.
\116\ OneChicago Letter 3 Summary at 1.
---------------------------------------------------------------------------
After considering these comments, the Commissions note that under
Section 7(c)(2)(b)(iii)(I) of the Exchange Act, customer margin
requirements for security futures must be consistent with the margin
requirements for comparable exchange-traded options. The Commissions
recognize that security futures may not be identical to exchange-traded
equity options and that there are differences between the products in
terms of their risk characteristics and how they are used by market
participants. However, the Commissions continue to believe that the
approach taken in this release, with respect to margin levels, is sound
because these products generally share similar risk profiles for
purposes of assessing margin insofar as both products provide exposure
to an underlying equity security or narrow-based equity security
index.\117\ Thus, both products can be used to hedge a long or short
position in the underlying equity security or narrow-based equity
security index. Each product also can be used to speculate on a
potential price movement of the underlying equity security or narrow-
based equity security index. Consequently, a financial intermediary's
potential exposure to a customer's unhedged security future or unhedged
exchange-traded equity option position is based on the market risk
(i.e., price volatility) of the underlying equity security or narrow-
based equity security index.
---------------------------------------------------------------------------
\117\ Derivatives may be broadly described as instruments or
contracts whose value is based upon, or derived from, some other
asset or metric. See also Risk Disclosure Statement for Security
Futures Contracts, available at https://www.nfa.futures.org/members/member-resources/files/security-futures-disclosure.pdf and
Characteristics and Risks of Standardized Options, available at
https://www.theocc.com/about/publications/character-risks.jsp.
---------------------------------------------------------------------------
In addition, both short security futures positions and certain
exchange-traded options strategies produce unlimited downside risk.
Investors in security futures and writers of options may lose their
margin deposits and premium payments and be required to pay additional
funds. In addition, a very deep-in-the money call or put option on the
same security (with a delta of one) is an option contract comparable to
a security futures contract. Further, as discussed above, one commenter
contends that synthetic futures strategies are an important segment of
today's options markets, that could compete with security futures, if
trading in security futures resumes.
The margin requirements for security futures and short unhedged
exchange-traded equity options are designed to ensure that the customer
can perform on the contractual obligations imposed by these products.
For these reasons, security futures and short exchange-traded equity
options can be appropriately considered to be comparable products for
the purposes of setting appropriate margin levels for security futures
consistent with the provisions of Section 7(c)(2)(B) of the Exchange
Act.\118\ OneChicago also argued that the Commissions should compare
the customer margin requirements for security futures with the margin
requirements for over-the-counter total return swaps, equity index
futures, and security futures traded overseas.\119\ In response,
Section 7(c)(2)(B) of the Exchange Act provides that the margin
requirements for security futures must be consistent with the margin
requirements for comparable options traded on any exchange registered
pursuant to Section 6(a) of the Exchange Act. The statute does not
directly contemplate comparisons with the margin requirements for the
products and markets identified by OneChicago. Rather, it requires
comparisons to comparable exchange-traded options.
---------------------------------------------------------------------------
\118\ See 2019 Proposing Release, 84 FR at 36436.
\119\ OneChicago Letter at 11.
---------------------------------------------------------------------------
In this context, an unhedged security future is comparable to an
unhedged exchange-traded equity option held in a Portfolio Margin
Account for the purposes of setting margin requirements under Section
7(c)(2)(B) of the Exchange Act.
As an alternative to implementing a risk model approach for all
security futures, OneChicago suggested implementing it on a more
limited basis for security futures combinations that result in STARS
transactions.\120\ A STARS transaction combines two security futures to
form a spread position. The front leg of the spread expires on the date
of the STARS
[[Page 75122]]
transaction and the second (or back) leg expires at a distant date.
OneChicago believed that a STARS transaction would be a substitute for
an equity repo or stock loan transaction with the transfer of stock and
cash accomplished through a security future transaction.\121\
OneChicago suggested that it would be appropriate to margin STARS
transactions at risk-based levels since they are exclusively used for
equity finance transactions.\122\ OneChicago also argued that risk-
based margin treatment for a STARS transaction would be consistent with
the Exchange Act and argued that there are no comparable options that
trade as a spread on a segregated platform and no combinations of
options can replicate the mechanics of a STARS transaction.\123\
---------------------------------------------------------------------------
\120\ OneChicago Letter at 19; see also Memorandum from the
Division of Trading and Markets regarding a July 16, 2019, meeting
with representatives of OneChicago (July 29, 2019).
\121\ OneChicago Letter at 19-20. OneChicago noted that the
expiration of the front leg results in a transfer of securities for
cash on the next business day following the trade date (T+1). When
the back leg expires, OneChicago noted that a reversing transaction
takes place that returns both parties to their original positions.
OneChicago Letter at 19.
\122\ OneChicago Letter at 19-20.
\123\ OneChicago Letter at 36.
---------------------------------------------------------------------------
The Commissions note that OneChicago has discontinued trading
operations and is no longer offering STARS transactions. However,
combining security futures into a STARS transaction does not change the
fundamental nature of the security futures involved in the
transaction--they remain security futures. In addition, as noted above,
the front leg of the spread expires on the date of the STARS
transaction, leaving only a single security future position in the
customer's account until the expiration of the back leg at a later
date. Consequently, for the reasons discussed above, it would not be
consistent with Section 7(c)(2)(B) of the Exchange Act to implement a
risk margin approach for security futures that are combined to create a
STARS transaction.
To summarize, the Commissions are not persuaded by OneChicago's
arguments that, at this time, implementing a risk model approach to
calculating margin for security futures would be permitted under
Section 7(c)(2)(B) of the Exchange Act. Moreover, implementing a risk
model approach would substantially alter how the required minimum
initial and maintenance margin levels for security futures are
calculated. It also would be a significant deviation from how margin is
calculated for listed equity options and other equity positions (e.g.,
long and short securities positions). It would not be appropriate at
this time to implement a different margining system for security
futures, given their relation to products that trade in the U.S. equity
markets. Implementing a different margining system for security futures
may result in substantially lower margin levels for these products as
compared with other equity products and could have unintended
competitive impacts.\124\ For these reasons, even if the Commissions
were persuaded at this time that OneChicago's interpretation was
permitted by the statute, the Commissions would not agree that it was
the appropriate interpretation.
---------------------------------------------------------------------------
\124\ See sections IV.A.6. (CFTC--Discussion of Alternatives)
and IV.B.5. (SEC--Reasonable Alternatives Considered) (each
discussing the use of risk-based margin models as an alternative to
the final rule amendments in this release).
---------------------------------------------------------------------------
Consequently, the Commissions are adopting the amendments to reduce
the required initial and maintenance margin levels for an unhedged
security futures position from 20% to 15%, as proposed.\125\
---------------------------------------------------------------------------
\125\ The Commissions continue to believe that these
amendments--because they relate to levels of margin--do not
implicate the requirement in Section 7(c)(2)(B)(iv) of the Exchange
Act that margin requirements for security futures (other than levels
of margin), including the type, form, and use of collateral, must be
consistent with the requirements of Regulation T. The Commissions
did not receive any comments objecting to this view.
---------------------------------------------------------------------------
The Commissions' margin requirements continue to permit SRAs and
security futures intermediaries to establish higher margin levels and
to take appropriate action to preserve their financial integrity.\126\
OneChicago advocated for two modifications to this provision of the
margin rules for security futures.\127\ First, it suggested that only
exchanges and clearinghouses that list and clear security futures
products be given the authority to set higher margin levels, because
they control the margin levels and thus the competitiveness of the
competing venues.\128\ In support of this suggestion, it identified an
exchange that has prescribed 20% margin levels for security futures
even though it does not list any security futures.\129\ Relatedly,
OneChicago recommended that the Commissions require that margin levels
be set higher than the proposed 15% minimum level if justified by the
risk of the security future and noted that while one SRA might set
higher levels based on risk, another SRA may maintain the 15%
levels.\130\
---------------------------------------------------------------------------
\126\ See CFTC Rule 41.42(c)(1) and SEC Rule 400(c)(1). See 2019
Proposing Release, 84 FR at 36440.
\127\ OneChicago Letter at 17.
\128\ OneChicago Letter at 17.
\129\ The NYSE has rules related to margin levels for security
futures, but it does not list any security futures.
\130\ OneChicago Letter at 17.
---------------------------------------------------------------------------
After considering these comments, the Commissions are not
incorporating OneChicago's suggested modifications regarding
establishing higher margin levels. The security futures margin rules
establish minimum levels and do not set any limitations as to maximum
levels. SRAs, including clearinghouses, and security futures
intermediaries are permitted to raise margin requirements above 15% if
justified by the risk of a security futures position. In addition,
security futures intermediaries also are subject to rules that require
them to raise margin requirements where appropriate to manage credit
risk in customer accounts.\131\ These rules provide SRAs and security
futures intermediaries important flexibility to manage risk as they
deem appropriate, including the ability to increase margin requirements
for specific positions or customer accounts. Limiting the ability to
increase margin requirements only to exchanges and clearinghouses that
list and clear security futures would be inconsistent with this
approach. For these reasons, it would not be appropriate to modify the
provisions in the security futures margin requirements permitting SRAs
and security futures intermediaries to set higher margin levels as
suggested by OneChicago.
---------------------------------------------------------------------------
\131\ See e.g., FINRA Rule 4210(d) which requires FINRA members
to establish procedures to: (1) Review limits and types of credit
extended to all customers; (2) formulate their own margin
requirements; and (3) review the need for instituting higher margin
requirements, mark-to-markets and collateral deposits than are
required by FINRA's margin rule for individual securities or
customer accounts; see also FINRA Rule 4210(f)(8) (providing
authority for FINRA, if market conditions warrant, to implement
higher margin requirements). See e.g., 17 CFR 1.11 (CFTC Rule 1.11)
(requiring FCMs to establish risk management programs that address
market, credit, liquidity, capital and other applicable risks,
regardless of the type of margining offered). See also National
Futures Association (``NFA'') Rule 2-26 FCM and IB Regulations,
which states that any member or associate who violates CFTC Rule
1.11 (and other rules) shall be deemed to have violated an NFA
requirement.
---------------------------------------------------------------------------
B. Conforming Revisions to the Strategy-Based Offset Table
1. The Commissions' Proposal
The Commissions' rules permit an SRA to set margin levels that are
lower than 20% of the current market value of the security future in
the case of an offsetting position involving security futures and
related positions.\132\ The SRA rules must meet the four criteria set
forth in Section 7(c)(2)(B) of the Exchange Act and must be effective
in accordance with Section 19(b)(2) of the
[[Page 75123]]
Exchange Act and, as applicable, Section 5c(c) of the CEA.\133\ In
connection with these provisions governing SRA rules, the Commissions
published the Strategy-Based Offset Table.\134\
---------------------------------------------------------------------------
\132\ See CFTC Rule 41.45(b)(2) and SEC Rule 403(b)(2). See also
2002 Adopting Release, 67 FR at 53158-61.
\133\ Section 19(b)(2) of the Exchange Act governs SRA
rulemaking with respect to SEC registrants, and Section 5c(c) of the
CEA governs SRA rulemaking with respect to CFTC registrants.
\134\ See 2002 Adopting Release, 67 FR at 53158-61.
---------------------------------------------------------------------------
The Commissions stated the belief that the offsets identified in
the Strategy-Based Offset Table were consistent with the strategy-based
offsets permitted for comparable offsetting positions involving
exchange-traded options.\135\ The Commissions further stated the
expectation that SRAs seeking to permit trading in security futures
will submit to the Commissions proposed rules that impose levels of
required margin for offsetting positions involving security futures in
accordance with the minimum margin requirements identified in the
Strategy-Based Offset Table. SRAs have adopted rules consistent with
the Strategy-Based Offset Table.\136\
---------------------------------------------------------------------------
\135\ Id. at 53159.
\136\ See, e.g., FINRA Rule 4210(f)(10) and Cboe Rule 10.3(k).
---------------------------------------------------------------------------
The Commissions proposed to re-publish the Strategy-Based Offset
Table to conform it to the proposed 15% required margin levels.\137\
The re-published Strategy-Based Offset Table would incorporate the 15%
required margin levels for certain offsetting positions (as opposed to
the current 20% levels) and would retain the same percentages for all
other offsets.
---------------------------------------------------------------------------
\137\ See 2019 Proposing Release, 84 FR at 36441-36443.
---------------------------------------------------------------------------
2. Comments and the Re-Published Strategy-Based Offset Table
OneChicago recommended several changes to the Strategy-Based Offset
Table, as proposed to be revised. First, OneChicago suggested reducing
the margin requirement for ``delta-neutral'' positions from 5% to the
lower of: (1) The total calculated by multiplying $0.375 for each
position by the instrument's multiplier, not to exceed the market value
in the case of long positions, or (2) 2% of the current market value of
the security futures contract.\138\ These recommended changes would not
be appropriate. The 5% requirement was based on the minimum margin
required by rules of securities SROs for offsetting long and short
positions in the same security.\139\ The 5% margin requirement for this
strategy continues to exist in current securities SRO rules.\140\
Accordingly, lowering the requirement as recommended by OneChicago
would not be consistent with Section 7(c)(2)(B) of the Exchange Act.
---------------------------------------------------------------------------
\138\ OneChicago Letter at 15. This recommendation would apply
to items 4, 10, 13, 17, 18, and 19 in the Strategy-Based Offset
Table, as proposed to be revised. See 2019 Proposing Release, 84 FR
at 36441-43.
\139\ See 2002 Adopting Release, 67 FR at 53158, n.187.
\140\ See, e.g., FINRA Rule 4210(e)(1).
---------------------------------------------------------------------------
OneChicago also requested that the Commissions incorporate total
return equity swaps into the Strategy-Based Offset Table.\141\
OneChicago stated that total return equity swaps are an exact
substitute for security futures. OneChicago did not specify whether it
was referring to cleared or non-cleared total return equity swaps. In
either case, it would not be appropriate to include them in the
Strategy-Based Offset Table. Securities SRO margin rules for options do
not, at this time, recognize offsets involving these products.
Therefore, adding them to the Strategy-Based Offset Table would not be
consistent with Section 7(c)(2)(B) of the Exchange Act.
---------------------------------------------------------------------------
\141\ OneChicago Letter at 16.
---------------------------------------------------------------------------
OneChicago further requested that offset positions margined at 10%
should be lowered to 7.5% to mirror the magnitude of the reduction of
minimum required margin levels from 20% to 15% for unhedged security
futures.\142\ This would make the margin requirements for offsets
recognized in the Strategy-Based Offset Table lower than offsets for
exchange-traded options currently permitted by securities SRO margin
rules. Therefore, modifying the Strategy-Based Offset Table in this
manner would not be consistent with Section 7(c)(2)(B) of the Exchange
Act.
---------------------------------------------------------------------------
\142\ OneChicago Letter at 16. The reduction in margin from 10%
to 7.5% would apply to items 2, 8, 9, 11,12 14, 15 and 16 in the
Strategy-Based Offset Table, as proposed to be revised.
---------------------------------------------------------------------------
Finally, OneChicago suggested that the Commissions could simplify
the Strategy-Based Offset Table by replacing it with an offset
rule.\143\ Under the suggested rule, offset positions would be margined
at the greater of: (1) The total calculated by multiplying $0.375 for
each position by the instrument's multiplier, not to exceed the market
value in the case of long positions; or (2) 15% of the delta exposed
portion of the portfolio. As discussed above, the Strategy-Based Offset
Table is designed to permit offsets that are consistent with offsets
recognized for comparable exchange-traded options under the securities
SRO margin rules. For the reasons discussed above, the rule suggested
by OneChicago would not be consistent with the permitted offsets for
exchange-traded options and, consequently, would not be consistent with
Section 7(c)(2)(B) of the Exchange Act.
---------------------------------------------------------------------------
\143\ OneChicago Letter at 16-17.
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For the foregoing reasons, the Commissions are re-publishing the
Strategy-Based Offset Table with the proposed revisions.\144\ The
Commissions expect that SRAs will submit to the Commissions proposed
rules that impose levels of required margin for offsetting positions
involving security futures in accordance with the minimum margin levels
identified in the Strategy-Based Offset Table.
---------------------------------------------------------------------------
\144\ Item 1 of the revised Strategy-Based Offset Table lists
the margin percentages for a long security future and a short
security future. These percentages are the baseline, not offsets,
but they are included in the table to preserve consistency with the
earlier offset table.
----------------------------------------------------------------------------------------------------------------
Security underlying Maintenance margin
Description of offset the security future Initial margin requirement requirement
----------------------------------------------------------------------------------------------------------------
1. Long security future or short Individual stock or 15% of the current market 15% of the current market
security future. narrow-based value of the security value of the security
securities index. future. future.
2. Long security future (or basket Individual stock or 15% of the current market The lower of: (1) 10% of
of security futures representing narrow-based value of the long the aggregate exercise
each component of a narrow-based securities index. security future, plus pay price \3\ of the put
securities index \1\) and long for the long put in full. plus the aggregate put
put option \2\ on the same out-of-the-money \4\
underlying security (or index). amount, if any; or (2)
15% of the current
market value of the long
security future.
3. Short security future (or Individual stock or 15% of the current market 15% of the current market
basket of security futures narrow-based value of the short value of the short
representing each component of a securities index. security future, plus the security future, plus
narrow-based securities index aggregate put in-the- the aggregate put in-the-
\1\) and short put option on the money amount, if any. money amount, if any.\5\
same underlying security (or Proceeds from the put
index). sale may be applied.
[[Page 75124]]
4. Long security future and short Individual stock or The initial margin 5% of the current market
position in the same security (or narrow-based required under Regulation value as defined in
securities basket \1\) underlying securities index. T for the short stock or Regulation T of the
the security future. stocks. stock or stocks
underlying the security
future.
5. Long security future (or basket Individual stock or 15% of the current market 15% of the current market
of security futures representing narrow-based value of the long value of the long
each component of a narrow-based securities index. security future, plus the security future, plus
securities index \1\) and short aggregate call in-the- the aggregate call in-
call option on the same money amount, if any. the-money amount, if
underlying security (or index). Proceeds from the call any.
sale may be applied.
6. Long a basket of narrow-based Narrow-based 15% of the current market 15% of the current market
security futures that together securities index. value of the long basket value of the long basket
tracks a broad based index \1\ of narrow-based security of narrow-based security
and short a broad-based security futures, plus the futures, plus the
index call option contract on the aggregate call in-the- aggregate call in-the-
same index. money amount, if any. money amount, if any.
Proceeds from the call
sale may be applied.
7. Short a basket of narrow-based Narrow-based 15% of the current market 15% of the current market
security futures that together securities index. value of the short basket value of the short
tracks a broad-based security of narrow-based security basket of narrow-based
index \1\ and short a broad-based futures, plus the security futures, plus
security index put option aggregate put in-the- the aggregate put in-the-
contract on the same index. money amount, if any. money amount, if any.
Proceeds from the put
sale may be applied.
8. Long a basket of narrow-based Narrow-based 15% of the current market The lower of: (1) 10% of
security futures that together securities index. value of the long basket the aggregate exercise
tracks a broad-based security of narrow-based security price of the put, plus
index \1\ and long a broad-based futures, plus pay for the the aggregate put out-of-
security index put option long put in full. the-money amount, if
contract on the same index. any; or (2) 15% of the
current market value of
the long basket of
security futures.
9. Short a basket of narrow-based Narrow-based 15% of the current market The lower of: (1) 10% of
security futures that together securities index. value of the short basket the aggregate exercise
tracks a broad-based security of narrow-based security price of the call, plus
index \1\ and long a broad-based futures, plus pay for the the aggregate call out-
security index call option long call in full. of-the-money amount, if
contract on the same index. any; or (2) 15% of the
current market value of
the short basket of
security futures.
10. Long security future and short Individual stock or The greater of: 5% of the The greater of: (1) 5% of
security future on the same narrow-based current market value of the current market value
underlying security (or index). securities index. the long security future; of the long security
or (2) 5% of the current future; or (2) 5% of the
market value of the short current market value of
security future. the short security
future.
11. Long security future, long put Individual stock or 15% of the current market 10% of the aggregate
option and short call option. The narrow-based value of the long exercise price, plus the
long security future, long put securities index. security future, plus the aggregate call in the
and short call must be on the aggregate call in-the- money amount, if any.
same underlying security and the money amount, if any,
put and call must have the same plus pay for the put in
exercise price. (Conversion). full. Proceeds from the
call sale may be applied.
12. Long security future, long put Individual stock or 15% of the current market The lower of: (1) 10% of
option and short call option. The narrow-based value of the long the aggregate exercise
long security future, long put securities index. security future, plus the price of the put plus
and short call must be on the aggregate call in-the- the aggregate put out-of-
same underlying security and the money amount, if any, the-money amount, if
put exercise price must be below plus pay for the put in any; or (2) 15% of the
the call exercise price. (Collar). full. Proceeds from the aggregate exercise price
call sale may be applied. of the call, plus the
aggregate call in-the-
money amount, if any.
13. Short security future and long Individual stock or The initial margin 5% of the current market
position in the same security (or narrow-based required under Regulation value, as defined in
securities basket \1\) underlying securities index. T for the long stock or Regulation T, of the
the security future. stocks. long stock or stocks.
14. Short security future and long Individual stock or The initial margin 10% of the current market
position in a security narrow-based required under Regulation value, as defined in
immediately convertible into the securities index. T for the long security. Regulation T, of the
same security underlying the long security.
security future, without
restriction, including the
payment of money.
15. Short security future (or Individual stock or 15% of the current market The lower of: (1) 10% of
basket of security futures narrow-based value of the short the aggregate exercise
representing each component of a securities index. security future, plus pay price of the call, plus
narrow-based securities index for the call in full. the aggregate call out-
\1\) and long call option or of-the-money amount, if
warrant on the same underlying any; or (2) 15% of the
security (or index). current market value of
the short security
future.
16. Short security future, Short Individual stock or 15% of the current market 10% of the aggregate
put option and long call option. narrow-based value of the short exercise price, plus the
The short security future, short securities index. security future, plus the aggregate put in-the-
put and long call must be on the aggregate put in-the- money amount, if any.
same underlying security and the money amount, if any,
put and call must have the same plus pay for the call in
exercise price. (Reverse full. Proceeds from the
Conversion). put sale may be applied.
17. Long (short) a basket of Narrow-based 5% of the current market 5% of the current market
security futures, each based on a securities index. value of the long (short) value of the long
narrow-based securities index basket of security (short) basket of
that together tracks the broad- futures. security futures.
based index \1\ and short (long)
a broad based-index future.
18. Long (short) a basket of Individual stock and The greater of: (1) 5% of The greater of: (1) 5% of
security futures that together narrow-based the current market value the current market value
tracks a narrow-based index \1\ securities index. of the long security of the long security
and short (long) a narrow based- future(s); or (2) 5% of future(s); or (2) 5% of
index future. the current market value the current market value
of the short security of the short security
future(s). future(s).
19. Long (short) a security future Individual stock and The greater of: (1) 3% of The greater of: (1) 3% of
and short (long) an identical narrow-based the current market value the current market value
security future traded on a securities index. of the long security of the long security
different market \6\. future(s); or (2) 3% of future(s); or (2) 3% of
the current market value the current market value
of the short security of the short security
future(s). future(s).
----------------------------------------------------------------------------------------------------------------
\1\ Baskets of securities or security futures contracts replicate the securities that compose the index, and in
the same proportion.
\2\ Generally, unless otherwise specified, stock index warrants are treated as if they were index options.
\3\ ``Aggregate exercise price,'' with respect to an option or warrant based on an underlying security, means
the exercise price of an option or warrant contract multiplied by the numbers of units of the underlying
security covered by the option contract or warrant. ``Aggregate exercise price'' with respect to an index
option means the exercise price multiplied by the index multiplier.
[[Page 75125]]
\4\ ``Out-of-the-money'' amounts are determined as follows: (1) For stock call options and warrants, any excess
of the aggregate exercise price of the option or warrant over the current market value of the equivalent
number of shares of the underlying security; (2) for stock put options or warrants, any excess of the current
market value of the equivalent number of shares of the underlying security over the aggregate exercise price
of the option or warrant; (3) for stock index call options and warrants, any excess of the aggregate exercise
price of the option or warrant over the product of the current index value and the applicable index
multiplier; and (4) for stock index put options and warrants, any excess of the product of the current index
value and the applicable index multiplier over the aggregate exercise price of the option or warrant.
\5\ ``In-the-money'' amounts are determined as follows: (1) For stock call options and warrants, any excess of
the current market value of the equivalent number of shares of the underlying security over the aggregate
exercise price of the option or warrant; (2) for stock put options or warrants, any excess of the aggregate
exercise price of the option or warrant over the current market value of the equivalent number of shares of
the underlying security; (3) for stock index call options and warrants, any excess of the product of the
current index value and the applicable index multiplier over the aggregate exercise price of the option or
warrant; and (4) for stock index put options and warrants, any excess of the aggregate exercise price of the
option or warrant over the product of the current index value and the applicable index multiplier.
\6\ Two security futures are considered ``identical'' for this purpose if they are issued by the same clearing
agency or cleared and guaranteed by the same derivatives clearing organization, have identical contract
specifications, and would offset each other at the clearing level.
C. Other Matters
One commenter urged the Commissions to make clear, where
appropriate, that margin rules of general applicability do not apply to
security futures.\145\ Specifically, this commenter requested
clarification about the intersection of the security futures rules and
CFTC general margin requirements under part 39 of the CFTC's
regulations for DCOs.\146\ The commenter cited to a CFTC rule proposal
related to customer initial margin requirements as an example of a rule
of general applicability that should be addressed by the Commissions.
Earlier this year, the CFTC adopted changes to the DCO core principles,
including 17 CFR 39.13(g)(8)(ii) (CFTC Rule 39.13(g)(8)(ii)) relating
to customer initial margin requirements.\147\ As the CFTC noted in the
2019 Proposing Release \148\ and in the final rule adopting changes to
DCO core provisions,\149\ the CFTC's Division of Clearing and Risk
issued an interpretative letter in September 2012 stating that the
specific initial margin requirements under CFTC Rule 39.13(g)(8)(ii) do
not apply to security futures positions.\150\ CFTC Letter No. 12-08 is
still in effect and may be relied upon by market participants. The CFTC
believes that CFTC Letter No. 12-08 addresses the commenter's concerns,
and the CFTC will not be revising the position taken by the CFTC's
Division of Clearing and Risk in this rulemaking.
---------------------------------------------------------------------------
\145\ See FIA Letter at 2.
\146\ See FIA Letter at 2; see also CFTC Letter No. 12-08 (Sept.
14, 2012); 2019 Proposing Release, 84 FR 36437, at n.40.
\147\ See Derivatives Clearing Organization General Provisions
and Core Principles, 85 FR 4800 (Jan. 27, 2020) (amending certain
CFTC regulations applicable to registered DCOs).
\148\ 2019 Proposing Release, 84 FR 36437, at n.40.
\149\ Derivatives Clearing Organization General Provisions and
Core Principles, 85 FR at 4812.
\150\ CFTC Letter No. 12-08 (Sept. 14, 2012) at 10, available at
https://www.cftc.gov/csl/12-08/download.
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III. Paperwork Reduction Act
A. CFTC
The Paperwork Reduction Act of 1995 (``PRA'') \151\ imposes certain
requirements on Federal agencies (including the CFTC and the SEC) in
connection with their conducting or sponsoring any collection of
information as defined by the PRA. The final rule amendments do not
require a new collection of information on the part of any entities
subject to these rules. Accordingly, the requirements imposed by the
PRA are not applicable to these rules.
---------------------------------------------------------------------------
\151\ 44 U.S.C. 3501 et seq.
---------------------------------------------------------------------------
B. SEC
The PRA \152\ imposes certain requirements on Federal agencies
(including the CFTC and the SEC) in connection with their conducting or
sponsoring any collection of information as defined by the PRA. The
final rule amendments do not contain a ``collection of information''
requirement within the meaning of the PRA. Accordingly, the PRA is not
applicable.
---------------------------------------------------------------------------
\152\ Id.
---------------------------------------------------------------------------
IV. CFTC Consideration of Costs and Benefits and SEC Economic Analysis
(Including Costs and Benefits) of the Proposed Amendments
A. CFTC
1. Introduction
These final rule amendments will permit customers in security
futures to pay a lower minimum margin level for an unhedged security
futures position. The final rules set required initial margin for each
long or short position in a security future at 15% of the current
market value. In connection with this change, the Strategy-Based Offset
Table will be restated so that it is consistent with the reduction in
the minimum initial margin.
Section 15(a) of the CEA requires the CFTC to consider the costs
and benefits of its actions before promulgating a regulation under the
CEA or issuing certain orders.\153\ Section 15(a) further specifies
that the costs and benefits shall be evaluated in light of five broad
areas of market and public concern: (1) Protection of market
participants and the public; (2) efficiency, competitiveness, and
financial integrity of futures markets; (3) price discovery; (4) sound
risk management practices; and (5) other public interest
considerations. The CFTC considers the costs and benefits resulting
from its discretionary determinations with respect to the Section 15(a)
factors below. Where reasonably feasible, the CFTC has endeavored to
estimate quantifiable costs and benefits. Where quantification is not
feasible, the CFTC identifies and describes costs and benefits
qualitatively.
---------------------------------------------------------------------------
\153\ 7 U.S.C. 19(a).
---------------------------------------------------------------------------
The CFTC requested comments on all aspects of the costs and
benefits associated with the proposed rule amendments. In particular,
the CFTC requested that commenters provide data and any other
information upon which the commenters relied to reach their conclusions
regarding the CFTC's proposed considerations of costs and
benefits.\154\ The Commissions received comments that indirectly
address the costs and benefits of the proposed amendments. Relevant
portions of the comments are discussed in the analysis below.
---------------------------------------------------------------------------
\154\ The CFTC sought ``estimates and views regarding the
specific costs and benefits for a security futures clearing
organization, exchange, intermediary, or trader that may result from
the adoption of the proposed rule amendment.'' 2019 Proposing
Release, 84 FR at 36446-47.
---------------------------------------------------------------------------
The CFTC's consideration of costs and benefits includes a brief
description of the economic baseline against which to compare the rule
amendments, a summary of the amendments, and separate, detailed
discussions of the costs and benefits of the amendments. Then, the CFTC
examines alternatives offered by commenters. Finally, the CFTC
considers each of the section 15(a) factors under the CEA.
2. Economic Baseline
The CFTC's economic baseline for this analysis is the twenty
percent margin requirement on security futures positions that was
adopted in 2002 and exists today in CFTC Rule 41.45(b)(1), along with
the offsetting positions table under CFTC Rule 41.45(b)(2) (Strategy-
Based Offset Table). In the 2002 Adopting Release, the Commissions
finalized a set of security futures margin rules that complied with the
statutory
[[Page 75126]]
requirements under Section 7(c)(2)(B) of the Exchange Act. The rules
state that, ``the required margin for each long or short position in a
security future shall be twenty (20) percent of the current market
value of such security future.'' \155\ The rules also allow SRAs to set
margin levels lower than the 20% minimum requirement for customers with
``an offsetting position involving security futures and related
positions.'' \156\ In addition, the rules that were finalized under the
2002 Adopting Release permit certain customers to take advantage of
exclusions to the minimum margin requirement for security futures.
---------------------------------------------------------------------------
\155\ CFTC Rule 41.45(b)(1), 17 CFR 41.45(b)(1). See CFTC Rule
41.43(a)(4), 17 CFR 41.43(a)(4) (defining the term ``current market
value.'').
\156\ CFTC Rule 41.45(b)(2), 17 CFR 41.45(b)(2).
---------------------------------------------------------------------------
The CFTC has considered the costs and benefits of the rule
amendments as compared with the baseline of the current minimum initial
and maintenance margin levels for unhedged security futures, which is
20% of the current market value of such security future. The CFTC notes
that OneChicago, the only exchange listing security futures in the
U.S., discontinued all trading operations on September 21, 2020. At
this time, there are no security futures contracts listed for trading
on U.S. exchanges. This release considers the costs and benefits that
would occur if OneChicago were to resume operations or another exchange
were to launch security futures contracts.
3. Summary of the Final Rules
The final rules lower the required initial and maintenance margin
levels for an unhedged security futures position from 20% to 15% of the
current market value of such a security futures position. In addition,
the final rules make certain revisions to the Strategy-Based Offset
Table in line with the revised margin requirement. These amendments to
the security futures margin rules bring margin requirements for
security futures held in futures accounts, or securities accounts that
are not Portfolio Margin Accounts, into alignment with the required
margin level for unhedged security futures held in Portfolio Margin
Accounts. The final rules do not make any other changes to the security
futures margin requirement regime.
4. Description of Costs
As a general matter, the CFTC believes that if security futures
trading resumes, the final rules will reduce costs relative to existing
CFTC Rule 41.45(b)(1) because the final rules decrease the level of
margin required for an unhedged security futures position from 20% to
15%. The CFTC has determined that, because there is no security futures
trading at this time, there may be new startup costs such as
operational or technology costs associated with calculating security
futures customer margin if a new exchange were to launch security
futures trading. Such costs would be less significant for OneChicago,
if it were to resume operations, given that the infrastructure for
calculating such margin already exists and would not require major
reprogramming or changes beyond costs that would be incurred to
relaunch security futures contracts. One commenter noted that the final
rules' ``margin requirements will be simpler to administer and risk
manage for intermediaries that facilitate trading in the market, and
better aligns with customer use of these products.'' \157\ The
Commissions received no other comments regarding this cost.
---------------------------------------------------------------------------
\157\ See FIA Letter at 2.
---------------------------------------------------------------------------
As set forth in the 2019 Proposing Release, the CFTC identified a
number of risk-related costs that could result from the final rules and
discusses each below.
i. Risk-Related Costs for Security Futures Intermediaries and Customers
One risk-related cost to consider, if security futures trading
resumes, is the potential cost to security futures intermediaries and
their customers that would result from a default of either an
intermediary or a customer.\158\ Reducing margin requirements for
security futures could expose security futures intermediaries and their
customers to losses in the event that margin collected is insufficient
to protect against market moves. Pursuant to the OCC's bylaws, any
security futures intermediary that is a clearing member of OCC grants a
security interest to OCC for any account it establishes and maintains,
and therefore a customer's assets may be obligated to OCC upon
default.\159\ As a result, security futures intermediaries that are
FCMs could be exposed to a loss if the 15% margin rate for security
futures is insufficient, to offset losses associated with a customer
default. However, this risk is mitigated by the fact that if the FCM
determines that a 15% margin level is insufficient to cover the
inherent risk of the customer position, the FCM has the authority to
collect additional margin from its customers, in excess of the minimum
requirement, in order to protect its financial integrity.\160\
Moreover, the FCM has an incentive to manage the risk of a customer's
default and could collect additional margin to do that.
---------------------------------------------------------------------------
\158\ In this context, an intermediary default describes a
clearing member that experiences a default event under the terms of
a clearinghouse's rules and procedures. Such default events
generally include a failure to deliver funds in a timely manner
(e.g., failure to satisfy a margin call). See OCC Rule 1102(a)--
Suspension, and OCC's Clearing Member Default Rules and Procedures,
available at https://ncuoccblobdev.blob.core.windows.net/media/theocc/media/risk-management/default-rules-and-procedures.pdf.
\159\ See OCC Bylaws, Article VI--Clearance of Confirmed Trades,
Section 3--Maintenance of Accounts, Interpretations and Policies
.07, adopted September 22, 2003, available at https://www.theocc.com/components/docs/legal/rules_and_bylaws/occ_bylaws.pdf.
\160\ See CFTC Rule 41.42(c)(1); SEC Rule 400(c)(1).
---------------------------------------------------------------------------
If security futures trading resumes, a similar risk-related cost
might arise where an FCM collects only the minimum margin required from
customers in order to maintain or expand its customer business, when it
has determined or should have determined that additional margin is
required to cover the inherent risk of the customer position. Lower
margin requirements might facilitate an FCM permitting its customers to
take on additional risk in their positions in order to increase
business for the FCM. Such additional risks could put the FCM at risk
if one of its customers defaulted on its payment obligations, and other
customers of the FCM could face losses if the FCM or one of its fellow
customers defaulted.
Another risk-related cost could stem from the possibility of
increased leverage among security futures customers. Customers posting
less initial margin to cover security futures positions might be able
to increase their overall market exposure and thereby increase their
leverage. Increased leverage in the security futures markets could
increase risks to overall financial stability and result in costs to
the broader financial markets insofar as security futures customers,
security futures intermediaries, and DCOs participate in financial
markets other than security futures.
As discussed in the proposal, the CFTC considered two final
potential risk-related costs (incentives for FCMs to collect less
margin and increased leverage at the customer level). The Commissions
received no comments regarding these costs. The CFTC believes these
theoretical costs are mitigated, to some degree, by regulations that
apply to security futures intermediaries that are registered as FCMs.
For example, FCMs are subject to capital requirements under CFTC
regulations,\161\ and in instances where
[[Page 75127]]
the security futures intermediary is jointly registered with the SEC as
a broker-dealer FCM, the SEC's capital rules also apply.\162\ In
addition, FCMs are required to establish a system of risk management
policies and procedures pursuant to CFTC Rule 1.11.\163\ This risk
management program is designed to incentivize the FCM to protect itself
and its customers against a variety of risks, including the risk of
inadequate margin coverage and increased leverage. The regulatory
regime to which FCMs are subject is designed to require them to fully
account for the potential future exposures of their customers' security
futures positions in the form of initial and maintenance margin.
---------------------------------------------------------------------------
\161\ See CFTC Rule 1.17, 17 CFR 1.17.
\162\ See SEC Rule 240.15c3-1, 17 CFR 240.15c3-1.
\163\ Under CFTC Rule 1.11, FCMs are required to establish risk
management programs that address market, credit, liquidity, capital
and other applicable risks, regardless of the type of margining
offered. See also NFA Rule 2-26 FCM and IB Regulations, which states
that any member or associate who violates CFTC Rule 1.11 (and other
rules) shall be deemed to have violated an NFA requirement.
---------------------------------------------------------------------------
Finally, as explained in the 2019 Proposing Release, risk-related
costs to the security futures intermediary have been further mitigated
by the fact that the vast majority of OneChicago's open interest was
held by eligible contract participants (``ECPs''), as defined in
Section 1a(18) of the CEA.\164\ OneChicago provided data to support
this statement prior to the issuance of the 2019 Proposing Release.
Generally speaking, ECPs are financial entities or individuals with
significant financial resources or other qualifications that make them
appropriate persons for certain investments.\165\ The CFTC believes
that because ECPs are well capitalized investors, they may be less
likely to default and transmit risks throughout the financial system.
According to the data provided by OneChicago, over 99% of the notional
value of OneChicago's products was held by ECPs as of March 1, 2016,
and March 1, 2017.\166\ The Commissions received no comments regarding
this data. However, the CFTC notes that an exchange that, in the
future, launches security futures may decide to market such contracts
to retail customers that are not ECPs.
---------------------------------------------------------------------------
\164\ See also CFTC Rule 1.3, 17 CFR 1.3.
\165\ For example, an individual can qualify as an ECP if the
individual has amounts invested on a discretionary basis, the
aggregate of which is in excess of: (i) $10,000,000; or (ii)
$5,000,000 if the individual also enters into an agreement,
contract, or transaction in order to manage the risk associated with
an asset owned or liability incurred, or reasonably likely to be
owned or incurred, by the individual.
\166\ The CFTC sought comments on all aspects of its
considerations of costs and benefits in the 2019 Proposing Release.
In particular, the CFTC requested data and any other information and
did not receive any comments questioning this data, or updated data
from OneChicago. As a result, the CFTC continues to refer to the
data provided by OneChicago relating to time periods in 2016 and
2017.
---------------------------------------------------------------------------
ii. Appropriateness of Margin Requirements
If security futures trading resumes, a possible risk-related cost
of lowering margin requirements for security futures is that a DCO may
not have sufficient margin on deposit to cover the potential future
exposure of cleared security futures positions. However, the risk
management expertise at security futures intermediaries and DCOs, as
well as the general applicability of CFTC Rule 39.13 to security
futures,\167\ supports the conclusion that DCOs and security futures
intermediaries will continue to manage the risks of these products
effectively even with lower minimum margin requirements.\168\
---------------------------------------------------------------------------
\167\ As noted above and elsewhere, the general requirements of
CFTC Rule 39.13 (17 CFR 39.13) are applicable to security futures
intermediaries and DCOs with respect to security futures, however,
the specific provision of CFTC Rule 39.13(g)(8)(ii) relating to
customer initial margin requirements has been addressed separately
by CFTC Letter No. 12-08 and that remains unchanged by this final
rule.
\168\ As discussed above, security futures intermediaries are
authorized to collect margin above the amounts required by the
Commissions. However, if security futures trading resumes, security
futures intermediaries could be incentivized to lower their margin
rates in order to compete for customer business as for-profit
entities. If security futures intermediaries were to engage in
competition for business based on margin pricing, it is possible
that security futures intermediaries would collect only the required
level of margin (i.e., 15% under the final rule change), regardless
of the market conditions, which could impair their ability to
protect against market risk and losses.
---------------------------------------------------------------------------
If security futures trading resumes, the risk security futures
customers and/or intermediaries would face from reducing initial and
maintenance margin would be addressed at the clearinghouse level
because there are additional protections under CFTC regulations. For
example, CFTC Rule 39.13(g)(2)(i) requires a DCO to establish initial
margin requirements that are commensurate with the risks of each
product and portfolio.\169\ In addition, CFTC Rules 39.13(g)(2)(ii) and
(iii) require that initial margin models meet set liquidation time
horizons and have established confidence levels of at least 99%.\170\
These DCO initial margin requirements are distinct from the margin
requirements to which customers are subject pursuant to these final
rules and, along with other risk-reducing measures, serve to mitigate
the possibility that a DCO may default (possibly resulting in a
systemic event). In the event that a DCO were to determine that a 15%
margin level for security futures would be insufficient to satisfy a
DCO's obligation under CFTC Rule 39.13, the DCO would be required to
collect additional margin from its clearing members.\171\
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\169\ CFTC Rule 39.13(g)(2)(i) is not addressed in CFTC Letter
No. 12-08.
\170\ CFTC Rules 39.13(g)(2)(ii) and (iii) are not addressed in
CFTC Letter No. 12-08. In accordance with these rules, OCC Rules
601(c) and 601(e) provide for initial margin for segregated futures
customer accounts to be calculated pursuant to the Standard
Portfolio Analysis of Risk (``SPAN'') on a gross basis, as well as
calculating on a net basis initial margin requirements for each
segregated futures accounts using STANS. OCC's scan ranges for the
SPAN margin models provide coverage for a minimum 99% confidence
level.
\171\ The CFTC expects that any difference between the margin
charged at the DCO and the margin charged by the security futures
intermediary will be addressed by additional margin calls, if
necessary. The DCO can require additional margin from its clearing
members (which in some cases will be the security futures
intermediary), to cover changes in market positions. DCOs and
clearing members are familiar with margin call procedures and have
established rules to efficiently transfer funds when needed. If a
customer's account has insufficient funds to meet the margin call,
its clearing member may provide the amount to the DCO and collect it
from the customer at a later time. In this scenario, the clearing
member may take on a liability or additional risk on the customer's
behalf for a short period of time. The CFTC notes that this practice
is the same for security futures as it is for other products subject
to clearing and it does not view this temporary shifting of risk
between the clearing member and the customer as a unique source of
risk to security futures. Furthermore, this amendment lowering the
required margin from 20% to 15% does not alter the relationship
between DCOs and their clearing members, or the relationship between
clearing members and their customers. The CFTC acknowledges that it
is possible that DCOs and security futures intermediaries will
collect different levels of margin, but it is not necessarily a
result of the final rules. Moreover, the difference in margin
collected is not an unmitigated source of risk for the security
futures intermediaries because they have the authority to collect
additional funds from their customers in the event of a margin call
and can choose to set margin levels higher than the minimum level
required by the Commissions.
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The CFTC observes that customer margin requirements for security
futures held by security futures intermediaries are materially distinct
from initial margin requirements for DCOs. The initial margin
requirements used by DCOs typically are risk-based, and CFTC rules are
designed to permit DCOs to use risk-based margin models to determine
the appropriate level of margin to be collected, subject to CFTC
regulations in Part 39, as applicable.
In addition to the initial margin requirements at the DCO level,
clearing members are required to satisfy certain financial resources
requirements, including a ``capital'' requirement, to demonstrate that
they can withstand certain risks under ``extreme but plausible market
conditions.'' \172\
[[Page 75128]]
Furthermore, the DCO is required to maintain its own financial
resources, which may include its own capital, guaranty fund deposits by
clearing members, default insurance, assessments for additional
guaranty fund contributions, and other financial resources, as
permitted.\173\ In combination, financial resource requirements for
clearing members, initial margin contributions, guaranty fund
contributions, and other resources provide additional protections at
the DCO level against the risk that a default by a customer or security
futures intermediary will create systemic risk.
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\172\ 17 CFR 39.12 (CFTC Rule 39.12(a)(2)) (defining the capital
requirement for clearing members with cross-references to the CFTC's
part 1 rules for FCMs and the SEC's rules for broker-dealers).
\173\ See generally 17 CFR 39.11(a) through (e) (CFTC Rule
39.11(a) through (e)). See also 17 CFR 1.12 (CFTC Rule 1.12)
(setting forth minimum financial requirements for FCMs and IBs).
---------------------------------------------------------------------------
In the event that a clearing member defaults on its obligations to
the DCO, the DCO has a number of ways to manage associated risks,
including transferring (or porting) the positions of the defaulted
clearing member and using the defaulting clearing member's margin and
other collateral on deposit to cover any losses. In order to cover the
losses associated with a clearing member default, the DCO would
typically draw from (in order): (1) The initial margin posted by the
defaulting clearing member; (2) the guaranty fund contribution of the
defaulting clearing member; (3) the DCO's own capital contribution; (4)
the guaranty fund contribution of non-defaulting clearing members; and
(5) an assessment on the non-defaulting clearing members. In the event
that a DCO could not transfer the positions of the defaulted clearing
member, it could liquidate those positions. Taken together, these
mutualized risk mitigation capabilities are largely unique to
clearinghouses, and help to ensure that they remain solvent when
dealing with defaults of their members, their members' customers, and/
or other periods of stressed market conditions.
As noted in the 2019 Proposing Release, the CFTC reviewed data from
security futures markets under normal market conditions and concluded
that a 15% level of margin would be sufficient to cover daily price
moves in most instances (i.e., more than 99.5%).\174\ This is
consistent with what the CFTC expects from risk-based margin regimes at
DCOs. The Commissions received no comments regarding this data
analysis. In addition, no commenters provided any quantitative data in
support or refutation of the CFTC's risk analysis. Therefore, the CFTC
continues to believe that the final rules will not have a substantial
negative impact on (1) the protection of market participants or the
public, (2) the financial integrity of security futures markets in the
United States, if trading resumes, or (3) sound risk management
practices of DCOs or security futures intermediaries.
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\174\ Conducting a value-at-risk analysis of 74 of the most
liquid security futures contracts during a limited time-frame
(November 2002-June 2010), CFTC staff found that there were 195
instances where a 15% margin was insufficient and 99 instances where
a 20% margin was insufficient. For all observations, a 15% margin
was sufficient for 99.81% of all observations while a 20% margin was
sufficient for 99.91% of all observations. While the period covered
by this study does include the high volatility exhibited in 2008, it
does not include the comparably high volatility exhibited in early
spring 2020.
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iii. Potential Costs Related to Competition and Market Arbitrage
One commenter responded to the 2019 Proposing Release with concerns
that a change in margin requirements for security futures would provide
an advantage to security futures and create a competitive disadvantage
for exchange-traded equity options.\175\ This commenter explained that
exchange-traded equity options are regularly used to establish
synthetic long and short exposures that produce exposures that are
nearly identical to exposure created by security futures.\176\
According to this commenter, there exists the possibility that the
lower margin requirements for security futures could result in
customers shifting from trading in equity options to security futures,
which in turn, could result in decreased liquidity and less price
discovery in the equity options markets.
---------------------------------------------------------------------------
\175\ Cboe/MIAX Letter at 2.
\176\ Cboe/MIAX Letter at 6.
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However, another commenter argued there may be reason to doubt that
changes in trading behavior would be precipitated by the lower margin
levels set forth in these final rules. OneChicago provided data to
support its view that security futures (referred to as ``single stock
futures'' in OneChicago Letter 3) and equity options did not trade
interchangeably.\177\ The five analyses that OneChicago conducted were
valuable to the CFTC's consideration of costs and benefits.
---------------------------------------------------------------------------
\177\ OneChicago Letter 3 at 2.
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In particular, OneChicago provided analysis comparing SPX (S&P 500)
options to E-mini S&P 500 futures contracts.\178\ This analysis
indicates that the products do not trade interchangeably and that the
ratios of SPX options open interest to E-mini futures open interest,
and SPX options volume to E-mini futures volume are not correlated with
the margin rate on the E-mini S&P 500 futures contracts.\179\ The CFTC
recognizes that there are many reasons why customers decide to trade in
one product over another (including tax ramifications), and that
security futures and equity options are not perfect substitutes. The
CFTC acknowledges that if security futures trading resumes, lower
margin requirements could increase trading in security futures above
their historical volumes (and some of that activity could be from
customers that previously traded equity options). However, a customer's
choice of trading instrument is not determined solely by margin
requirements.
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\178\ The CFTC notes that the E-mini futures contracts are not
security futures, but are futures regulated solely by the CFTC
(i.e., they are not jointly regulated by the CFTC and SEC). The
comparison between E-mini futures contracts and SPX options is still
helpful to understand the interplay between the futures and equity
options markets.
\179\ According to OneChicago's analysis, there is a
statistically significant negative correlation between SPX options
and E-mini futures. OneChicago Letter 3 at 6.
---------------------------------------------------------------------------
Another reason to doubt the negative competitive impact of these
final rules on exchange-traded equity options is that the 2008 adoption
of Portfolio Margin Rules for exchange-traded equity options did not
cause security futures customers to migrate their positions to those
products, even though it arguably provided those options with a
competitive advantage over security futures because of the lower
minimum margin rate.\180\ Moreover, the vast majority of security
futures customers would have been eligible for lower margin
requirements but did not move their positions from futures accounts to
Portfolio Margin Accounts, which were margined under the Portfolio
Margin Rules (i.e., margin required was equal to 15% for an unhedged
position). The CFTC believes that, if trading in security futures
resumes, the final rules' amendments are unlikely to create a
competitive disadvantage for exchange-traded equity options, as the 15%
margin rate is already in effect for positions held in a Portfolio
Margin Account.
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\180\ A competitive advantage for options may have existed
because options are held in a securities account by default. In
contrast, most security futures positions were held in futures
accounts, and in order for a trader to take advantage of the lower
margin rate for a security futures position, such a trader would
have to move those positions into a different type of account (i.e.,
from a futures account to a securities account) with associated
costs.
---------------------------------------------------------------------------
OneChicago's closure after years of much lower trading activity
than in exchange-traded equity options suggests that security futures
in the U.S. may
[[Page 75129]]
have been operating at a competitive disadvantage to related markets.
However, based on publicly available Eurex volume data,\181\ security
futures trading on U.S. stocks in other jurisdictions is lower than
trading in security futures on European companies, even on the Eurex
exchange in Germany where margin requirements are calculated using
risk-based methodologies.\182\ Therefore, factors other than margin
requirements may be influencing demand for security futures (e.g., tax
ramifications or availability of competing products). Nonetheless, the
CFTC expects that lowering the security futures margin requirement to
15% from 20% will help mitigate this competitive disadvantage and could
encourage a resumption of security futures trading in the U.S.
---------------------------------------------------------------------------
\181\ See Eurex statistics published daily, available at https://www.eurexchange.com/exchange-en/data/statistics.
\182\ Trading by U.S. persons in security futures contracts
listed on Eurex is subject to certain conditions under an SEC order
and a CFTC staff advisory. Provided that a number of conditions are
met, only qualified U.S. persons are permitted to trade security
futures on a single security issued by a foreign private issuer or a
narrow-based security index that is listed on a non-U.S. exchange
that is not required to register with the SEC. See SEC's Order under
Section 36 of the Securities Exchange Act of 1934 Granting an
Exemption from Exchange Act Section 6(h)(1) for Certain Persons
Effecting Transactions in Foreign Security Futures and under
Exchange Act Section 15(a)(2) and Section 36 Granting Exemptions
from Exchange Act Section 15(a)(1) and Certain Other Requirements,
Exchange Act Release No. 60194 (June 30, 2009), 74 FR 32200 (Jul. 7,
2009), and Division of Clearing and Intermediary Oversight Advisory
Concerning the Offer and Sale of Foreign Security Futures Products
to Customers Located in the United States, available at https://www.cftc.gov/idc/groups/public/@internationalaffairs/documents/ssproject/fsfpadvisory.pdf (June 8, 2010).
---------------------------------------------------------------------------
iv. Costs and Benefits Associated With Requested Changes to the Margin
Offsets Table
The Commissions are updating and restating the table of offsets for
security futures to reflect the new (15%) minimum margin requirement.
The CFTC believes that if security futures trading resumes, lowering
the margin requirements for certain offsets will not increase costs to
customers, security futures intermediaries, or DCOs. The categories of
permissible offsets will remain the same and there is no change to the
inputs used to calculate the offset, other than to decrease the initial
and maintenance margin on all security futures from 20% to 15%.
Moreover, the same risk to the customers and security futures
intermediaries will exist if the Commissions decrease the margin
required for security futures trading combinations eligible for offsets
as it will with security futures without an offset.
As discussed above, OneChicago suggested that the Commissions make
a number of changes to the Strategy-Based Offset Table.\183\ OneChicago
asked that the Offset Table be amended to account for customers holding
delta-neutral positions (e.g., a customer holds an equal and opposite
position in stock and/or a security future).\184\ Although the CFTC
agrees that it would make sense to account for a neutral position when
setting margin levels, the CFTC believes the revised margin offset
table included in this release balances the efficiencies of offsetting
positions against the outstanding risks associated with these financial
products in light of the fact that equity markets and security futures
markets are subject to separate regulatory oversight. In addition, as
explained above, the Commissions determined that lowering the offset
table requirements further is inconsistent with current securities SRO
rules, and thus would be inconsistent with the Exchange Act. For this
reason, the Commissions are not adopting OneChicago's requested
amendments to the Strategy-Based Offset Table.
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\183\ OneChicago Letter at 15-17.
\184\ According to OneChicago's suggestion, margin for delta-
neutral positions should be equal to the lower of: (1) The total
calculated by multiplying $0.375 for each position by the
instrument's multiplier, not to exceed the market value in the case
of long positions, or (2) 2% of the current market value of the
security futures contract. OneChicago Letter at 15.
---------------------------------------------------------------------------
OneChicago also asked that the Commissions add total return equity
swaps to the Strategy-Based Offset Table.\185\ Total return equity
swaps serve a similar, if not identical, economic function to security
futures contracts as commonly used at OneChicago. Providing an offset
for swaps could incentivize customers to trade in either product, or
this combination of products, and could result in increased liquidity.
Adding a new product to the offset table would provide a benefit to
customers trading in total return equity swaps and security futures
because those customers would be subject to lower margin requirements.
However, as stated above, the Commissions have determined that adding a
total return swap offset to the Strategy-Based Offset Table would be
inconsistent with securities SRO rules at this time and thus would be
inconsistent with the Exchange Act. For this reason, the Commissions
are not adopting this suggested change to the Strategy-Based Offset
Table.
---------------------------------------------------------------------------
\185\ OneChicago Letter at 16.
---------------------------------------------------------------------------
In addition, OneChicago recommended that the Commissions reduce the
maintenance margin required for certain types of positions from 10% to
7.5%.\186\ A lower margin requirement under the offset table would
provide an individual customer with an offsetting position a small
benefit. However, as stated above, the Commissions have determined that
lowering the margin requirement for certain strategies from 10% to 7.5%
in the Strategy-Based Offset Table would be inconsistent with
securities SRO rules at this time and thus would be inconsistent with
the Exchange Act. For this reason, the Commissions are not adopting
this suggested change to the Strategy-Based Offset Table.
---------------------------------------------------------------------------
\186\ OneChicago Letter at 16. As suggested by OneChicago, the
reduction in margin from 10% to 7.5% would apply to items 2, 8, 9,
11, 12, 14, 15, and 16 in the Strategy-Based Offset Table.
---------------------------------------------------------------------------
Finally, OneChicago requested that the Commissions simplify the
Strategy-Based Offsets Table overall by replacing the table with a
rule. The CFTC has not identified specific benefits associated with
adopting a rule rather than updating the Strategy-Based Offsets Table.
However, the CFTC believes that any structural change to the offset
table that is adopted for the security futures regime but not for the
equity options regime could introduce uncertainty and confusion in the
markets, and could inhibit customers seeking the reduced margin
benefits of offsetting positions. OneChicago stated that the rule
change it identified would not result in margin levels that are lower
than margin levels required under the Strategy-Based Offset Table for
exchange-traded equity options under Portfolio Margin Rules. As stated
above, the Commissions have determined that replacing the Strategy-
Based Offsets Table with a rule would be inconsistent with the
securities SRO rules at this time and thus would be inconsistent with
the Exchange Act. For this reason, the Commissions are not adopting
this suggested change to the Strategy-Based Offset Table.
Although the Commissions are not revising the Strategy-Based Offset
Table as requested by OneChicago, the CFTC believes the offsets
described in this release will, if security futures trading resumes,
offer certain benefits and will not increase costs by materially
decreasing protections or increasing risks. Again, as added assurance
that there are multiple levels of risk protection for security futures,
the CFTC notes that security futures intermediaries and customers will
continue to be required to comply with daily mark-to-market and
variation
[[Page 75130]]
settlement procedures applied to security futures, as well as the large
trader reporting regime that applies to futures accounts.\187\
---------------------------------------------------------------------------
\187\ Under the CFTC's large trader reporting regime, clearing
members and FCMs (as well as foreign brokers) file reports with the
CFTC containing futures and options position information for traders
that have positions at or above certain reporting thresholds. See
part 17 of the CFTC's regulations and 17 CFR 15.03(b) (CFTC Rule
15.03(b)).
---------------------------------------------------------------------------
5. Description of Benefits Provided by the Final Rules
The CFTC believes that the final rules will, if security futures
trading resumes, produce significant benefits by reducing minimum
margin requirements for security futures positions to levels equal to
margin levels for exchange-traded options. The amendment to CFTC Rule
41.45(b)(1) will align customer margin requirements for security
futures held in a futures or a securities account with those that are
held in a Portfolio Margin Account. The CFTC believes this alignment
may increase competition by establishing a level playing field between
security futures carried in a Portfolio Margin Account and security
futures carried in a futures account or a securities account that is
not subject to Portfolio Margin Rules should OneChicago begin offering
these products again or new market entrants emerge.
This benefit is expected to apply most directly to customers with
security futures positions held in futures accounts because they cannot
be margined under Portfolio Margin Rules. According to OneChicago,
because of operational issues, almost all security futures positions
were carried in futures accounts.\188\ As a result, almost all, if not
all, security futures were held in futures accounts and subject to the
CFTC's customer account requirements. Therefore, any reduction in
customer initial and maintenance margin requirements, if security
futures trading resumes, would be expected to benefit all or close to
all security futures customers because they historically held positions
in futures accounts and did not benefit from Portfolio Margin Rules.
---------------------------------------------------------------------------
\188\ See OneChicago Petition at 2.
---------------------------------------------------------------------------
Additionally, the reduced minimum margin level could, if security
futures trading resumes, facilitate more trading in security futures
than would otherwise occur, which could enhance the likelihood a
revival would succeed and increase market liquidity to the benefit of
market participants and the public.\189\ Increased liquidity could
contribute to the financial integrity of security futures markets
overall. For example, market liquidity may be particularly beneficial
in the context of a customer default at an FCM, when the FCM must
manage the defaulting customer's security futures positions through
transferring or liquidating those positions.\190\
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\189\ OneChicago represented that one of its customers (Jurrie
Reinders, Societe General) believed that the ``uncompetitive''
margin requirements for security futures have reduced trading
volumes. OneChicago Letter at 29.
\190\ As noted above, the FIA Letter stated that the final rules
would help FCMs manage their risk. See FIA Letter, at 2. See also
discussion of CFTC rules under parts 1 and 39, above.
---------------------------------------------------------------------------
The lower minimum margin requirement also could, if security
futures trading resumes, decrease the direct cost of trading in
security futures. In response to the Commissions' request for comments
providing data, OneChicago estimated that for the time period between
September 1, 2018, and August 1, 2019, the notional value of margin
collected on OneChicago positions would be reduced by $130 million if
the lower 15% margin requirement had been in place.\191\ This would
have represented significant savings in the amount of margin required
to be paid by and collected from customers in satisfaction of the
CFTC's part 41 margin requirements. A decrease in trading costs,
through lower minimum margin requirements should OneChicago begin
offering these products again or new market entrants emerge, also may
increase capital efficiency because additional funds would be available
for other uses.
---------------------------------------------------------------------------
\191\ OneChicago estimated that between September 1, 2018, and
August 1, 2019, the notional value of margin collected on OneChicago
positions was approximately $540 million (under a 20% minimum margin
requirement) compared to $410 million that would have been collected
under the final rules (under a 15% minimum margin requirement).
OneChicago Letter at 14.
---------------------------------------------------------------------------
As noted above, the final rules may have beneficial competitive
effects vis-[agrave]-vis domestic markets. In addition, lowering the
minimum margin requirement may enable a U.S. security futures exchange
to better compete in the global marketplace, where security futures
traded on foreign exchanges are subject to risk-based margin model
requirements that are generally lower than those applied to security
futures traded in the U.S.\192\ Apart from OneChicago's letters and a
comment from one of its customers, the Commissions received no comments
regarding benefits associated with increased domestic or global
competition.
---------------------------------------------------------------------------
\192\ OneChicago stated that the Eurex exchange lists futures on
U.S. stocks with risk-based margins that are lower than the 20%
margin for futures on the same stocks that were listed at OneChicago
(OneChicago Letter at 13). However, based on publicly available
data, the volume on Eurex for futures on U.S. stocks is much lower
than occurred at OneChicago even as security futures volume is high
for stocks in European companies.
---------------------------------------------------------------------------
The final rules restate the table of offsets for security futures
to reflect the proposed 15% minimum margin requirement. As discussed in
detail above, these offsets will, if security futures trading resumes,
provide the benefits of capital efficiency to customers because offsets
recognize the unique features of certain specified combined strategies
and would permit margin requirements that better reflect the risk of
these strategies. Moreover, the same benefits of lowering margin costs
for customers and increasing business in security futures could result
from lowering margin requirements for offsetting security futures
positions.
6. Discussion of Alternatives
Although the CFTC did not identify any alternatives in the
proposal,\193\ commenters suggested a number of alternative security
futures margin options, along with other suggestions for the
Commissions to consider. This discussion of those alternatives includes
certain commenter proposals that the Commissions still do not believe
are viable at this time for the reasons discussed by the Commissions in
more detail above.
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\193\ See 2019 Proposing Release, 84 FR at 36446. In the
proposal, the CFTC stated that it did not believe that there were
any reasonable alternatives to consider given statutory constraints
tied to current practices in the exchange-traded equity options
market. Id. at n. 92.
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i. Reducing Contract Sizes for Security Futures
One commenter, citing a statement by SEC Commissioner Jackson,
indicated that the Commissions failed to consider reasonable
alternatives such as reducing the contract size for security
futures.\194\ According to Commissioner Jackson's Statement, ``reducing
contract size could also increase access to single-stock futures for
the most popular securities and improve efficiency.'' \195\ The CFTC
agrees that changing the contract size for security futures might make
the products more attractive to a wider group of market participants,
resulting in increased liquidity,\196\ but
[[Page 75131]]
would not change the overall amount of margin required for a given
position. Thus, the CFTC believes that this alternative would be less
effective at increasing liquidity than lowering margin requirements.
Reducing the security futures contract size would lower the initial
capital expenditure for a customer and could attract wider
participation, but could possibly increase transaction costs, as a
percentage of overall initial costs in putting on the position.\197\ As
explained above, the Commissions anticipate that these final rules may
produce greater liquidity in security futures, as well as create more
efficient capital distribution. Market participants will be able to
reallocate funds that are saved on lower margin levels. Under this
alternative, market participants would not benefit from any increased
capital efficiencies. Because reducing contract sizes does not provide
the same capital efficiency opportunities to customers, the CFTC does
not believe it offers as many benefits as the final rules.
---------------------------------------------------------------------------
\194\ Letter from the Jeffrey Mahoney, General Counsel, Council
of Institutional Investors (Aug. 26, 2019) (``CII Letter'') at 4.
See also Commissioner Robert J. Jackson Jr., Public Statement,
Statement on Margin for Security Futures (July 3, 2019), available
at https://www.sec.gov/news/public-statement/jackson-statement-margin-security-futures (``Commissioner Jackson's Statement'').
\195\ Commissioner Jackson's Statement.
\196\ A security futures exchange could change the contract size
for security futures by amending terms of the security futures
contract such that one security futures contract represents only 50
shares of the underlying stock instead of 100.
\197\ The increase in transaction costs would be the result of
the fixed cost staying the same, but the initial expenditure being
lower.
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ii. Rules-Based Margin With Flexible Margin Collection Intervals
One commenter agreed with Commissioner Jackson's concern that the
proposal did not consider other reasonable alternatives such as a
rules-based margin regime that includes flexible margin collection, or
settlement intervals, which is an idea proposed by former SEC
economists.\198\ According to the economists' research paper on this
topic, security futures that are subject to strategy-based margining
may be less sensitive to changes in market conditions.\199\ The
economists analyzed different margin collection time periods to
determine whether risks to customers would be affected by the length of
time that passed between contract execution and settlement. The
economists found that a 1-day margin collection period (i.e., initial
and maintenance margins are required to be collected within 1 day of
the trade) likely would lead to higher margin requirements than would
otherwise be required under a risk-based margin regime. As a
comparison, they also studied a 4-day collection period (i.e., initial
and maintenance margins are required to be collected within 4 days of
the trade) and found that the additional time could lead to both
significant over- and under-margining relative to a risk-based margin
model regime.
---------------------------------------------------------------------------
\198\ See Commissioner Jackson's Statement; see also CII Letter
at 4.
\199\ Hans R. Dutt & Ira L. Wein, On the Adequacy of Single-
Stock Futures Margining Requirements, 10 J. FUTURES MARKETS 989
(2003).
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This research explores how changes in the date on which margin is
collected could provide different levels of protection for customer
positions in security futures.\200\ The paper suggests that such a rule
change could produce adequate margin coverage, if calibrated correctly,
to protect against default. On the other hand, one commenter opposed
the alternative of changing the margin collection period, arguing that
this could ``build up exposures'' and would remove one of the critical
futures market protections (e.g., paying and collecting margin to
prevent customers from accumulating large exposures).\201\
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\200\ The CFTC notes that this research paper was published in
2003, before significant changes to the CFTC's regulatory regime
were adopted pursuant to the Dodd-Frank Wall Street Reform and
Consumer Protection Act. It is uncertain whether the alternatives
considered and discussed in the research paper would comply with
current CFTC requirements. Additionally, there are no programs
offering this alternative, and whether such a program could comply
with the statutory constraints under the Exchange Act is uncertain.
\201\ OneChicago Letter at 6.
---------------------------------------------------------------------------
The CFTC has not analyzed a particular program offered by an
exchange or security futures intermediary, nor examined any rulebooks
outlining how such a program would be implemented. However, if such a
change were submitted for review, the CFTC would consider, among other
things, how a change in the date of margin collection would affect how
FCMs manage margin funds. CFTC rules govern FCM practices and require
that FCMs take certain precautions with customer funds.\202\ In some
cases, customers may benefit from a more prompt payment of margin funds
to FCMs because those funds will be subject to certain protections, and
FCMs would encourage prompt payment of margin funds to protect against
customer position risk. The CFTC also observes that changes to the
collection period would depend on changes in contractual provisions
between clearinghouses and their clearing members, and between the
clearing members and their customers, as well as rule changes for
exchange operating procedures.
---------------------------------------------------------------------------
\202\ See 17 CFR 1.20 through 1.30 (CFTC Rules 1.20 through
1.30).
---------------------------------------------------------------------------
The Commissions are adopting the final rules because they produce a
desired policy outcome of aligning the minimum margin requirements for
security futures held in non-Portfolio Margin Accounts with the margin
required for security futures in a Portfolio Margin Account, for the
reasons discussed above. The CFTC believes that any changes to the date
of margin collection period are distinct from this policy objective,
may not be uniformly adopted by security futures markets, and may
result in an accumulation of risk for customers and security futures
intermediaries. Accordingly, changing the margin collection period is
not a viable alternative to the final rules adopted in this release.
iii. Use of Risk-Based Margin Models
In the 2019 Proposing Release, the Commissions specifically
requested comment on ``any other risk-based margin methodologies that
could be used to prescribe margin requirements for security futures.''
In response, a number of commenters expressed a preference for using
risk-based models to margin security futures and argued that such a
regime would be consistent with the Exchange Act.\203\ As discussed in
section II.A. above, implementing a risk model approach to calculate
margin for security futures would be inconsistent with how margin is
calculated for exchange-traded equity options at this time and may
result in margin levels for unhedged security futures positions that
are lower than the lowest level of margin applicable to unhedged
exchange-traded equity options (i.e., 15%). Consequently, because no
exchange-traded equity options are subject to risk-based margin
requirements, adopting a risk model approach at this time for security
futures would conflict with the requirements of Section 7(c)(2)(B) of
the Exchange Act.\204\
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\203\ See La Botz Letter (``I request the Commission to please
correct the margin discrepancy placed upon the [security futures]
products by going to a risk based margining as utilized by
clearinghouses on other [security futures] products worldwide.'').
See also Ianni Letter, and OneChicago Letter.
\204\ See section II.A. above (discussing a risk model approach
and Section 7(c)(2)(B) of the Exchange Act).
---------------------------------------------------------------------------
The CFTC is considering a risk-based model alternative solely for
purposes of analyzing the potential costs and benefits of the final
rules under a hypothetical future scenario. The CFTC has extensive
familiarity and experience with overseeing entities that use risk-based
margin model regimes for derivatives clearing.\205\ Risk-based margin
models produce efficiencies because the initial margin is calculated
using certain macro-economic risk factor inputs that change with market
[[Page 75132]]
conditions. DCOs successfully manage the initial margin requirements
for clearing members using risk-based margin models. Risk-based margin
model regimes also provide effective protection against default for
customers, intermediaries, and clearinghouses. While the CFTC is
broadly supportive of risk-based margin models and believes there are
benefits to those regimes, in the context of security futures, the
costs and benefits require careful attention.
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\205\ As a market regulator with jurisdiction over derivatives
clearinghouses, one of the CFTC's primary functions is to supervise
the derivatives clearing activities of DCOs, their clearing members,
and any entities using the DCOs' services. The CFTC supervisory
program takes a risk-based approach.
---------------------------------------------------------------------------
As seen in some of the data provided by OneChicago, risk-based
margin does not necessarily mean that the margin collected will be
lower than under current margin requirements for security futures or
the amended final rules under part 41 of the CFTC's regulations. In
fact, there may be reason to believe that it could be higher.
OneChicago provided an example from the 2008-2010 financial crisis.
During that time period, margin requirements on SPX options remained
constant at 8% (the maximum initial margin), if held in a Portfolio
Margin Account.\206\ However, during that same time period, E-mini
futures contracts were charged margin at levels higher than 8% because
they were subject to risk-based margin and the volatility at the time
required greater margin levels.\207\ In this instance, the margin
required under a risk-based model would be higher than the maximum
initial margin that is set at a constant percentage rate. The CFTC
observes that this comparison is informative, but not dispositive.
---------------------------------------------------------------------------
\206\ OneChicago Letter 3 at 3.
\207\ As noted above, E-mini futures contracts are not jointly
regulated by the CFTC and SEC because they are broad-based equity
index futures and do not fall under the definition of ``security
futures'' under the CEA. However, for purposes of examining the
relationship between futures contracts and options, the comparison
may be relevant.
---------------------------------------------------------------------------
Importantly, because the security futures margin regime includes a
minimum margin requirement only, it is less likely that there would be
an instance in which a risk-based model results in greater margin
levels than the margin charged to a customer under the final rules. As
the Commissions have emphasized throughout this release, FCMs and DCOs
may, if security futures trading resumes, charge additional margin
above the 15% minimum level required, if it would be prudent to protect
against increased risk. In practice, this means that in a period of
market volatility a risk-based model may require higher margin levels
to account for that volatility, but an FCM and/or DCO likely would
require higher margin during such periods of market volatility under
the current rules. Even under the initial and maintenance margin
requirements today, FCMs and DCOs provide a backstop for margin
purposes by being required to collect higher margins if market
conditions or other circumstances change.\208\ Use of a risk-based
margin model would sometimes result in higher margins than the 15%
minimum margin level adopted in this release, but it would not
necessarily change the margin amount posted by a customer.
---------------------------------------------------------------------------
\208\ For example, OneChicago provided a sample dataset that
compares the margin level required under the current security
futures margin rule (20%), the new rule (15%), and under a risk-
based margin approach used by OCC. Out of the 20 security futures,
17 security futures would be subject to lower margin requirements
under risk-based margining. One contract would be subject to a 17.7%
margin requirement under the new rule and the risk-based model,
because that contract is exposed to higher market risks. One
contract would continue to be margined at a 20% level, even under
the new rule and risk-based margining. Finally, one contract would
continue to be margined at a 23% level regardless of the approach
taken to determine margin requirements. Thus, the idea that risk-
based margining would produce lower margin levels for all contracts
at all times is incorrect. OneChicago Letter at 27.
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The CFTC recognizes there may be savings that can accrue under
risk-based margin models for purposes of initial and maintenance
margin, but notes that variation margining practices will not change
for security futures.\209\ Taken together, the overall margin regime
for security futures under a risk-based margin model regime ultimately
may at various times be equal to, greater than, or less than, the
margin requirements set forth under the final rules.
---------------------------------------------------------------------------
\209\ In the context of security futures, FCMs are required to
continue daily mark-to-market valuations and exchange of variation
margin.
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However, as discussed in section II.A. above, the CFTC is not
persuaded by commenters' arguments that, at this time, implementing a
risk model approach to calculating margin for security futures would be
permitted under Section 7(c)(2)(B) of the Exchange Act. Moreover,
implementing a risk model approach would substantially alter how the
required minimum initial and maintenance margin levels for security
futures are calculated. It also would be a significant deviation from
how margin is calculated for listed equity options and other equity
positions (e.g., long and short securities positions). It would not be
appropriate at this time to implement a different margining system for
security futures, given their relation to products that trade in the
U.S. equity markets. Further, implementing a different margining system
for security futures may result in substantially lower margin levels
for these products as compared with other equity products and could
have unintended competitive impacts. For this reason, the suggested
alternative to permit risk-based margin models to determine customer
margin requirements for security futures is not viable.
iv. Risk-Based Margin for STARS Transactions
Recognizing that the Commissions may not be able to adopt risk-
based margin for all security futures, OneChicago asked the Commissions
to consider the alternative of adopting risk-based margin for its STARS
transactions only. The CFTC notes that OneChicago has shut down and is
no longer offering STARS transactions. For purposes of this discussion
of suggested alternatives, the CFTC will examine whether subjecting
STARS transactions or similar products that may be offered in the
future to risk-based margin requirements would provide additional costs
or benefits when compared to the final rules.
STARS transactions represented a combination of two security
futures contracts that formed a spread position. After combining the
two legs of the spread in the customer's account, one leg expired, and
a single security future position remained in the account. A STARS
transaction resulted in a hedged transaction that involved two
customers transferring either a stock position or a security futures
position, and once the back leg of the transaction expired the parties
returned to their original positions. According to OneChicago, there
would be cost savings to structuring the transaction this way for
purposes of facilitating equity repo or stock loan transactions.
As stated above, the Commissions have determined that because no
exchange-traded equity options are subject to risk-based margin
requirements, adopting a risk model approach at this time for STARS
transactions would conflict with the requirements of Section 7(c)(2)(B)
of the Exchange Act.\210\ For this reason, as well as the recent
announcements by OneChicago, this alternative is not viable.
---------------------------------------------------------------------------
\210\ See section II.A. above (discussing a risk model approach
and Section 7(c)(2)(B) of the Exchange Act).
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7. Consideration of Section 15(a) Factors
This section analyzes the expected results of amending CFTC Rule
41.45(b)(1) to reduce the minimum initial and maintenance margin levels
for each security future from 20% to 15% of the current market value of
such contract, and adopting the Margin Offset Table changes as
proposed, in light of
[[Page 75133]]
the five factors under Section 15(a) of the CEA.
i. Protection of Market Participants and the Public
The CFTC believes that the final rules maintain the protection of
market participants and the public from the risks of a default in the
security futures market, if trading in that market resumes. The CFTC
continues to believe that a 15% minimum initial and maintenance margin
requirement in combination with other protections, such as certain
provisions of CFTC Rule 39.13, applicable to DCOs that offer to clear
security futures products,\211\ will protect U.S. market participants,
including security futures customers and security futures
intermediaries, from the risk of a default in security futures markets.
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\211\ As discussed above, in response to the FIA Letter, under
CFTC Letter No. 12-08, the CFTC's Division of Clearing and Risk
interpreted certain sections of CFTC Rule 39.13 and stated that the
customer margin rule under CFTC Rule 39.13(g)(8)(ii) does not apply
to customer initial margin collected as a performance bond for
customer security futures positions. CFTC Letter No. 12-08 at 10
(Sept. 14, 2012). However, there are other aspects of CFTC Rule
39.13 that offer protections such as other risk controls like risk
limits that may prevent a clearing member from carrying positions
with potential exposures above certain thresholds. See CFTC Rule
39.13(h)(1).
---------------------------------------------------------------------------
In addition, security futures intermediaries, such as FCMs, are
authorized to collect additional margin from their customers if the FCM
believes a customer's positions may pose unmanaged risk.\212\ In
addition, any DCOs offering to clear security futures are required to
maintain certain risk management procedures, which include measures to
prevent potential losses from clearing member defaults and methods to
limit risks to the DCO's financial resources.\213\ The objective is
that DCOs will always have sufficient financial resources to manage the
risks presented by security futures.
---------------------------------------------------------------------------
\212\ See CFTC Rule 41.42(c)(1) and SEC Rule 400(c)(1). See 2019
Proposing Release, 84 FR at 36440.
\213\ See CFTC Rule 39.13(f) and (h).
---------------------------------------------------------------------------
One commenter expressed a concern that, based on the statutory
criteria prescribed in the Exchange Act for determining security
futures' margin requirements, lowering margin requirements for security
futures could result in ``potential significant risks to the capital
markets and investors.'' \214\ Further, this commenter cited to the
Commissions' discussions in the 2019 Proposing Release regarding
margin's role in risk mitigation and the potential costs associated
with reducing margin levels. As stated above, the CFTC continues to
believe that the reduction in margin requirements under the final rules
will not decrease the protection to market participants or the public
because, although margin requirements are a critical component of any
risk management program for cleared financial products, they are not
the only risk management technique in place for DCOs or their clearing
members.
---------------------------------------------------------------------------
\214\ CII Letter at 2.
---------------------------------------------------------------------------
ii. Efficiency, Competitiveness, and Financial Integrity of the Markets
The final rules are intended to enhance the efficiency and
competitiveness of the security futures market in the United States by
bringing the initial and maintenance margin requirements for security
futures in line with requirements for security futures subject to
Portfolio Margin Rules. Market participants trading in security futures
will benefit from lower margin requirements. Furthermore, a decrease in
initial and maintenance margin requirements from 20% to 15% of the
current market value of each security futures contract may increase the
attractiveness of security futures and help facilitate the revival of
the security futures markets, whether at OneChicago, or at another
exchange. However, even with lower margin requirements, customer
decisions to trade in security futures would still be influenced by
hedging demands and competition with substitutes or similar products.
The final rules also are expected to improve the competitiveness of
security futures as compared to exchange-traded options. The final
rules' amendments to reduce margin requirements also may facilitate a
more competitive security futures market in the United States as
compared with international markets.\215\ Overall, the CFTC believes
that the final rules will have a positive effect on competition in the
U.S. security futures market without providing an undue competitive
advantage to security futures over comparable exchange-traded equity
options.\216\
---------------------------------------------------------------------------
\215\ Data from OneChicago indicates that the risk-based
margining system applied by Eurex (a non-U.S. security futures
exchange), is consistently lower than the 15% margin requirement
adopted in the final rules. See e.g., Figure 2--Margin Levels for
Dow Components at Eurex and OneChicago. OneChicago Letter at 25.
\216\ See also the CFTC's analysis of anti-trust considerations
in section VII. below. The CFTC has identified no anticompetitive
effects of the final rules.
---------------------------------------------------------------------------
The CFTC continues to believe that a 15% margin requirement for
security futures will, if security futures trading resumes, be
sufficient to protect customers and DCOs against the risk of default in
greater than 99% of cases. According to economic data reviewed by CFTC
staff, the CFTC believes that a 15% margin requirement for security
futures will protect other customers and DCOs against most risks of
default.
Furthermore, the final rules could enhance the financial integrity
of any potential security futures market in the United States. Lowering
the amount of initial and maintenance margin required for customers
trading in security futures may facilitate the revival of security
futures markets, and if that revival occurs, increase the number of
customers trading in security futures and/or increase the amount of
trading. An increase in the number of customers in the security futures
market also could increase the number of FCMs offering to clear for
such customers, which could lead to more efficient transfers of
customer positions by a DCO in the event of a clearing member or
customer default. Furthermore, a larger and more diversified customer
base could reduce risks in the security futures market overall. For all
of these reasons, enhanced liquidity would serve to strengthen the
financial integrity of the security futures market.
Again, the CFTC notes that the DCOs that may clear security futures
would be subject to CFTC regulations requiring the DCO to maintain
adequate risk management policies and overall financial resources. DCOs
may require additional margin, in an amount that is greater than 15%,
on certain security futures positions or portfolios if the DCO notes
particular risks associated with the products or portfolios.
Accordingly, the CFTC believes that the final rules will maintain, or
possibly improve, the financial integrity of the security futures
markets in the U.S.
The CFTC believes that the final rules effectively address the need
for market efficiency, competition, and financial integrity consistent
with the statutory requirements under Section 7(c)(2)(B)(iii) of the
Exchange Act. The CFTC also considered alternatives presented by
commenters, as discussed above, but does not believe that there are any
viable alternatives to the final rules at this time.
iii. Price Discovery
The lower margin requirements adopted under the final rules may
facilitate the revival of security futures markets, and if that revival
occurs, could increase competition and result in some new customers
entering the security futures market along with increased trading by
previously existing customers. In addition, trading from foreign
markets could shift to the U.S. security futures market as a result of
the change in margin requirements. All
[[Page 75134]]
things being equal, this increased activity in the U.S. security
futures market could have a positive effect on price discovery in the
security futures market, if trading resumes. However, as the CFTC has
noted before, price discovery in security futures markets most likely
has occurred in the liquid and transparent security markets underlying
previously existing security futures contracts, rather than the
relatively low-volume security futures themselves.\217\
---------------------------------------------------------------------------
\217\ See Position Limits and Position Accountability for
Security Futures Products, 84 FR 51020.
---------------------------------------------------------------------------
One commenter, citing to SEC Commissioner Jackson's Statement,
shared the view that a serious economic analysis would have considered
whether reducing margin requirements improves price discovery or,
instead, incentivizes a shift toward futures markets in order to seek
out leverage.\218\ SEC Commissioner Jackson's Statement noted that if
market participants shifted toward futures markets, it could result in
less liquidity in related markets (i.e., equity markets) without
contributing to any additional price discovery. Although some portion
of increased trading in security futures may be the result of customers
switching from equity markets to security futures markets, the lower
margin requirements for security futures may, if security futures
trading resumes, facilitate arbitrage between the underlying security
and security futures markets. This arbitrage between the two markets
may enhance price discovery and provide a benefit to customers.
---------------------------------------------------------------------------
\218\ CII Letter at 4.
---------------------------------------------------------------------------
The CFTC notes that changes in price discovery may be difficult to
measure.\219\ However, the CFTC believes that the final rules'
amendments are unlikely to harm price discovery and indeed may improve
price discovery in the security futures market in the United States if
security futures trading resumes.
---------------------------------------------------------------------------
\219\ One commenter shared SEC Commissioner Jackson's view that
the effects of a lower margin requirement on price discovery in
financial markets could be studied by looking at relevant data. CFTC
staff reviewed trading volume data at OneChicago to determine
whether a change to increase the default maximum level of equity
security futures products' position limits resulted in a change in
trading activity in security futures products, but without
additional data on related equity contracts it is not possible to
draw a definitive conclusion about effects on price discovery.
---------------------------------------------------------------------------
iv. Sound Risk Management Practices
The final rules' amendments will lower the minimum initial and
maintenance margin required for security futures positions. If security
futures trading resumes, this may encourage potential hedgers or other
risk managers to increase their use of security futures for risk
management purposes. Moreover, a lower margin requirement could
encourage new market participants to enter the security futures markets
for potential hedging and risk management purposes. The final rules'
amendments are consistent with sound risk management practices,
especially to the extent that there is increased liquidity in
potentially revived security futures markets.
In addition, as discussed in detail above, margin requirements are
a critical component of any risk management program for cleared
derivatives. Security futures have been risk-managed successfully
through central clearing and initial and maintenance margin
requirements for almost twenty years (including time periods of
historic market volatility).\220\ Current minimum margin requirements
for security futures (20%) are higher than minimum margin requirements
for comparable exchange-traded equity options held in a Portfolio
Margin Account.
---------------------------------------------------------------------------
\220\ The CFTC staff notes that the VIX, which measures market
expectations of near term volatility as conveyed by stock index
option prices, has recently approached peak levels due to increased
market volatility in March 2020 (the VIX measurement on March 16,
2020, was close to 83). Previously high volatility was measured in
October and November 2008 during the financial crisis (when the VIX
measurement reached the 80s). See, e.g., VIX data available from the
Federal Reserve Bank of Saint Louis at https://fred.stlouisfed.org/series/VIXCLS.
---------------------------------------------------------------------------
The CFTC recognizes the necessity of sound initial and maintenance
margin requirements for DCO and FCM risk management programs. Initial
and maintenance margin collected addresses potential future exposure,
and in the event of a default, such margin protects non-defaulting
parties from losses. The final rules maintain those protections. As
noted above, based on past data, the 15% margin level is likely to
cover more than 99% of the risks of default associated with security
futures positions, if trading resumes.
v. Other Public Interest Considerations
The CFTC has not identified any additional public interest
considerations related to the costs and benefits of the final rules.
B. SEC
1. Introduction
In the following economic analysis, the SEC considers the benefits
and costs, as well as the effects on efficiency, competition, and
capital formation that the SEC anticipates will result from the SEC's
final rules.\221\ The SEC evaluates these benefits, costs, and other
economic effects relative to a baseline, which the SEC takes to be the
current state of the markets for security futures products and the
regulations applicable to those markets. The economic effects the SEC
considered in adopting these rule amendments are discussed below and
have informed the policy choices described throughout this release.
---------------------------------------------------------------------------
\221\ The Exchange Act states that when the SEC is engaging in
rulemaking under the Exchange Act and is required to consider or
determine whether an action is necessary or appropriate in the
public interest, the SEC shall consider, in addition to the
protection of investors, whether the action will promote efficiency,
competition, and capital formation. 15 U.S.C. 78c(f). In addition,
Exchange Act Section 23(a)(2) requires the SEC, when making rules or
regulations under the Exchange Act, to consider, among other
matters, the impact that any such rule or regulation would have on
competition and states that the SEC shall not adopt any such rule or
regulation which would impose a burden on competition that is not
necessary or appropriate in furtherance of the Exchange Act. See 15
U.S.C. 78w(a)(2).
---------------------------------------------------------------------------
The final rule amendments will lower the required initial and
maintenance margin levels for unhedged security futures from the
current level of 20% to 15%. Furthermore, in connection with the SEC's
rules which permit an SRA to set margin levels that are lower than 15%
of the current market value of the security future in the presence of
an offsetting position involving security futures and related
positions, the SEC is re-publishing the Strategy-Based Offset Table
with the proposed revisions, to conform it to the adopted 15% required
margin levels.\222\
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\222\ Conforming reductions to minimum margin percentages on
hedged security futures positions will be reflected in a restatement
of the table of offsets published in the 2002 Adopting Release. The
Strategy-Based Offset Table is not part of the Code of Federal
Regulations.
---------------------------------------------------------------------------
The SEC received a number of comments on the proposal. Some
commenters supported the proposal,\223\ while other commenters raised
concerns.\224\ The SEC has considered these comments, as discussed in
detail in the sections that follow. This adopting release also revisits
the benefits, the costs, and other economic effects identified in the
2019 Proposing Release.\225\ Much of the discussion below on the costs,
benefits, and other effects is qualitative in nature. Wherever possible
the SEC has attempted to quantify potential economic effects,
incorporating data and other information provided by commenters in its
analysis of the economic effects of
[[Page 75135]]
the final rules. In addition to more detailed information on current
activity in the security futures market, the SEC considered information
supplied by commenters on the potential reduction in margin required to
support security futures positions based on current levels of market
activity and on the likelihood that investors migrated to the security
futures market from related markets. However the SEC generally lacks
the data necessary to estimate, among other things, the potential
impact of the final rule amendments on overall investor participation
in the security futures markets and bid-ask spreads in that market and
related markets.
---------------------------------------------------------------------------
\223\ See FIA Letter.
\224\ See OneChicago Letter; OneChicago Letter 2; OneChicago
Letter 3; Cboe/MIAX Letter; CII Letter; Bost/Davis Letter; Moran/
Tillis/Rounds Letter.
\225\ See 2019 Proposing Release, 84 FR at 36447.
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2. Baseline
The SEC evaluates the impact of final rules relative to a baseline
that includes the regulatory regime applicable to the markets for
security futures, as well as the current state of these markets. As
discussed above, the term ``security future'' refers to a futures
contract on a single security or on a narrow-based security index.\226\
More generally, ``security futures product'' refers to security futures
as well as any put, call, straddle, option, or privilege on a security
future.\227\
---------------------------------------------------------------------------
\226\ See supra note 1.
\227\ See Section 1a(45) of the CEA and Section 3(a)(56) of the
Exchange Act (both defining the term ``security futures product'').
---------------------------------------------------------------------------
Unlike futures markets on commodities or ``broad-based'' equity
indexes, security futures have had a limited role in U.S. financial
markets, which may be due in part to uncertainty relating to tax
treatment \228\ and competition from the more developed equity, equity
swap, and options markets.\229\ Incentives to participate in the
security futures markets (rather than the markets for the underlying
security, options, or swap markets) may stem from reduced market
frictions (e.g., short sale constraints), lower cost of establishing a
short position compared to the equity market, and reduced counterparty
risk due to daily resettlement, relative to comparable OTC instruments
(e.g., equity swaps).
---------------------------------------------------------------------------
\228\ Specifically, the proposition that exchange-for-physical
single stock security futures qualify for the same tax treatment as
stock loan transactions under Section 1058 of the Internal Revenue
Code has not been tested. See e.g., Exchange Act Release No. 71505
(Feb. 7, 2014).
\229\ Security futures markets face competition from equity and
options markets because in principle, the payoff from a security
futures position is readily replicated using either the underlying
security, or through options on the underlying security.
---------------------------------------------------------------------------
As with other types of futures, both the buyer and seller in a
security futures transaction can potentially default on his or her
respective obligation. Because of this, an intermediary to a security
futures transaction will typically require a performance bond
(``initial and maintenance margin'') from both parties to the
transaction. The clearing organization will also require such
performance bonds from its clearing members (i.e., the clearing
intermediary of the security futures transaction). Higher margin levels
imply lower leverage, which reduces risk. Private incentives encourage
a broker-dealer that intermediates security futures transactions to
require a level of margin that adequately protects its interests.
However, in the presence of market frictions, private incentives
alone may lead to margin levels that are inefficient. For example,
intermediaries may set margin levels that, while privately optimal, do
not internalize the cost of the negative externalities caused by the
potential high leverage level associated with low margins. Moreover,
even when all parties are fully aware of the risks of leverage,
privately negotiated margin arrangements may be too low. For example,
the risk resulting from higher leverage levels can impose negative
externalities on financial system stability, the costs of which would
not be reflected in privately negotiated margin arrangements. To the
extent that such market failures are not ameliorated by existing market
institutions,\230\ they provide an economic rationale for regulatory
minimum margin requirements.\231\
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\230\ For centrally cleared markets, including the security
futures market, clearinghouses may impose membership and minimum
margin requirements that cause clearing members to internalize a
greater share of the costs associated with customers' higher
leverage.
\231\ Monetary authorities may also rely on regulatory margin
requirements as a policy tool. The SEC does not consider such
motives here.
---------------------------------------------------------------------------
i. The Security Futures Market
Security futures can provide a convenient means of obtaining delta
exposure to an underlying security.\232\ To effectively compete with
other venues for obtaining similar exposures (e.g., equity and equity
options markets), security futures markets must reduce market frictions
or provide more favorable regulatory treatment. Security futures
markets may reduce market frictions by providing a lower cost means of
financing equity exposures. They can simplify taking short positions by
eliminating the need to ``locate'' borrowable securities.\233\ Security
futures can also be used to create synthetic equity repurchase
agreements or equity loans, which carry similar terms as their over-
the-counter counterparts.\234\ Finally, security futures can also
provide an opportunity for customers to gain greater leverage through
lower margin requirements (relative to margin in securities or options
transactions).
---------------------------------------------------------------------------
\232\ The derivative of the theoretical price of a futures
contract with respect to the price of the underlying (i.e., the
``delta'') is 1. For a $1 increase (decrease) in the price of an
underlying security, the theoretical price of its security future
increases (decreases) by $1.
\233\ In these respects, a security future functions like a
cleared total return swap.
\234\ This can be achieved by simultaneously entering into a
security futures position that expires at the end of the trading day
and another security futures position of the same size and on the
same underlying security but in the opposite direction and expiring
at a future date, compared to the other position. See also
Memorandum from the SEC's Division of Trading and Markets regarding
a July 16, 2019, meeting with representatives of OneChicago
(including OneChicago's presentation on STARS as synthetic equity
repos or equity loans).
---------------------------------------------------------------------------
The one U.S. exchange that provided trading in security futures,
OneChicago, discontinued all trading operations on September 21, 2020.
As of the end of 2019, 13,792 security futures contracts \235\ on 1,638
symbols were traded on the exchange. Of these 13,792 contracts, 343 had
open interest at the end of the year. Total open interest at the end of
the year was 602,276 contracts. Annual trading volume in 2019 was close
to 7.4 million contracts, an increase of approximately 4% from the
prior year. At this time, however, no security futures contracts are
listed for trading on U.S. exchanges.
---------------------------------------------------------------------------
\235\ The typical contract is written on 100 shares of
underlying equity.
---------------------------------------------------------------------------
According to OneChicago, prior to the cessation of trading, almost
all security futures positions were carried in futures accounts of
CFTC-regulated FCMs.\236\ Consequently, the SEC believes only a small
fraction of security futures accounts previously fell under the SEC's
customer margin requirements for security futures. The SEC believes
that none of the accounts that were subject to the SEC's security
futures margin rules used the Portfolio Margin Rules.\237\ Therefore,
the SEC believes that all of the securities accounts that previously
fell under the SEC's margin rules would have been subject to the
general initial and maintenance margin requirement of 20% and the
associated Strategy-Based Offset Table.
---------------------------------------------------------------------------
\236\ See OneChicago Petition.
\237\ If security futures positions were held in a Portfolio
Margin Account they would be included in the risk-based portfolio
margin calculation and thus effectively subject to a lower (i.e.,
15%) margin requirement under the baseline. Based on an analysis of
FOCUS filings from year-end 2019, no broker-dealers had collected
margin for security futures accounts in a Portfolio Margin Account.
---------------------------------------------------------------------------
[[Page 75136]]
ii. Regulation
In the U.S., a security future is considered both a security and a
future, so customers who wish to buy or sell security futures must
conduct the transaction through a person registered both with the CFTC
as either an FCM or an IB and the SEC as a broker-dealer.\238\ In
addition, an investor can trade security futures using either a futures
account or a customer securities account.
---------------------------------------------------------------------------
\238\ See supra note 12.
---------------------------------------------------------------------------
As discussed in section I, Section 7(c)(2)(B) of the Exchange Act
provides that the customer margin requirements must satisfy four
requirements. First, they must preserve the financial integrity of
markets trading security futures products.\239\ Second, they must
prevent systemic risk.\240\ Third: (1) They must be consistent with the
margin requirements for comparable options traded on any exchange
registered pursuant to Section 6(a) of the Exchange Act; \241\ and (2)
the initial and maintenance margin levels must not be lower than the
lowest level of margin, exclusive of premium, required for any
comparable exchange-traded equity options.\242\ Fourth, excluding
margin levels, they must be, and remain consistent with, the margin
requirements established by the Federal Reserve Board under Regulation
T.\243\
---------------------------------------------------------------------------
\239\ See Section 7(c)(2)(B)(i) of the Exchange Act.
\240\ See Section 7(c)(2)(B)(ii) of the Exchange Act.
\241\ See Section 7(c)(2)(B)(iii)(I) of the Exchange Act.
\242\ See Section 7(c)(2)(B)(iii)(II) of the Exchange Act.
\243\ See Section 7(c)(2)(B)(iv) of the Exchange Act.
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Under existing SEC rules, the minimum initial and maintenance
margin requirement for a customer's unhedged security futures position,
not subject to an exemption is 20% of its current market value.\244\
SRAs may allow margin levels lower than 20% for accounts with
``strategy-based offsets'' (i.e., hedged positions).\245\ Strategy-
based offsets can involve security futures as well as one or more
related securities or security futures position, consistent with the
Strategy-Based Offset Table.\246\
---------------------------------------------------------------------------
\244\ See SEC Rule 403(b)(1).
\245\ See SEC Rule 403(b)(2).
\246\ See section II.B. above (discussing the Strategy-Based
Offset Table).
---------------------------------------------------------------------------
Accounts subject to the Portfolio Margin Rules are also exempt from
the customer margin requirements for security futures.\247\ Under
currently approved Portfolio Margin Rules, the effective margin
requirement for an unhedged security futures position or an exchange-
traded option on a narrow-based index or an individual equity is
15%.\248\ Under current rules, only customer securities accounts held
through SEC-regulated broker-dealers could potentially be subject to
the Portfolio Margin Rules; however, the SEC is not aware of any
broker-dealers offering such accounts. Margin requirements for security
futures positions of clearing members (i.e., their accounts at a
clearing agency or DCO) are also exempt from the security futures
margin requirements.\249\
---------------------------------------------------------------------------
\247\ See CFTC Rule 41.42(c)(2)(i), 17 CFR 41.42(c)(2)(i); SEC
Rule 400(c)(2)(i), 17 CFR 242.400(c)(2)(i).
\248\ This follows from the methodology of current SRO Portfolio
Margin Rules as applied to delta one securities. There is no
comparable portfolio margining system for security futures held in a
futures account and, therefore, these positions, if unhedged, are
subject to the required 20% initial and maintenance margin levels.
\249\ See SEC Rule 400(c)(2)(i) through (v), 17 CFR
242.400(c)(2)(i) through (v). Clearing members are instead subject
to margin rules of the clearing organization as approved by the SEC
pursuant to Section 19(b)(2) of the Exchange Act, 15 U.S.C.
78s(b)(2).
---------------------------------------------------------------------------
3. Considerations of Costs and Benefits
Under the final rule amendments being adopted in this release, the
initial and maintenance margin requirements for a security futures
position will be reduced from 20% to 15% of the current market value of
the position. This section discusses both the likely economic effects
of the final rule amendments conditional on the resumption of trading
in security futures, and the extent to which the final rule amendments
may affect the likelihood that trading in security futures contracts
resumes.
One commenter expressed concern that the SEC did not present any
substantive analysis of the proposed amendment's possible
benefits.\250\ In response to this comment, as stated in the 2019
Proposing Release, the SEC cannot quantify the benefits to investors
from the potential effects of the final rule amendments on investor
demand, investor participation, price discovery and liquidity.\251\ As
discussed in more detail below, OneChicago provided information about
the likely reduction in initial margin requirements it expected from
the proposed rule amendments. Although this information supports the
SEC's view that the final rule amendments could increase investor
participation in the security futures market if trading resumes, it is
not possible to meaningfully estimate the magnitude of any such
increase, and related implications for the market for exchange-traded
equity options without additional information about investors'
sensitivity of demand for security futures and exchange-traded equity
options positions with respect to changes in margin levels.\252\ This
sensitivity is difficult to estimate because it requires historical
data on positions and associated margins from customer securities
accounts, which broker-dealers currently do not report to the SEC.\253\
While the SEC's analysis of the costs and benefits of the final rule
amendments are qualitative in nature, the inability to quantify certain
benefits and costs does not mean that the overall benefits and costs of
the final rule amendments are any less significant.
---------------------------------------------------------------------------
\250\ See CII Letter at 3.
\251\ See 2019 Proposing Release, 84 FR at 36449.
\252\ This sensitivity is more formally known as the margin
elasticity of demand.
\253\ While the minimum margin requirements are set by
regulation and therefore known, the actual margin associated with a
position is set by a broker-dealer and may be different from the
regulatory minimum.
---------------------------------------------------------------------------
Security futures prices reflect the aggregate demand for security
futures of all participating investors, including those that are
subject to margin requirements and those that are not. Among other
things, this demand depends on the costs associated with margin
requirements, such as the opportunity cost of the margin collateral.
All else equal, higher margin levels may reduce individual demand
because of potential higher trading costs.
As stated above, at the end of 2019, open interest in the U.S.
security futures markets was 602,276 contracts. SEC staff understands
that approximately 2% of these contracts were held in securities
accounts subject to SEC margin requirements.\254\ None of these
accounts is believed to have been subject to Portfolio Margin Rules.
This information, in combination with information supplied by
commenters, can be used to construct a hypothetical estimate of the
effect of the final rules on initial margin collected were security
futures to continue to trade at OneChicago. According to OneChicago,
the total reduction in margin collected (including margin collected on
security futures held in futures accounts,) would have been $130
million.\255\ Because the SEC estimates approximately 2% of these
contracts were held in securities accounts, the margin reduction
attributable to securities accounts would have been approximately $2.6
million.\256\ The SEC expects this may overestimate the impact of the
final rule, as broker-dealers may currently impose
[[Page 75137]]
initial margin requirements exceeding 20% on certain security futures
if they deem higher margin amounts necessary for risk management.\257\
---------------------------------------------------------------------------
\254\ See 2019 Proposing Release, 84 FR at 36449.
\255\ OneChicago Letter at 14.
\256\ Calculated as $130 million x 0.02 = $2.6 million.
\257\ See OneChicago Letter at 14 (stating that as of August 26,
2019, 92% of OneChicago security futures had a risk level above
20%).
---------------------------------------------------------------------------
i. Impact on Investor Participation
By lowering the minimum margin requirement for unhedged security
futures positions held outside Portfolio Margining Accounts, the final
rule amendments may affect participation in the security futures
market, in the event that trading in security futures resumes in the
United States. Reducing the trading costs for investors that hold these
positions outside of Portfolio Margin Accounts may increase demand for
security futures and may benefit investors by reducing the costs of
taking on or laying off risk exposures.
The potential trading cost savings associated with the final rule
amendments may also increase the competitiveness of security futures
relative to certain potential close substitutes that are not directly
affected by the margin requirements of the final rule amendments. As a
result, if security futures trading resumes, the final rule amendments
may encourage higher investor participation in the security futures
market relative to what was previously observed under current initial
margin requirements, to the benefit of financial intermediaries that
offer security futures to their customers and exchanges that list
security futures for trade, while potentially reducing fees earned by
intermediaries and exchanges from services provided in related markets.
In addition to margin requirements, individual demand for security
futures depends on the availability of other financial instruments (or
strategies based on these instruments) that may be viewed by an
investor as close substitutes to security futures. For example, certain
OTC instruments that offer delta one exposure to the underlying
security and certain security futures positions may be viewed as close
substitutes.\258\ Furthermore, certain option spread positions and
certain futures positions may be viewed by some investors as close
substitutes.\259\ These potential substitutes exist on a continuum, and
some alternative strategies have risk profiles and cash flows more
similar to security futures than others.\260\ In the presence of these
alternatives, individual demand for a security futures position depends
on the relative cost of alternative strategies, including the cost of
financing the alternative position (e.g., margin requirements) and the
cost of bearing risk exposures that are incremental to the desired risk
exposure obtainable through security futures.
---------------------------------------------------------------------------
\258\ See OneChicago Letter (describing these OTC instruments,
including equity swaps and stock loans).
\259\ See section IV.B.4.ii.a infra (discussing comparability of
exchange-traded options and security futures).
\260\ One commenter specifically argued that that single stock
futures and equity options are sufficiently distinct that they do
not trade interchangeably, and supplied data to support its claim.
See section IV.B.4.ii.a infra.
---------------------------------------------------------------------------
The final rule amendments will also result in more consistent
margining for identical unhedged security futures positions held within
or outside Portfolio Margining Accounts. This will promote regulatory
parity of security futures margin requirements between Portfolio Margin
Accounts and securities accounts that do not offer portfolio margining,
as well as between securities and futures accounts. To the extent that
customers are currently unwilling to bear the costs of opening
Portfolio Margin Accounts, they may decline opportunities to
participate in the security futures market or may instead bear the
costs of holding security futures in their securities accounts. If
trading resumes, parity in margin requirements could result in
efficiencies for customers who might otherwise open separate accounts
to obtain security futures exposure in response to differing margin
requirements across account types.
ii. Impact on use of Leverage and Investor Behavior
If security futures trading resumes, the final rule amendments may
provide investors with opportunities to take on additional leverage.
Because security futures allow investors to acquire 100% exposure in
the underlying security (also known as ``delta one'' exposure) for a
fraction of the cost of funding a position in the cash market, the
final rule amendments may reduce the cost of financing leveraged
exposures through security futures. In particular, the final rule
amendments may increase the attractiveness of security futures as means
to finance delta one exposure.
Increased leverage can result in larger investor losses, and may
exacerbate the potential costs to investors from trading patterns that
reflect behavioral biases. For example, in equity markets, retail
investors may be subject to costs from certain trading patterns that
are consistent with the so-called ``disposition effect''--an aversion
to realize losses. To the extent that the final rule amendments lower
the cost that retail investors bear when they participate in the
security futures market and encourage more participation, the potential
costs associated with the ``disposition effect'' and other behavioral
biases could be exacerbated.
However, the potential costs associated with retail investors'
behavioral biases are likely to be limited in aggregate, because (i)
under the baseline, retail investors are believed to represent a very
small fraction (less than 1%) of open interest in security futures; and
(ii) broker-dealers may still impose higher initial margin requirements
and other measures to manage risk exposures to their customers and meet
clearing organization requirements.
One commenter noted that the daily variation settlement in the
futures market would counter the disposition effect as it relates to
security futures, while the current margining system in the options
markets exacerbate the effect.\261\ The SEC appreciates the analysis
provided by this commenter. However, contrary to the conclusion of this
analysis, both the margin on a futures position and the margin on an
options position move in the same direction (as compared to opposite
directions, as suggested by the commenter), because in the exchange-
traded equity options market, the initial and maintenance margin
generally applies to the short position only.\262\
---------------------------------------------------------------------------
\261\ See OneChicago Letter, Appendix A.
\262\ Thus, when the option position increases in value for the
long investor, the maintenance margin assessed to the short investor
(the seller of the position) increases proportionally. Customers who
buy long exchange-traded options generally must pay for them in
full. See supra note 94 (discussing margin requirements for long
exchange-traded options).
---------------------------------------------------------------------------
iii. Impact on Financial Intermediaries
The final rule amendments may also provide benefits to financial
intermediaries that facilitate trading in security futures, thereby
providing incentives to list security futures. Broker-dealers and
exchanges generally charge fees for purchases and sales of listed
securities and derivatives contracts. To the extent that the final rule
amendments increase future participation in security futures markets if
trading resumes, security futures exchanges and broker-dealers that
offer customers the ability to trade security futures in securities
accounts may earn higher fees from security futures activity, than
would be the case in the absence of the final rule amendments, although
an increase in revenues in the security futures market may reduce fees
earned from activity in related markets.
[[Page 75138]]
In turn, opportunities to earn higher fees from enabling transactions
in security futures may encourage exchanges to list security futures.
As a result, the final rule amendments could incrementally increase the
likelihood that trading in security futures contracts resumes.
Lowering the regulatory minimum margin requirements for security
futures margin could also impose costs on broker-dealers, their
customers, and counterparties. To the extent that lower regulatory
margin requirements cause some broker-dealers to impose lower margin
requirements on customers if trading resumes, the final rule amendments
could increase the default risk of the broker-dealer, and a broker-
dealer default would likely impact the defaulting broker-dealer's
customers and counterparties. However, broker-dealers participating in
security futures markets would be subject to clearing organizations'
margin requirements and the SEC's broker-dealer financial
responsibility rules (including minimum capital requirements).\263\
Such requirements are reasonably designed to mitigate the risk of a
broker-dealer's default. In addition, in the event of such a default,
the SEC's customer protection rule would protect customers' assets held
in a securities account.\264\
---------------------------------------------------------------------------
\263\ 17 CFR 240.15c3-1.
\264\ 17 CFR 240.15c3-3. The SEC acknowledges that any security
futures held in futures accounts would benefit from the CFTC's
customer protection rules found in part 1 of the CFTC's regulations.
---------------------------------------------------------------------------
iv. Resumption of Trading in the U.S. Security Futures Market
The final rule amendments may increase investors' willingness to
participate in the security futures markets to an extent that is
sufficient to result in resumption in exchange trading of security
futures in the U.S. Although we expect the final rule amendments to
have, at most, an incremental effect on the likelihood that trading
resumes, the potential revitalization of the U.S. security futures
market could produce economic consequences for investors,
intermediaries, and financial markets.
A liquid U.S. security futures market could result in both costs
and benefits for investors. Access to security futures could benefit
investors by reducing the costs that investors incur to obtain risk
exposures or finance other transactions. As discussed earlier, security
futures can allow investors to obtain low-cost exposure to underlying
securities.\265\ In particular, security futures can simplify the
process of taking short positions by eliminating the need to locate
borrowable securities. Moreover, security futures can be combined to
produce synthetic equity loans or equity repurchase agreements.\266\
These activities, however, have attendant risks. As discussed above, an
investor that uses security futures to obtain leveraged exposure to
underlying securities also is exposed to the risk of larger losses.
---------------------------------------------------------------------------
\265\ See section IV.B.2.i.
\266\ Id.
---------------------------------------------------------------------------
Resumption of trade in the U.S. security futures market could
permit intermediaries to earn additional revenues by serving investors
that participate in the security futures market. Whether revenues from
transaction services increase depends on whether investors transact in
security futures in addition to cash market securities rather than
simply reallocating their cash market activities to security futures
markets.
v. Effects of Revisions to Strategy-Based Offset Table
As discussed in section II.B. above, the revised Strategy-Based
Offset Table is being re-published as proposed.\267\ The re-published
Strategy-Based Offset Table incorporates the 15% required margin levels
for certain offsetting positions and retains the same percentages for
all other offsets. The revisions to the Strategy-Based Offset Table
would promote consistency with the lower margin levels on unhedged
security futures positions of the final rule amendments. If security
futures trading resumes, the revisions would generally benefit
investors from the lower cost of carrying offset positions. The SEC
also expects any additional costs incurred by broker-dealers to
incorporate the revised Strategy-Based Offset Table into their existing
policies and procedures to be similarly insubstantial.
---------------------------------------------------------------------------
\267\ See 2019 Proposing Release, 84 FR at 36441-43.
---------------------------------------------------------------------------
4. Effects on Efficiency, Competition, and Capital Formation
In addition to the specific costs and benefits discussed above, the
reductions to minimum margin requirements on unhedged security futures
that the SEC is adopting may have broader effects on efficiency,
competition, and capital formation.
i. Efficiency
Should trading in security futures resume, the SEC expects the
final rule amendments to result in incremental improvements in
efficiency to the extent that they permit investors to obtain the risk
exposures they desire at lower cost. The final rule amendments may also
improve liquidity in the security futures market and impact the
informational efficiency of security futures prices, as well as the
prices for related financial instruments. Reducing minimum margin
requirements could also impact the financial system more broadly
though, as discussed below, we do not expect such effects to be
substantial.
a. Efficiency and Transactions Costs
Under the current minimum margin requirements two identical
security futures positions may be subject to different margin levels
because they are held in different types of accounts. A potential
concern with the current margin requirements in these situations, and
more generally, is whether they can result in price distortions or
introduce inefficiencies in how investors allocate funds.
Current margin requirements may not necessarily result in price
distortions. This is because certain participating investors, such as
market makers,\268\ are exempt from the current margin requirements
(which would still apply to any positions held on behalf of a
customer), and they may step in to become the ``marginal investor'' in
situations where current margin requirements might otherwise distort
prices.\269\ For example, if security futures trading resumes investors
trading from outside a Portfolio Margin Account, who are not exempt
from margin requirements, would face trading costs associated with
margin requirements that may hinder their ability to trade with each
other. A seller and a buyer who agree on the value of a security
futures product may nevertheless fail to agree on a transaction price
because the buyer demands a discount to compensate herself for the cost
of meeting margin requirements, while the seller demands a premium to
compensate herself for the same costs. On their own, these distortions
would result in wider bid-ask spreads in security futures markets.
However, because market participants such as market makers, who are
exempt from margin requirements, bear minimal costs to transact, these
investors have the ability to provide quotes that are
[[Page 75139]]
generally more competitive than the quotes provided by other types of
investors, reducing uncertainty in the value of security futures.
---------------------------------------------------------------------------
\268\ Market makers are subject to exemptions from margin
requirements. See CFTC Rule 41.42(c)(2)(v); SEC Rule 400(c)(2)(v).
\269\ A market participant or investor is considered
``marginal'' if they are willing to buy or sell security futures
even for small deviations between the price of a security futures
contract and the contract's fundamental value and thus sets the
price of the contract. Such activities may be more profitable for
market makers if they encounter lower trading frictions (including
margin requirements) relative to other market participants.
---------------------------------------------------------------------------
Nevertheless, current margin requirements may result in potential
allocative inefficiencies. Trading costs associated with the current
margin requirements may impact investor demand, and therefore
willingness to take on or lay off risk exposures using security
futures. In particular, risk sharing under the regulatory minimum
margin requirements may be different relative to the case where margin
levels are optimally determined to reflect the risks of security
futures positions. The difference between the allocation of financial
risk that result from current margin requirements and the allocation
associated with the margin requirements that are optimally determined
may be viewed as an allocative inefficiency. Allocative inefficiency
may also manifest if trading costs in security futures drive investors
to use alternative products to obtain financing or manage risk, which
are less suited to their needs.
If security futures trading resumes, certain investors could reduce
these potential allocative inefficiencies by trading out of a Portfolio
Margin Account,\270\ where margin requirements can result in much lower
margin levels compared to those that apply outside such accounts.
However, as of the fourth quarter of 2019, no investors appeared to be
trading in security futures out of Portfolio Margin Accounts, despite
the fact that they did trade significantly in exchange-traded equity
options out of these accounts. This observation may indicate that
investors that qualify for Portfolio Margin Accounts have not traded
security futures.\271\ Alternatively, such investors may have chosen to
trade security futures outside of Portfolio Margin accounts, implying
that the costs they faced as a result of the current margin
requirements were not sufficiently large to discourage their
participation or to persuade them to open a Portfolio Margin Account.
---------------------------------------------------------------------------
\270\ Not all investors are eligible to open a Portfolio Margin
Account. See Cboe/MIAX Letter at 4.
\271\ With the exception of investors that are exempt from
margin requirements, the investors that hold or are eligible to open
a Portfolio Margin Account are best positioned to trade security
futures at margin levels that could be substantially below the
current minimum margin requirements. The extent to which they face
low margin levels on a new security futures position depends on any
offsetting positions--either security futures or exchange-traded
options positions--that they hold in their Portfolio Margin Account
at that time when they seek to enter the new security future
position.
---------------------------------------------------------------------------
Nevertheless, because opening Portfolio Margin Accounts entails
costs, not all investors can trade out of these accounts,\272\
therefore some investors may face barriers to participation in the
security futures market, if trading resumes. The potential
inefficiencies associated with these barriers arise when the margin
levels associated with current minimum margin requirements for security
futures are larger than the margin levels associated with margin
requirements that are optimally determined, and not because similar
positions are margined differently in other markets.
---------------------------------------------------------------------------
\272\ See Cboe/MIAX Letter (describing potential costs and
requirements associated with opening a Portfolio Margining Account).
---------------------------------------------------------------------------
The final rule amendments will lower the minimum initial margin
requirements for certain security futures positions, and in turn reduce
the trading costs for these positions. To the extent trading costs
result in inefficiencies, the final rule amendments, by lowering
trading costs, may reduce potential inefficiencies associated with the
current initial margin requirements.
Furthermore, as discussed above, lower trading costs in certain
security futures positions may increase investor demand for security
futures, and may encourage greater market participation in this market
if trading in security futures resumes. Greater participation may
increase competition over prices, which in turn may result in improved
price discovery and liquidity in the security futures market. However,
the effect of the final rule amendments on price discovery and
liquidity may be limited because, as discussed above, the marginal
participant in this market is likely one that is currently exempt from
the customer margin requirements for security futures and therefore,
able to supply liquidity at relatively low cost.
One commenter stated that the lower minimum margin requirements
combined with investors' search for sources of leverage, may increase
liquidity in the security futures market while simultaneously reducing
liquidity and price efficiency in other related markets.\273\ The SEC
acknowledges that the final rule amendments may encourage resumption of
trading in the U.S. security futures market and, if trading resumes,
may encourage arbitrageurs to rely more on the security futures market
to take advantage of potential mispricing compared to other markets, or
may increase the risk of adverse selection in equity markets if it
encourages less-informed investors to migrate to the security futures
market to obtain leveraged equity exposure at low cost.\274\ However,
the SEC does not believe that the resumption of trading in security
futures or heightened focus on the security futures market would
necessarily reduce informational efficiency or liquidity in aggregate
across related markets. Markets that support trade in financial
instruments that reference the same underlying security tend to be
interconnected to a high degree.\275\ Furthermore, investors may access
security futures quotes and post-trade information. As such, even if
trading in security futures resumes and the final rule amendments shift
price discovery from related markets to the security futures market,
information impounded in security futures prices may inform trading in
those related markets.\276\
---------------------------------------------------------------------------
\273\ See CII Letter at 3.
\274\ See Stewart Mayhew, Atulya Sarin & Kuldeep Shastri, The
Allocation of Informed Trading Across Related Markets: An Analysis
of the Impact of Changes in Equity-Option Margin Requirements, 50 J.
FIN. 1635 (1995) (showing that a reduction in options margin
requirements decreased options market bid/ask spreads and increased
option market depth-of-book, while increasing equity market bid/ask
spreads and decreasing equity market depth-of-book).
\275\ See, e.g. Sugato Chakravarty, Huseyin Gulen & Stewart
Mayhew, Informed Trading in Stock and Option Markets, 59 J. FIN.
1253 (2004) (showing that price discovery takes place both in the
equity market and the equity options market, with the latter
contributing by about 17%). Similarly, another study documents
informational flows between credit default swap markets, equity
options markets and equity markets. See Antje Berndt & Anastaysia
Ostrovnaya, Do Equity Markets Favor Credit Market News over Options
Market News?, 4(2) Q. J. FIN. 1 (2014).
\276\ See, e.g. David Easley, Maureen O'Hara & P. S. Srinivas,
Option Volume and Stock Prices: Evidence on Where Informed Traders
Trade, 53 J. FIN. 431 (1998) and Jun Pan & Allen Poteshman, The
Information in Option Volume for Future Stock Prices, 19 REV. FIN.
STUD. 871 (2006) (both showing that equity options trading provide
valuable information for equity markets).
---------------------------------------------------------------------------
b. Systemic Considerations
The final rule amendments may also impact efficiency through their
impact on risk management. As discussed above, broker-dealers likely
weigh the costs associated with customer defaults against the benefits
of lower margin requirements when setting margin requirements for their
customers. Although such private considerations would produce market-
determined margin levels that were optimal from a broker-dealer's
perspective, market imperfections could lead broker-dealers to impose
margin requirements on customers that are not efficient for the
financial system as a whole. The relevant market imperfections in the
context of margin requirements relate to
[[Page 75140]]
externalities on financial stability arising from excessive
leverage.\277\
---------------------------------------------------------------------------
\277\ The SEC acknowledges that other market imperfections
(e.g., asymmetric information, adverse selection) may also play a
role, although the SEC believes these to be less relevant to this
context. Asymmetric information about market participants' quality
can lead privately negotiated margin levels to be inefficient. For
example, competition among broker-dealers may lead to a ``race to
the bottom'' in margin requirements when customers' ``quality'' is
not perfectly observable. See e.g., Tano Santos & Jose A.
Scheinkman, Competition among Exchanges, 116 Q. J. ECON. 1027
(2001). Alternatively, problems of adverse selection (e.g.,
potential to re-invest customer margin in risky investments) or
moral hazard (e.g., expectations of government rescue) may also
create incentives for broker-dealers to offer margin requirements
that are too low. Asymmetric information about broker-dealer quality
may make it impossible for customers to provide sufficient market
discipline, leading to a problem similar to that faced by bank
depositors. See Mathias Dewatripont & Jean Tirole, Efficient
Governance Structure: Implications for Banking Regulation, in
CAPITAL MARKETS AND FINANCIAL INTERMEDIATION 12 (Colin Mayer &
Xavier Vives eds., 1993).
---------------------------------------------------------------------------
Historically, a key aspect of the rationale for regulatory margin
requirements on securities transactions was the belief that such
requirements could improve efficiency by limiting stock market
volatility resulting from ``pyramiding credit.'' \278\ Leveraged
exposures built up during price run-ups could lead to the collapse of
prices when a small shock triggers initial and maintenance margin calls
and a cascade of de-leveraging. The utility of such margin requirements
in limiting such ``excess'' volatility and the contribution of
derivatives markets to such volatility have been a perennial topic of
debate in the academic literature, rekindled periodically by crisis
episodes.\279\ Most recently, the 2007-2008 financial crisis saw
similar concerns (i.e., procyclical leverage, margin call-induced
selling spirals) raised in the securitized debt markets.\280\ While
lower margin requirements can increase the risk and severity of market
dislocations--given the current limited scale of the security futures
markets and the limited role played by SEC registrants in these
markets--the adopted reductions to minimum margin requirements are
unlikely to present a material financial stability concern.
---------------------------------------------------------------------------
\278\ See Thomas Gale Moore, Stock Market Margin Requirements,
74 J. POL. ECON. 158 (1966).
\279\ See id. See also Stephen Figlewski, Futures Trading and
Volatility in the GNMA Market, 36 J. FIN. 445 (1981). See also
Franklin R Edwards, Does Futures Trading Increase Stock Market
Volatility?, 44 FIN. ANALYSTS J. 63 (1988). See also Paul H Kupiec,
Margin Requirements, Volatility, and Market Integrity: What Have We
Learned Since the Crash?, 13 J. FIN. SERVICES RES. 231 (1998).
\280\ See e.g., Tobias Adrian & Hyun Song Shin, Liquidity and
Leverage, 19 J. FIN. INTERMEDIATION 418 (2010).
---------------------------------------------------------------------------
One commenter expressed concern that the criteria for prescribing
margin requirements under the Exchange Act to preserve the financial
integrity of markets trading security futures products and preventing
systemic risk appear to indicate potential significant risks to the
capital markets and investors by lowering margin requirements.\281\
This commenter noted that the 2019 Proposing Release specifically
acknowledged that margin requirements are a critical component of any
risk management program for cleared financial products and that higher
margin levels imply lower leverage, which reduces risk.\282\ As
described in the baseline, the vast majority of security futures
positions were held in futures accounts at CFTC-regulated entities,
and, consequently, only a small fraction of the security futures
accounts were subject to the SEC's margin rules. Therefore, even if
trading in security futures resumes and participation in security
futures markets were to increase modestly as a result of the final rule
amendments, the adopted reductions to minimum margin requirements are
unlikely to have a significant impact on the financial integrity of the
security futures market and are unlikely to lead to systemic risk.\283\
---------------------------------------------------------------------------
\281\ See CII Letter at 2.
\282\ See CII Letter at 2.
\283\ See 2019 Proposing Release, 84 FR at 36438, and 36449-50.
---------------------------------------------------------------------------
ii. Competition
The SEC has considered the potential impact of the final rule
amendments on competition. This section discusses those impacts in
detail and considers the views of commenters on the extent to which
reducing minimum margin requirements for certain accounts introduces or
eliminates competitive disparities between markets for different types
of financial instruments and markets in different jurisdictions.
a. Competition Among Related Markets
The 2019 Proposing Release stated that the proposed initial and
maintenance margin requirements would establish a more level playing
field between options exchanges and security futures exchanges, and
between broker-dealers/securities accounts and FCMs/futures
accounts.\284\ Although the SEC continues to expect the final rule
amendments to place these exchanges and account types on a more level
footing, some commenters took issue with this view. One commenter
argued that the final rule amendments would give unhedged security
futures a competitive advantage over exchange-traded equity options
when held outside a Portfolio Margining Account.\285\ This commenter
suggested that subjecting security futures and exchange-traded equity
options to different margin requirements in this way may disrupt the
regulatory parity that currently exists between security futures and
exchange-traded equity options as the proposal would create
preferential margin levels for unhedged security futures held outside
of a Portfolio Margin Account.\286\ This commenter also believed that
the proposal implies that exchange-traded equity options and security
futures are not competing products, stating that currently there is
significant trading in option spread positions that ``replicate long
and short security futures'' outside Portfolio Margin Accounts.\287\
---------------------------------------------------------------------------
\284\ See 2019 Proposing Release, 84 FR at 36451.
\285\ See Cboe/MIAX Letter at 6-8.
\286\ See Cboe/MIAX Letter at 2.
\287\ See Cboe/MIAX Letter at 6-8.
---------------------------------------------------------------------------
The SEC agrees that security futures and exchange-traded equity
options can have similar economic uses. Nevertheless, for the reasons
discussed in section II.A.2 of this release, reducing the margin levels
for an unhedged security future held outside of a Portfolio Margin
Account to 15% is unlikely to result in a competitive disadvantage for
exchange-traded equity options in practice if trading in security
futures resumes.
The SEC acknowledges that because the adopted margin requirements
apply only to unhedged security futures positions held outside
Portfolio Margining Accounts, the final rule amendments may result in
different margin requirements across security futures positions and
exchange-traded equity options positions held in this type of account.
To the extent some investors view a security futures position and an
option spread position that replicates the contractual payoffs of the
security futures position as close substitutes, the final rule
amendments may result in different costs for these positions when held
outside of a Portfolio Margining Account and may cause these investors
to prefer the security futures position to the option spread position.
From this perspective, the final rule amendments may potentially have
an adverse competitive effect on exchange-traded equity options if
trading in security futures resumes in the U.S. However, this potential
adverse competitive impact likely would be small as a substantial
portion of exchange-traded equity options are traded in Portfolio
Margin Accounts where the margin requirement for an unhedged exchanged-
traded option on a
[[Page 75141]]
narrow-based index or single-equity is 15%.\288\
---------------------------------------------------------------------------
\288\ See 2019 Proposing Release, 84 FR 36450.
---------------------------------------------------------------------------
OneChicago disagreed with the notion that security futures and
exchange-traded equity options strategies could be comparable, noting
that because security futures provide an investor with 100% exposure
(i.e., delta one exposure) to the underlying security, security futures
should instead be compared to other financial instruments that offer
delta one exposure, such as uncleared OTC equity swaps and cleared OTC
stock loans.\289\
---------------------------------------------------------------------------
\289\ OneChicago Letter.
---------------------------------------------------------------------------
OTC total return equity swaps and stock loans may compete with
security futures to provide delta one exposure at lower cost compared
to outright acquisition of the underlying security. From this
perspective, to the extent that security futures compete with these OTC
instruments, the final rule amendments would increase the
competitiveness of security futures relative to these OTC instruments.
However, this potential competitive effect is limited, because, as
OneChicago noted, under certain conditions, the costs of financing
delta one exposure through OTC equity swaps and stock loans can be
substantially smaller compared to the cost of security futures.\290\
---------------------------------------------------------------------------
\290\ OneChicago Letter. In addition, as discussed in section
II.A. of this release, Section 7(c)(2)(B) of the Exchange Act
provides that the margin requirements for security futures must be
consistent with the margin requirements for comparable exchange-
traded options. The Exchange Act does not directly contemplate
comparisons with the margin requirements for the products and
markets identified by OneChicago. Rather, it requires comparisons to
comparable exchange-traded options.
---------------------------------------------------------------------------
OneChicago further argued that the risk profile of a security
futures position cannot be replicated with exchange-traded equity
options, and on this basis challenged the argument that lower margin
requirements for security futures would reduce the competitiveness of
exchange-traded equity options.\291\ OneChicago stated that security
futures products are not comparable to exchange-traded equity options
because they have different risk profiles; exchange-traded equity
options are subject to dividend risk, pin risk, and early assignment
risk, while security futures are not.\292\ Further, OneChicago
challenged the concerns raised by other commenters that the proposed
margin requirements would result in ``regulatory arbitrage,'' arguing
that the many salient differences between security futures and
exchange-traded equity options make it virtually impossible to
replicate a security futures position using exchange-traded equity
options.\293\ OneChicago suggested that the comparison between a
security futures position and an option spread position that
``replicates'' the security futures cannot be limited to a comparison
between the contractual payoffs of these two positions. In particular,
this commenter argued that a proper comparison should include payoffs
that may occur throughout the life of the position, including payoffs
from the security future's daily settlement of variation margin (i.e.,
marking-to-market and paying or collecting variation margin) that
differs from initial and maintenance margin requirements in options
markets.\294\
---------------------------------------------------------------------------
\291\ See OneChicago Letter; OneChicago Letter 2.
\292\ OneChicago Letter at 2, 9; OneChicago Letter 2 at 1-2.
\293\ See OneChicago Letter 2.
\294\ See also OneChicago Letter (providing a more in depth
analysis of these issues together with some data that outlines
various payoff structures for different strategies based on
currently traded contracts).
---------------------------------------------------------------------------
The SEC acknowledges that even if the contractual payoffs of a
security futures position could be perfectly replicated with the
payoffs of an option spread position,\295\ the risk profiles of the two
positions may still be different.\296\ For example, the daily variation
margin settlement of the security futures position may give rise to
payoffs throughout the life of the positions that could expose the
holders of the position to funding risk. Similarly, the exchange of
variation margin for the options spread position also exposes investors
to funding risk, but to a lesser degree compared to a security futures
position.\297\ As noted by OneChicago, unlike a security futures
position, an option spread position may be subject to a number of risks
that reflect potential strategic behavior that is commonplace in the
options markets, including dividend risk, assignment risk, and pin
risk.\298\ Because funding risks and the risks that reflect strategic
behavior in options markets may affect the security futures and the
option spread positions differently, the two positions may not have the
same risk profile.
---------------------------------------------------------------------------
\295\ It is well known that in theory a long security futures
position can be perfectly replicated with an option spread position
consisting of a long European call and a short European put. Both
options have the same expiration, and each has a strike price equal
to the futures price. This result is also known as the put-call
parity. See, e.g. JOHN C. HULL, FUNDAMENTALS OF FUTURES AND OPTIONS
MARKETS, (Pearson Prentice Hall, 2017).
\296\ A number of practical factors challenge the extent to
which security futures can be perfectly replicated using an options
spread position. First, most stock options currently trading are
American style rather than European style. American style options
typically sell at a premium relative to European style options
because of the value of exercising early. Second, if the strike
price of these options (which is set to equal the futures price)
falls outside the range currently trading, liquidity may be limited
and these options may sell at a premium (or at a discount if short).
Third, certain features of the futures and options markets may
introduce payoffs throughout the life of these positions that may
further complicate the replication strategy. For example, the daily
settlement process in the futures market may result in additional
payments or payouts to the holder of the futures position, relative
to the contractual payoffs of the position. Similarly, the practice
of exchanging variation margin in the options market may result in
additional payments/payouts to the holder of the options positions.
These additional payments generally help reduce the potential loss
due to a counterparty failure, but may also expose a counterparty to
funding risk. Finally, the option spread position may be subject to
a number of risks that reflect potential strategic behavior that is
commonplace in the options markets, including dividend risk,
assignment risk, and pin risk (for definitions of dividend risk,
assignment risk and pin risk, see OneChicago Letter 3, at n.23, 24,
and 25). The futures position may also be exposed to some of these
risks through the daily settlement process (for example, the price
of a futures contract on a dividend-paying stock would reflect an
unanticipated change in the dividend policy at the time when this
change in policy is made public). The factors outlined above point
to potential price disparities between the security futures and the
option spread positions that cannot be arbitraged away. The last two
factors also point to sources of potential risks, and therefore
sources of potential losses, that may impact the two positions
differently. In general, these factors may cause the risk profile of
the security futures and the risk profile of the option spread
positions to drift apart.
\297\ The margin on the security futures position is calculated
on the current market value of the position, while the margin on the
option spread position is generally calculated on the value of the
short leg of the position, outside of a Portfolio Margin Account.
\298\ See supra note 296 (describing what these risks are). See
also OneChicago Letter 3, at n.23-25.
---------------------------------------------------------------------------
Notwithstanding these differences, under certain conditions, the
risk profiles of the two positions may be sufficiently similar for some
investors, and may be viewed by these investors as close (but not
necessarily perfect) substitutes. These strategies are economic
equivalents to a certain degree because both provide exposure to an
underlying equity security or narrow-based equity security index
outside the cash equity market.\299\ Thus, both strategies can be used
to hedge, at least partially, a long or short position in the
underlying equity security or narrow-based equity security index.
Similarly, each strategy can also be used to speculate on a potential
price movement of the underlying equity security or narrow-based equity
security index. Furthermore, both short security futures positions and
certain exchange-traded equity options strategies produce unlimited
downside risk. Investors in security futures and writers of options may
lose their initial and maintenance
[[Page 75142]]
margin on deposit and premium payments and be required to pay
additional funds in the event of a default of a broker-dealer or
clearinghouse.
---------------------------------------------------------------------------
\299\ See supra note 117.
---------------------------------------------------------------------------
In addition, a deep-in-the money call or put option on the same
security can have a delta approaching one if the underlying security
takes values in a certain range of outcomes. Over such a range of
outcomes, equity option contracts may be comparable to a security
futures contract. Further, as stated by one commenter, synthetic
futures strategies are an important segment of today's options markets
competing everyday with security futures.\300\
---------------------------------------------------------------------------
\300\ See Cboe/MIAX Letter at 6-7.
---------------------------------------------------------------------------
OneChicago provided empirical analyses to support its claim that
changes to security futures margin rates would not impact exchange-
traded equity options. In one analysis, OneChicago observed data
inconsistent with a statistically positive correlation between the E-
mini margin rates and either the ratio of SPX (S&P 500) options open
interest to E-mini S&P 500 futures open interest or the ratio of SPX
trading volume to E-mini trading volume.\301\ In another analysis,
OneChicago provided statistical data on the correlation in open
interest between security futures and exchange-traded equity options.
This analysis shows that there is no significant correlation between
the two types of open interest, and OneChicago saw this finding as
supporting their conclusion that market participants have discrete uses
for security futures and ``equity options and that the derivatives are
not interchangeable.'' \302\
---------------------------------------------------------------------------
\301\ OneChicago Letter 3 at 12-15.
\302\ OneChicago Letter 3 at 15.
---------------------------------------------------------------------------
The SEC appreciates the empirical analyses provided by OneChicago,
while also noting that the inferences in these analyses are subject to
multiple limitations that make it difficult to conclude on the basis of
these analyses that reducing minimum initial and maintenance margin
requirements for security futures would not reduce the use of
comparable options strategies. It is unclear to what degree results
from the SPX options market and the E-mini futures market can be
generalized to exchange-traded equity options and security futures.
Unlike their single-stock counterparts, derivatives that are based on
broad-based indices can be used by a wide range of institutional and
retail investors for purposes broader than obtaining exposure to
individual equities or obtaining cash to finance other positions.
Participants in these markets may seek to efficiently hedge market risk
or express views on the direction or volatility of equity indices.
Moreover, the markets for futures and options that track the S&P 500
index or track an investable portfolio of S&P 500 equities include more
than just the products that OneChicago analyzed. This makes it
difficult to extrapolate results from these markets to the markets for
exchange-traded options and security futures. Furthermore, OneChicago's
analysis of security futures and exchange-traded equity options
compares security futures to all equity options contracts, without
focusing on those segments of the equity options market most comparable
to security futures, such as strategies that approximate delta one
exposure.
The final rule amendments may improve the ability of security
futures intermediaries and exchanges to compete in the market for other
financial services. Certain analyses submitted by OneChicago to the
comment file support this view with evidence that security futures
would be used for different purposes than exchange-traded equity
options.\303\ For example, OneChicago compared trade size (number of
contacts and notional value) in security futures with trade size in
options markets and security future delivery rates with options
exercise rates,\304\ and concluded that the higher trade size and
higher delivery rates in security futures markets indicated that
investors use the security futures market for financing purposes. When
summarizing its findings, OneChicago stated that the delivery data
makes ``clear'' that the ``markets view and use the products
differently.'' \305\ OneChicago further asserted that certain security
futures strategies represent exchange-traded substitutes for securities
lending and equity repo transactions.\306\
---------------------------------------------------------------------------
\303\ OneChicago Letter at 2-3.
\304\ OneChicago Letter 3 at 9-12.
\305\ OneChicago Letter 3 Summary at 1.
\306\ OneChicago Letter 3, at 22.
---------------------------------------------------------------------------
b. Foreign Markets for Security Futures
Finally, OneChicago noted that U.S. security futures markets faced
competition from foreign markets that rely on risk-based initial margin
that, in contrast to Portfolio Margin Accounts, do not have a strategy-
based floor and in which ``naked positions are margined at risk-based
levels.'' \307\ OneChicago supplied initial margin requirements for
security futures written on Dow Jones Industrial Average components at
Eurex on July 25, 2019, ranging from 6.64% to 14.71%. The SEC
acknowledges that other jurisdictions may choose to implement initial
margin requirements for security futures under local legal regimes that
differ from those of the United States. To the extent that customers
may access a number of different markets, higher initial margin
requirements in one jurisdiction may place intermediaries and exchanges
regulated by that jurisdiction at a competitive disadvantage relative
to others.\308\ However, as discussed above, the SEC is not persuaded
by arguments that implementing a risk model approach to calculating
margin for security futures would at this time be permitted under U.S.
law and, furthermore, notes that the final rule amendments may reduce
the degree of competitive disadvantage if trading resumes in the U.S.,
at least insofar as foreign markets would draw away customers that
would otherwise trade security futures outside of Portfolio Margin
Accounts.\309\
---------------------------------------------------------------------------
\307\ OneChicago Letter, at n.54 and accompanying text.
\308\ OneChicago submitted a customer letter supporting this
point. See OneChicago Letter, Appendix C.
\309\ See supra note 182 in section IV.A.4. (CFTC--Description
of Costs) (noting that trading by U.S. persons in security futures
contracts listed on Eurex is subject to certain conditions under an
SEC order and a CFTC staff advisory).
---------------------------------------------------------------------------
iii. Capital Formation
As discussed above, the potential benefits to investors that flow
from the final rule amendments including a lower cost of obtaining
underlying securities, the opportunity to take on more leverage
(relative to the baseline), and the potential increase in price
competitiveness, may increase investor demand for access to security
futures contracts. To the extent security futures trading resumes in
the U.S., and investor participation causes the market for security
futures to grow, the final rule amendments would have an impact on
capital formation. An active security futures market can reduce the
frictions associated with shorting equity exposures (making it easier
for negative information about a firm's fundamentals to be incorporated
into security prices) or financing securities exposures. This could
promote more efficient capital allocations by facilitating the flow of
financial resources to their most productive uses.
5. Reasonable Alternatives Considered
In the 2019 Proposing Release, the SEC stated it did not believe
there are reasonable alternatives to the proposal to reduce minimum
margin levels for unhedged security futures.\310\ Two
[[Page 75143]]
commenters took issue with this observation and suggested several
alternatives for the SEC to consider.\311\ One commenter suggested two
alternatives: (1) Reduce the size of security futures contracts; and
(2) rule-based margin with flexible settlement intervals.\312\ The
other commenter suggested two additional alternatives: (1) Risk-based
margins for all security futures products; and (2) risk-based margins
for select security futures products involving STARS transactions.\313\
---------------------------------------------------------------------------
\310\ 2019 Proposing Release, 84 FR at 36451.
\311\ See CII Letter at 4; OneChicago Letter.
\312\ See CII Letter at 4; see also Commissioner Jackson's
Statement.
\313\ See OneChicago Letter; OneChicago Letter 2; OneChicago
Letter 3; see also Ianni Letter; La Botz Letter.
---------------------------------------------------------------------------
The SEC addresses the suggested alternatives below. The discussion
of those alternatives includes certain commenter proposals that the
Commissions still do not believe are viable at this time for the
reasons discussed by the Commissions in more detail above.
i. Reduce the Size of the Security Futures Contract
One commenter suggested that an alternative to lowering the margin
on security futures could be to reduce the size of a security futures
contract.\314\ This commenter noted that a similar reduction in the
size of the S&P e-mini futures contract that led to the creation of S&P
micro e-mini futures could increase access to single-stock futures for
the most popular securities and improve efficiency.\315\ The SEC
acknowledges that one way to reduce the dollar value of margin required
for a position in a given contract is to reduce the size of the
contract. However, an investor is more likely to determine her optimal
exposure in terms of notional value or as a proportion of her available
financial resources, rather than as a number of contracts. This
alternative would not change the amount of margin that would be
assessed on such an investor's optimal exposure. For example, if the
size of the contract were reduced by half, so would the value of margin
required, subject to certain caveats,\316\ but the investor would need
twice as many contracts to establish her optimal exposure. Thus, the
total margin for this exposure would not change significantly from the
baseline. However, a reduction in contract size is known to encourage
market participation, and therefore, this alternative may spur demand
for security futures.\317\
---------------------------------------------------------------------------
\314\ See CII Letter at 4; see also Commissioner Jackson's
Statement.
\315\ See CII Letter at 4.
\316\ There may be other factors that may affect whether the
margin scales up or down with the size of the contract, in a linear
fashion.
\317\ See, e.g., Lars Nord[eacute]n, Does an Index Futures Split
Enhance Trading Activity and Hedging Effectiveness of the Futures
Contract, 26 J. FUTURES MARKETS 1169 (2006).
---------------------------------------------------------------------------
ii. Rule-Based Margins With Flexible Margin Settlement Intervals
The same commenter suggested another alternative that would
maintain the current minimum margin requirements and reduce margins by
changing the margin settlement intervals for security futures.\318\
This alternative is based on the findings of one study, which
quantifies the extent to which current margin requirements overmargin
or undermargin a futures position relative to a risk-based margin
requirement (e.g., traditional futures).\319\ This study finds that
current margin requirements are overly conservative, and that
increasing the length of the margin settlement interval may help
alleviate the problem. The study further suggested that exchanges
should be allowed to set the length of the margin settlement interval
as a means of competing with one another.
---------------------------------------------------------------------------
\318\ See CII Letter at 4.
\319\ Hans R. Dutt & Ira L. Wein, On the Adequacy of Single-
Stock Futures Margining Requirements, 10 J. FUTURES MARKETS 989
(2003).
---------------------------------------------------------------------------
While changing the length of the margin settlement interval may
provide another way of reducing margins, it is not clear how feasible
this method would be in practice. Allowing exchanges to set different
margin settlement intervals for different products and update these
over time would increase complexity and potentially impose operation
costs on market participants. Because this alternative is not used
currently in any equity markets (to the SEC's knowledge), and because
there is uncertainty about how to calibrate the mechanism to deliver
margin requirements in this context, the operational costs of this
alternative could be large.
Moreover, the SEC recognizes that daily margin settlement is an
important risk management tool in the markets for security futures,
especially in light of recent market volatility. OneChicago--the only
exchange trading security futures at the time the rule amendments were
proposed--also cited risk management concerns, arguing that such an
approach would remove a critical protection in futures markets.\320\
---------------------------------------------------------------------------
\320\ OneChicago Letter at 6.
---------------------------------------------------------------------------
Finally, the Commissions are adopting the final rules because they
produce a desired policy outcome of aligning the minimum margin levels
for security futures held in non-Portfolio Margin Accounts with the
margin levels for security futures in a Portfolio Margin Account, for
the reasons discussed in section II.A. above. Modifying margin
settlement intervals would not accomplish this policy outcome.
For these reasons, the SEC is not adopting an approach that
includes rules-based margin requirements with flexible settlement
intervals in this release.
iii. Risk-Based Margin for All Security Futures Products
OneChicago suggested the alternative of using risk-based margin
requirements for security futures products. OneChicago stated that
risk-based margin requirements would give security futures the best
chance to compete with other products that provide delta one exposure
to an underlying security, including products traded in overseas
markets and that are subject to similar risk-based margin
requirements.\321\ According to OneChicago's analysis, the Commissions'
proposal to lower the required margin levels from 20% to 15% would have
resulted in a 25% reduction in the value of initial margin collected
(from $540 million to $410 million); whereas using a risk-based margin
model would have resulted in a 61% reduction (from $540 million to $210
million).\322\ This suggests that the margin savings to investors from
risk-based margin requirements may be economically significant.
---------------------------------------------------------------------------
\321\ See OneChicago Letter at 12-13.
\322\ OneChicago Letter at 14.
---------------------------------------------------------------------------
OneChicago also supported its position that the Commissions should
permit risk-based margin for security futures, presenting analysis that
estimated that 92% of OneChicago products were ``overmargined'' (in the
sense that the minimum margin requirement was greater than the level
that would result from a risk-based margin calculation) at a 20%
minimum margin requirement and 84% of OneChicago products would be
``overmargined'' at a 15% minimum margin requirement. This analysis
suggests that the final rule amendments would set margin requirements
for 8% of OneChicago products equal to the margin levels that would
arise from risk-based margining but that a substantial majority of
OneChicago products would have minimum margin requirements above risk-
based levels, if security
[[Page 75144]]
futures trading at OneChicago resumes.\323\
---------------------------------------------------------------------------
\323\ Id.
---------------------------------------------------------------------------
The SEC acknowledges that risk-based initial margin requirements
may result in more efficient levels of margin being collected compared
with margin requirements based on fixed margin levels. Moreover, moving
to risk-based margin requirement would likely achieve a larger
reduction in competitive frictions between security futures and
alternative means of financing delta one exposure (e.g., use of OTC
equity swaps and stock loans) than the final rules.
However, as discussed in section II.A. above, the SEC is not
persuaded by OneChicago's arguments that, at this time, implementing a
risk model approach to calculating initial margin for security futures
would be permitted under Section 7(c)(2)(B) of the Exchange Act given
that such risk-based margin models are not currently used to set
initial margin for customers in the equity options markets. Moreover,
implementing a risk model approach would substantially alter how the
required minimum initial and maintenance margin levels for security
futures are calculated. It also would be a significant deviation from
how margin is calculated for listed equity options and other equity
positions (e.g., long and short securities positions). It would not be
appropriate at this time to implement a different margining system for
security futures, given their relation to products that trade in the
U.S. equity markets. Further, implementing a different margining system
for security futures may result in substantially lower margin levels
for these products as compared with other equity products and could
have unintended competitive impacts. For these reasons, this suggested
alternative to permit risk-based margin models to determine customer
margin requirements for security futures is not viable.
iv. Risk-Based Margin for a Subset of Security Futures Products
OneChicago suggested the alternative of using risk-based margin
requirements for STARS transactions.\324\ OneChicago stated that risk-
based margin requirements would allow STARS transactions to compete
with other transactions that market participants currently use to
finance their activities.
---------------------------------------------------------------------------
\324\ OneChicago Letter at 19; see also Memorandum from the
SEC's Division of Trading and Markets regarding a July 16, 2019,
meeting with representatives of OneChicago.
---------------------------------------------------------------------------
The SEC's consideration of this alternative is similar to the
alternative of permitting risk-based initial margin requirements for
all security futures transactions. While the SEC acknowledges that
risk-based initial margin requirements may be more efficient than
margin requirements based on fixed margin levels, the SEC is not
persuaded by OneChicago's arguments that, at this time, implementing a
risk model approach to calculating initial margin for STARS
transactions would be permitted under Section 7(c)(2)(B) of the
Exchange Act. For this reason, as well as the recent announcements by
OneChicago, this suggested alternative for STARS transactions is not
viable.
V. Regulatory Flexibility Act
A. CFTC
The Regulatory Flexibility Act (``RFA'') requires that Federal
agencies, in promulgating rules, consider the impact of those rules on
small entities.\325\ The final rules would affect designated contract
markets, FCMs, and customers who trade in security futures, if security
futures trading resumes. The CFTC has previously established certain
definitions of ``small entities'' to be used by the CFTC in evaluating
the impact of its rules on small entities in accordance with the
RFA.\326\
---------------------------------------------------------------------------
\325\ 5 U.S.C. 601 et seq.
\326\ Policy Statement and Establishment of Definitions of
``Small Entities'' for Purposes of the Regulatory Flexibility Act,
47 FR 18618, 18618-21 (Apr. 30, 1982).
---------------------------------------------------------------------------
In its previous determinations, the CFTC has concluded that
contract markets are not small entities for purposes of the RFA, based
on the vital role contract markets play in the national economy and the
significant amount of resources required to operate as SROs.\327\ The
CFTC also has determined that notice-designated contract markets are
not small entities for purposes of the RFA.\328\
---------------------------------------------------------------------------
\327\ Id. at 18619.
\328\ Designated Contract Markets in Security Futures Products:
Notice-Designation Requirements, Continuing Obligations,
Applications for Exemptive Orders, and Exempt Provisions, 66 FR
44960, 44964 (Aug. 27, 2001).
---------------------------------------------------------------------------
The CFTC has previously determined that FCMs are not small entities
for purposes of the RFA, based on the fiduciary nature of FCM-customer
relationships as well as the requirements that FCMs meet certain
minimum financial requirements.\329\ In addition, the CFTC has
determined that notice-registered FCMs,\330\ for the reasons applicable
to FCMs registered in accordance with Section 4f(a)(1) of the CEA,\331\
are not small entities for purposes of the RFA.\332\
---------------------------------------------------------------------------
\329\ Supra note 326 at 18619.
\330\ A broker or dealer that is registered with the SEC and
that limits its futures activities to those involving security
futures products may notice register with the CFTC as an FCM in
accordance with Section 4f(a)(2) of the CEA (7 U.S.C. 6f(a)(2)).
\331\ 7 U.S.C. 6f(a)(1).
\332\ 2002 Adopting Release, 67 FR at 53171.
---------------------------------------------------------------------------
Finally, the CFTC notes that according to data from OneChicago, 99%
of all customers that transacted in security futures as of March 1,
2016, and March 1, 2017, qualified as ECPs. The CFTC has found that
ECPs should not be considered small entities for the purposes of the
RFA.\333\ Based on this information, an overwhelming majority of the
customers that traded security futures in the past were ECPs and not
small entities. Although it is possible that an exchange that launches
security futures trading in the future may market these contracts to
retail customers that are not ECPs, the CFTC believes that it is still
unlikely that the final rules will affect small entities. Therefore, a
change in the margin level for security futures is not anticipated to
affect small entities.
---------------------------------------------------------------------------
\333\ Opting Out of Segregation, 66 FR 20740, 20743 (Apr. 25,
2001).
---------------------------------------------------------------------------
Accordingly, the CFTC Chairman, on behalf of the CFTC, hereby
certifies pursuant to 5 U.S.C. 605(b), that the final rules will not
have a significant economic impact on a substantial number of small
entities.
B. SEC
The RFA requires that Federal agencies, in promulgating rules,
consider the impact of those rules on small entities.\334\ Section 3(a)
\335\ of the RFA generally requires the SEC to undertake a regulatory
flexibility analysis of all proposed rules to determine the impact of
such rulemaking on small entities unless the SEC certifies that the
rule amendments, if adopted, would not have a significant economic
impact on a substantial number of small entities.\336\
---------------------------------------------------------------------------
\334\ 5 U.S.C. 601 et seq.
\335\ 5 U.S.C. 603.
\336\ 5 U.S.C. 605(b). The final rule amendments are discussed
in detail in section II. above. The SEC discusses the economic
consequences of the amendments in section IV. (Economic Analysis)
above. As discussed in section III. (Paperwork Reduction Act) above,
the final rule amendments do not contain a ``collection of
information'' requirement within the meaning of the PRA.
---------------------------------------------------------------------------
Pursuant to Section 605(b) of the RFA,\337\ the SEC certified in
the 2019 Proposing Release, that the proposed amendments to reduce the
required margin for security futures from 20% to 15% would not have a
significant economic impact on any ``small entity'' for purposes of the
RFA.\338\ The SEC solicited comment on the RFA analysis
[[Page 75145]]
in the 2019 Proposing Release.\339\ The SEC received no comments in
response to this request. The SEC is adopting the amendments in this
release, as proposed.
---------------------------------------------------------------------------
\337\ See 5 U.S.C. 605(b).
\338\ See 2019 Proposing Release, 84 FR at 36452.
\339\ Id.
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For purposes of SEC rulemaking in connection with the RFA,\340\ a
small entity includes a broker-dealer that had total capital (net worth
plus subordinated liabilities) of less than $500,000 on the date in the
prior fiscal year as of which its audited financial statements were
prepared pursuant to 17 CFR 240.17a-5(d),\341\ or, if not required to
file such statements, a broker-dealer with total capital (net worth
plus subordinated liabilities) of less than $500,000 on the last day of
the preceding fiscal year (or in the time that it has been in business,
if shorter); and is not affiliated with any person (other than a
natural person) that is not a small business or small
organization.\342\ The final rule amendments will reduce the required
margin for security futures from 20% to 15%. The final rule amendments
will affect brokers, dealers, and members of national securities
exchanges, including FCMs required to register as broker-dealers under
Section 15(b)(11) of the Exchange Act, relating to security
futures.\343\
---------------------------------------------------------------------------
\340\ Although Section 601 of the RFA defines the term ``small
entity,'' the statute permits agencies to formulate their own
definitions. The SEC has adopted definitions for the term ``small
entity'' for the purposes of SEC rulemaking in accordance with the
RFA. Those definitions, as relevant to this rulemaking, are set
forth in SEC Rule 0-10 (under the Exchange Act), 17 CFR 240.0-10.
See Statement of Management on Internal Accounting Control, Exchange
Act Release No. 18451 (Jan. 28, 1982), 47 FR 5215 (Feb. 4, 1982).
\341\ SEC Rule 17a-5(d) (under the Exchange Act).
\342\ See 17 CFR 240.0-10(c).
\343\ See SEC Rule 400(a), 17 CFR 242.400(a).
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IBs and FCMs may register as broker-dealers by filing Form BD-
N.\344\ However, because such IBs may not collect customer margin they
are not subject to these rules. In addition, the CFTC has concluded
that FCMs are not considered small entities for purposes of the
RFA.\345\ Accordingly, there are no IBs or FCMs that are small entities
for purposes of the RFA that would be subject to the final rule
amendments.
---------------------------------------------------------------------------
\344\ These notice-registered broker-dealers are not included in
the 873 small broker-dealers discussed below, because they are not
required to file FOCUS Reports with the SEC. See SEC Rule 17a-
5(m)(4), 17 CFR 240.17a-5(m)(4).
\345\ See 47 FR 18618, 18618-21 (Apr. 30, 1982). See also 66 FR
14262, 14268 (Mar. 9, 2001).
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In addition, all members of national securities exchanges
registered under Section 6(a) of the Exchange Act are registered
broker-dealers.\346\ The SEC estimates that as of December 31, 2019,
there were approximately 873 broker-dealers that were ``small'' for the
purposes of SEC Rule 0-10. Of these, the SEC estimates that there are
approximately ten broker-dealers that are carrying broker-dealers
(i.e., can carry customer margin accounts and extend credit).\347\
However, based on December 31, 2019, FOCUS Report data, none of these
small carrying broker-dealers carried debit balances.\348\ This means
these ``small'' carrying firms are not extending margin credit to their
customers, and therefore, the final rule amendments likely will not
apply to them. Finally, OneChicago was the only U.S. national
securities exchange listing security futures until it discontinued all
trading operations on September 21, 2020. Therefore, while some small
broker-dealers could be affected by the final rule amendments, the
amendments will not have a significant impact on a substantial number
of small broker-dealers.
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\346\ National securities exchanges registered under Section
6(g) of the Exchange Act--notice registration of security futures
product exchanges--may have members who are floor brokers or floor
traders who are not registered broker-dealers; however, these
entities cannot clear securities transactions or collect customer
margin, and, therefore, the final rule amendments will not apply to
them.
\347\ These small broker-dealers file a FOCUS Report Part II on
a monthly basis, which is required to be filed by broker-dealers
that clear transactions or carry customer accounts and do not use
models to calculate net capital. See 17 CFR 240.17a-5(a)(2)(ii).
\348\ In addition, based on December 31, 2019, FOCUS Report
data, none of these small broker-dealers posted margin to a clearing
agency/DCO related to security futures positions written, purchased
or sold in customer accounts (FOCUS Report, Line 4467).
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Accordingly, the SEC certifies that the final rule amendments will
not have a significant economic impact on a substantial number of small
entities for purposes of the RFA.
VI. Other Matters
Pursuant to the Congressional Review Act,\349\ the Office of
Information and Regulatory Affairs has designated these rules as not a
``major rule,'' as defined by 5 U.S.C. 804(2).
---------------------------------------------------------------------------
\349\ 5 U.S.C. 801 et seq.
---------------------------------------------------------------------------
If any of the provisions of these final rules, or the application
thereof to any person or circumstance, is held to be invalid, such
invalidity shall not affect other provisions or application of such
provisions to other persons or circumstances that can be given effect
without the invalid provision or application.
VII. Anti-Trust Considerations
Section 15(b) of the CEA requires the CFTC to take into
consideration the public interest to be protected by the antitrust laws
and endeavor to take the least anticompetitive means of achieving the
purposes of the CEA, in issuing any order or adopting any CFTC rule or
regulation (including any exemption under Section 4(c) or 4c(b)), or in
requiring or approving any bylaw, rule, or regulation of a contract
market or registered futures association established pursuant to
section 17 of the CEA.\350\ The CFTC believes that the public interest
to be protected by the antitrust laws is generally to protect
competition.
---------------------------------------------------------------------------
\350\ 7 U.S.C. 19(b).
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The CFTC has determined that the final rules are not
anticompetitive and have no anticompetitive effects. In the proposal,
the CFTC requested comment on whether there are less anticompetitive
means of achieving the relevant purposes of the CEA. The objective of
the proposal was to bring margin requirements for security futures held
in futures accounts or securities accounts that are not Portfolio
Margin Accounts, into alignment with the required margin level for
unhedged security futures held in Portfolio Margin Accounts.
One commenter argued that the final rules could create a
competitive disadvantage for exchange-traded equity options.\351\ As
explained in more detail above, if security futures trading resumes,
these final rules will reduce the margin level for an unhedged security
future held outside of a Portfolio Margin Account to 15% and should not
result in a competitive disadvantage for exchange-traded equity
options, as the 15% margin rate is already in effect for exchange-
traded options held in a Portfolio Margin Account.
---------------------------------------------------------------------------
\351\ Cboe/MIAX Letter at 2 and 6.
---------------------------------------------------------------------------
A different commenter argued that the current strategy-based margin
regime does not level the playing field with options, but rather, acts
as a barrier to entry for competition and puts security futures at a
competitive disadvantage.\352\ The CFTC notes that, given the statutory
constraints that require the margin requirements for security futures
to be consistent with the margin requirements for comparable exchanged-
traded equity options, the CFTC has not identified any less
anticompetitive means of achieving the purposes of the CEA.
---------------------------------------------------------------------------
\352\ OneChicago Letter at 2.
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VIII. Statutory Basis
The SEC is amending SEC Rule 403(b)(1) pursuant to the Exchange
Act, particularly Sections 3(b), 6, 7(c), 15A and 23(a). Further, these
amendments are adopted pursuant to the authority
[[Page 75146]]
delegated jointly to the SEC, together with the CFTC, by the Federal
Reserve Board in accordance with Exchange Act Section 7(c)(2)(A).
List of Subjects
17 CFR Part 41
Brokers, Margin, Reporting and recordkeeping requirements, Security
futures products.
17 CFR Part 242
Brokers, Confidential business information, Reporting and
recordkeeping requirements, Securities.
COMMODITY FUTURES TRADING COMMISSION
17 CFR Part 41
For the reasons discussed in the preamble, the Commodity Futures
Trading Commission amends 17 CFR part 41 as set forth below:
PART 41--SECURITY FUTURES PRODUCTS
0
1. The authority citation for part 41 continues to read as follows:
Authority: Sections 206, 251 and 252, Pub. L. 106-554, 114
Stat. 2763, 7 U.S.C. 1a, 2, 6f, 6j, 7a-2, 12a; 15 U.S.C. 78g(c)(2).
0
2. In Sec. 41.45, republish paragraph (b) heading and revise paragraph
(b)(1) to read as follows:
Sec. 41.45 Required margin.
* * * * *
(b) Required margin--(1) General rule. The required margin for each
long or short position in a security future shall be fifteen (15)
percent of the current market value of such security future.
* * * * *
SECURITIES AND EXCHANGE COMMISSION
17 CFR Part 242
In accordance with the foregoing title 17, chapter II, part 242 of
the Code of Federal Regulations is amended as follows:
PART 242--REGULATIONS M, SHO, ATS, AC, NMS, AND SBSR AND CUSTOMER
MARGIN REQUIREMENTS FOR SECURITY FUTURES
0
3. The authority citation for part 242 continues to read as follows:
Authority: 15 U.S.C. 77g, 77q(a), 77s(a), 78b, 78c, 78g(c)(2),
78i(a), 78j, 78k-1(c), 78l, 78m, 78n, 78o(b), 78o(c), 78o(g),
78q(a), 78q(b), 78q(h), 78w(a), 78dd-1, 78mm, 80a-23, 80a-29, and
80a-37.
0
4. Section 242.403 is amended by revising paragraph (b)(1) to read as
follows:
Sec. 242.403 Required margin.
* * * * *
(b) * * *
(1) General rule. The required margin for each long or short
position in a security future shall be fifteen (15) percent of the
current market value of such security future.
* * * * *
By the Securities and Exchange Commission.
Dated: October 22, 2020.
Vanessa A. Countryman,
Secretary.
Issued in Washington, DC, on October 29, 2020, by the Commodity
Futures Trading Commission.
Christopher Kirkpatrick,
Secretary of the Commission.
Note: The following appendices will not appear in the Code of
Federal Regulations.
CFTC Appendices to Customer Margin Rules Relating to Security Futures--
Commission Voting Summary and Commissioners' Statements
Appendix 1--CFTC Voting Summary
On this matter, Chairman Tarbert and Commissioners Quintenz,
Behnam, Stump, and Berkovitz voted in the affirmative. No
Commissioner voted in the negative.
Appendix 2--Statement of Support of CFTC Commissioner Brian Quintenz
I am pleased to support today's final rule lowering the minimum
margin requirement to hold security futures, from 20% to 15% of a
position's market value.\1\ The lower margin requirement would apply
to security futures held in a futures account and to positions held
in a securities account not subject to portfolio margin rules. The
new margin requirement would be consistent with the current margin
requirements both for security futures positions held in a
securities account subject to portfolio margin rules and for
exchange-traded equity options.
---------------------------------------------------------------------------
\1\ Amended CFTC regulation 41.45(b) and SEC rule 242.403(b).
---------------------------------------------------------------------------
I note that today's final rule indicates that OneChicago, the
only exchange that has listed security futures in the United States,
has recently discontinued trading operations. This underscores the
determinative impact statutory provisions can have on the viability
of both products and whole business lines. The Securities Exchange
Act requires security futures to be margined comparably to options
traded on an exchange registered with the SEC.\2\ While the intent
of that provision is understandable, the economics underlying it
appear to be severely sub-optimal. Today's lowering of the required
minimum margin, consistent with the Securities Exchange Act, should
make trading this product more cost effective than it has been, but
it still may not be sufficiently cost effective to make the product
economically viable. From that perspective, I hope policy makers
revisit this provision, to ensure its ultimate effect is consistent
with its intent. I believe financial markets policy should
appropriately balance concerns of safety and soundness with
promoting a range of innovative products, and more can certainly be
done in that regard on this issue.
---------------------------------------------------------------------------
\2\ Section 7(c)(2)(B) of the Securities Exchange Act.
---------------------------------------------------------------------------
Finally, as I noted above, this rule serves as a positive
example of productive cooperation between the CFTC and the SEC, and
I hope that additional joint actions arise in the future.
Appendix 3--Statement of CFTC Commissioner Dawn D. Stump
I am pleased to be a part of today's Joint Open Meeting of the
Commodity Futures Trading Commission (``CFTC'') and the Securities
and Exchange Commission (``SEC''). I commend:
Chairmen Tarbert and Clayton for holding this Meeting
to provide transparency into our work in jointly addressing issues
of mutual interest to both our agencies;
Commissioner Quintenz at the CFTC and Commissioner
Peirce at the SEC for laying the groundwork for this Joint Meeting
through their efforts to harmonize the regulatory regimes of the
agencies, as these harmonization efforts benefit not only those we
regulate, but also the public we all serve; and
The staff of the agencies for putting before us a Joint
Final Rule that will lower the margin level for an unhedged security
futures position from 20% to 15%, which I firmly believe is sound
public policy.
And yet, while I don't want to rain on today's parade, I
nevertheless feel compelled to express a few regrets.
I regret, for example, that the Commissions did not take the
common-sense step of reducing the security futures margin level from
20% to 15% years ago. After all, OneChicago, the only U.S. exchange
that made a long-term effort to develop a market for security
futures, asked us to take this step 12 years ago in 2008. And the
self-regulatory organization rules establishing a 15% margin level
for unhedged security futures held in a securities portfolio margin
account (with which the action we are taking will align) have been
in effect for at least 10 years since 2010. I appreciate that the
global financial crisis and the ensuing regulatory focus on swaps
and other reforms diverted attention from security futures. But it
is nonetheless disappointing that it took the Commissions a decade
to take the step we take today--and even more disappointing given
that OneChicago did not survive to see it, as it discontinued all
trading operations about a month ago on September 21.
I also regret that the adopting release does not recognize the
unique circumstances presented by the recent exit of OneChicago and
the fact that no U.S. exchange currently lists security futures for
trading, and thus issues opinions on hypothetical questions that I
do not believe we should be addressing here. By way of background,
when the Commissions proposed to reduce the margin level of an
unhedged security futures position from 20% to 15%, we also
requested comment on whether there are any other risk-
[[Page 75147]]
based margin methodologies that could be used to prescribe margin
requirements for security futures.\1\ In response, OneChicago urged
the Commissions to permit the use of risk-based margin models for
security futures--similar to what is done for other futures
contracts. I am in complete agreement that we should not adopt such
a sweeping change to the manner in which margin is calculated for
security futures based solely on the response to a single request
for comment in a proposal designed to address a wholly different
type of margin calculation rule.
---------------------------------------------------------------------------
\1\ Customer Margin Rules Relating to Security Futures, 84 FR
36434, 36441 (July 26, 2019). The proposing release also asked
commenters, if their answer to this question was yes, to ``please
identify the margin methodologies and explain how they would meet
the comparability standards under the [Securities] Exchange Act [of
1934].'' Id.
---------------------------------------------------------------------------
Unfortunately, though, the adopting release goes further, and
rejects OneChicago's arguments regarding the Commissions' authority
to adopt risk-based margining for security futures. Some of these
arguments are fact-based, and thus a future change in facts could
yield a different conclusion, which is appropriate.\2\ But the
adopting release also rejects OneChicago's interpretive arguments
that the Commissions can adopt risk-based margining for security
futures even absent a change in factual circumstances.\3\ I think
that is unfortunate, for three reasons.
---------------------------------------------------------------------------
\2\ The Securities Exchange Act of 1934 (``Exchange Act'')
provides that margin levels for security futures must, among other
things, be: (i) Consistent with the margin requirements for
comparable options traded on any exchange registered pursuant to
Section 6(a) of the Exchange Act; and (ii) not lower than the lowest
level of margin, exclusive of premium, required for any comparable
exchange-traded options. See Sections 7(c)(2)(B)(iii)(I)-(II) of the
Exchange Act (emphasis added). The adopting release concludes that
risk-based margining for security futures is inappropriate, in part,
because it would substantially deviate from how margin requirements
are calculated for exchange-traded equity options at this time. If
risk-based margining were permitted for such equity options in the
future, then risk-based margining for security futures might follow,
too.
\3\ OneChicago's interpretive arguments included that: (i) The
Commissions' reading of Sections 7(c)(2)(B)(iii)(I)-(II) of the
Exchange Act as focusing on margin levels is incorrect; and (ii)
security futures contracts are not ``comparable'' to equity options
and, therefore, the ``consistent with'' and ``not lower than''
margin restrictions in Sections 7(c)(2)(B)(iii)(I)-(II) of the
Exchange Act do not apply.
---------------------------------------------------------------------------
First, I do not believe that we should be offering advisory
opinions on interpretive questions that, in light of the demise of
OneChicago, no CFTC- or SEC-registered exchange is currently asking.
In my view, these hypothetical questions are not material given the
circumstances before us, and should therefore be left to future CFTC
and SEC Commissioners, to be decided in the context of a live
request to list and trade security futures.
Second, risk-based margining for security futures is permitted
in Europe, and while factors other than margin requirements may
influence demand for security futures, its rejection in the adopting
release creates a potential competitive disadvantage for U.S.
exchanges vs. their international counterparts. The Commodity
Exchange Act (``CEA'') specifies that one of its purposes is ``to
promote responsible innovation and fair competition among boards of
trade, other markets and market participants.'' \4\ The
interpretation in the adopting release fails to fulfill that
purpose.
---------------------------------------------------------------------------
\4\ CEA section 3(b), 7 U.S.C. 5(b) (emphasis added).
---------------------------------------------------------------------------
Third, it should be remembered that the trading of security
futures on U.S. exchanges before the year 2000 was prohibited due to
jurisdictional disputes over the treatment of products that have
attributes of both SEC-regulated securities and CFTC-regulated
derivatives. In the Commodity Futures Modernization Act of 2000
(``CFMA''), Congress repealed that prohibition and permitted
security futures to trade on U.S. exchanges pursuant to a framework
of joint regulation by the CFTC and the SEC.\5\ Yet, the rejection
of risk-based margining in the adopting release risks stifling the
very security futures market that the CFMA intended to promote.
---------------------------------------------------------------------------
\5\ Commodity Futures Modernization Act of 2000, Public Law 106-
554, 114 Stat. 2763 (2000).
---------------------------------------------------------------------------
Nevertheless, it is my sincere hope that while the reduction in
margin level for an unhedged security futures position from 20% to
15% may have come too late for OneChicago, it will incentivize
another U.S. exchange to launch security futures. And in that event,
it is my further hope that the Commissions will bring an open mind
to any interpretive arguments the exchange may advance if it
requests recognition of risk-based margining for its contracts.
In the meantime, I support the Joint Final Rule that is before
us.
Appendix 4--Supporting Statement of CFTC Commissioner Dan M. Berkovitz
I support today's final rule on customer margin requirements for
security futures (``Final Rule''), issued jointly with the
Securities and Exchange Commission (``SEC''). The Final Rule ensures
that margin requirements for unhedged security futures will be
consistent regardless of the type of customer account in which they
are held. The Final Rule presents no new risks to the financial
system, and is an overdue effort to align margin requirements for
security futures.\1\
---------------------------------------------------------------------------
\1\ Congress established a framework for the trading and joint
regulation of security futures in the Commodity Futures
Modernization Act of 2000 (``CFMA''). Among other requirements, the
CFMA specified that customer margin requirements for security
futures products must be consistent with the margin requirements for
comparable options traded on a registered securities exchange, and
that the initial and maintenance margin levels must not be lower
than the lowest level of margin, exclusive of premium, required for
any comparable exchange-traded options.
---------------------------------------------------------------------------
Unhedged security futures held in a ``portfolio margin'' account
have been subject to a 15 percent minimum margin amount since
certain securities self-regulatory organizations (``SROs'') launched
portfolio margining pilot programs starting in 2007.\2\ In contrast,
prior to this Final Rule, such unhedged security futures held in a
futures account or in a securities customer account that is not
subject to portfolio margining were subject to a 20 percent margin
requirement. This structure produced disparate treatment of security
futures based solely on the customer account class in which they
were held.
---------------------------------------------------------------------------
\2\ Portfolio margining allows a broker-dealer to combine
certain of a customer's securities and security futures positions
held in a securities account for purposes of determining the margin
requirements for those positions. Such portfolio margining began
with a 2007 pilot program pursuant to the rules of CBOE Exchange.
The program became permanent in 2008. FINRA adopted its own
portfolio margining rules in 2010. Portfolio margining for security
futures is not available in a futures customer account. Thus, prior
to this Final Rule, the 15 percent treatment available to security
futures held in a portfolio margined account was unavailable to
security futures held in a futures account.
---------------------------------------------------------------------------
The Final Rule addresses this disparate treatment with no
increased risks to the financial system. It brings all unhedged
security futures to the same 15 percent margin requirement,
consistent with existing margin requirements for security futures
and equity options held in portfolio margin accounts that have been
in place for over a decade.
I support the two Commissions' efforts in today's Final Rule to
address one aspect of trading in security futures, consistent with
the CFMA's statutory requirements. Unfortunately, these efforts are
too late to be of any near-term benefit. Notably, the only U.S.
derivatives exchange that offered security futures products
discontinued trading in September, 2020.
I look forward to continuing to work with staff and my fellow
Commissioners at both the CFTC and the SEC on a viable margin regime
for security futures going forward.
I thank my fellow Commissioners at the CFTC and the SEC, as well
as staff of the two agencies, for their work on this Final Rule.
[FR Doc. 2020-24353 Filed 11-23-20; 8:45 am]
BILLING CODE 6351-01-8011-01-P
[Federal Register Volume 85, Number 227 (Tuesday, November 24, 2020)]
[Rules and Regulations]
[Pages 75112-75147]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 2020-24353]
[[Page 75111]]
Vol. 85
Tuesday,
No. 227
November 24, 2020
Part II
Commodity Futures Trading Commission
-----------------------------------------------------------------------
17 CFR Part 41
Securities and Exchange Commission
-----------------------------------------------------------------------
17 CFR Part 242
Customer Margin Rules Relating to Security Futures; Final Rule
Federal Register / Vol. 85 , No. 227 / Tuesday, November 24, 2020 /
Rules and Regulations
[[Page 75112]]
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COMMODITY FUTURES TRADING COMMISSION
17 CFR Part 41
RIN 3038-AE88
SECURITIES AND EXCHANGE COMMISSION
17 CFR Part 242
[Release No. 34-90244; File No. S7-09-19]
RIN 3235-AM55
Customer Margin Rules Relating to Security Futures
AGENCY: Commodity Futures Trading Commission and Securities and
Exchange Commission.
ACTION: Joint final rule.
-----------------------------------------------------------------------
SUMMARY: The Commodity Futures Trading Commission (``CFTC'') and the
Securities and Exchange Commission (``SEC'') (collectively, the
``Commissions'') are adopting rule amendments to lower the margin
requirement for an unhedged security futures position from 20% to 15%
and adopting certain conforming revisions to the security futures
margin offset table.
DATES: This rule is effective December 24, 2020.
FOR FURTHER INFORMATION CONTACT:
CFTC: Melissa A. D'Arcy, Special Counsel and Sarah E. Josephson,
Deputy Director, Division of Clearing and Risk, at (202) 418-5430; and
Michael A. Penick, Economist at (202) 418-5279, and Ayla Kayhan,
Economist at (202) 418-5947, Office of the Chief Economist, Commodity
Futures Trading Commission, Three Lafayette Centre, 1155 21st Street
NW, Washington, DC 20581.
SEC: Michael A. Macchiaroli, Associate Director, at (202) 551-5525;
Thomas K. McGowan, Associate Director, at (202) 551-5521; Randall W.
Roy, Deputy Associate Director, at (202) 551-5522; Sheila Dombal
Swartz, Senior Special Counsel, at (202) 551-5545; or Abraham Jacob,
Special Counsel, at (202) 551-5583; Division of Trading and Markets,
Securities and Exchange Commission, 100 F Street NE, Washington, DC
20549-7010.
SUPPLEMENTARY INFORMATION:
I. Background
II. Final Rule Amendments
A. Lowering the Minimum Margin Level From 20% to 15%
1. The Commissions' Proposal
2. Comments and Final Amendments
B. Conforming Revisions to the Strategy-Based Offset Table
1. The Commissions' Proposal
2. Comments and the Re-Published Strategy-Based Offset Table
C. Other Matters
III. Paperwork Reduction Act
A. CFTC
B. SEC
IV. CFTC Consideration of Costs and Benefits and SEC Economic
Analysis (Including Costs and Benefits) of the Proposed Amendments
A. CFTC
1. Introduction
2. Economic Baseline
3. Summary of the Final Rules
4. Description of Costs
5. Description of Benefits Provided by the Final Rules
6. Discussion of Alternatives
7. Consideration of Section 15(a) Factors
B. SEC
1. Introduction
2. Baseline
3. Considerations of Costs and Benefits
4. Effects on Efficiency, Competition, and Capital Formation
5. Reasonable Alternatives Considered
V. Regulatory Flexibility Act
A. CFTC
B. SEC
VI. Other Matters
VII. Anti-Trust Considerations
VIII. Statutory Basis
I. Background
A security future is a futures contract on a single security or on
a narrow-based securities index.\1\ The Commodity Futures Modernization
Act of 2000 (``CFMA'') lifted the ban on trading security futures and
established a framework for the joint regulation of these products by
the Commissions.\2\ Among other things, the CFMA amended Section 7 of
the Securities Exchange Act of 1934 (``Exchange Act'') to establish a
margin program for security futures. Section 7(c)(2)(A) of the Exchange
Act provides that it shall be unlawful for any broker, dealer, or
member of a national securities exchange \3\ to, directly or
indirectly, extend or maintain credit to or for, or collect margin from
any customer on, any security future unless such activities comply with
the regulations prescribed by: (1) The Board of Governors of the
Federal Reserve System (``Federal Reserve Board''); or (2) the
Commissions jointly pursuant to authority delegated by the Federal
Reserve Board.
---------------------------------------------------------------------------
\1\ See Section 1a(44) of the Commodity Exchange Act (``CEA'')
and Section 3(a)(55) of the Exchange Act (both defining the term
``security future''). A ``security future'' is distinguished from a
``security futures product,'' which is defined to include a security
future as well as any put, call, straddle, option, or privilege on a
security future. See Section 1a(45) of the CEA and Section 3(a)(56)
of the Exchange Act (both defining the term ``security futures
product''). Under Section 2(a)(1)(D)(iii)(II) of the CEA and Section
6(h)(6) of the Exchange Act, the Commissions may, by order, jointly
determine to permit the listing of options on security futures. The
Commissions have not exercised this authority. The amendments being
adopted in this release relate to margin requirements for security
futures and not for options on security futures. Most of the
discussion in this release relates to security futures. The term
``security futures products'' will be used when discussing security
futures and options on security futures.
\2\ See Appendix E of Public Law 106-554, 114 Stat. 2763 (2000).
Futures on security indexes that are not narrow-based are subject to
the exclusive jurisdiction of the CFTC.
\3\ A futures commission merchant (``FCM'') (as defined in
Section 1(a)(28) of the CEA) may be a member of a national
securities exchange, a clearing member of a clearinghouse, or a
customer of a clearing member of a clearinghouse.
---------------------------------------------------------------------------
Section 7(c)(2)(B) of the Exchange Act provides that the customer
margin requirements for security futures products adopted by the
Federal Reserve Board or jointly by the Commissions, ``including the
establishment of levels of margin (initial and maintenance),'' must
satisfy four requirements. First, they must preserve the financial
integrity of markets trading security futures products.\4\ Second, they
must prevent systemic risk.\5\ Third: (1) They must be consistent with
the margin requirements for comparable options traded on any exchange
registered pursuant to Section 6(a) of the Exchange Act; \6\ and (2)
the initial and maintenance margin levels must not be lower than the
lowest level of margin, exclusive of premium, required for any
comparable exchange-traded options.\7\ Fourth, excluding margin levels,
they must be, and remain consistent with, the margin requirements
established by the Federal Reserve Board under 12 CFR part 220
(``Regulation T'').\8\
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\4\ See Section 7(c)(2)(B)(i) of the Exchange Act.
\5\ See Section 7(c)(2)(B)(ii) of the Exchange Act.
\6\ See Section 7(c)(2)(B)(iii)(I) of the Exchange Act. In this
release, this provision of the statute is sometimes referred to as
the ``consistent with restriction.''
\7\ See Section 7(c)(2)(B)(iii)(II) of the Exchange Act. In this
release, this provision of the statute is sometimes referred to as
the ``not lower than restriction.''
\8\ See Section 7(c)(2)(B)(iv) of the Exchange Act.
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On March 6, 2001, the Federal Reserve Board delegated its authority
under Section 7(c)(2)(A) of the Exchange Act to the Commissions.\9\
Pursuant to that delegation, the Commissions adopted rules in 2002
establishing a margin program for security futures.\10\
[[Page 75113]]
These rules require security futures intermediaries to collect margin
from their customers.\11\ A security futures intermediary is a
creditor, as defined under Regulation T, with respect to its financial
relations with any person involving security futures, and includes
registered entities such as brokers-dealers and FCMs.\12\
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\9\ See Letter from Jennifer J. Johnson, Secretary of the Board,
Federal Reserve Board, to James E. Newsome, Acting Chairman, CFTC,
and Laura S. Unger, Acting Chairman, SEC (Mar. 6, 2001) (``FRB
Letter''); see also Customer Margin Rules Relating to Security
Futures, Exchange Act Release No. 44853 (Sep. 26, 2001), 66 FR 50720
(Oct. 4, 2001) (``2001 Proposing Release'') (reprinting the FRB
Letter in Appendix B).
\10\ See Customer Margin Rules Relating to Security Futures,
Exchange Act Release No. 46292 (Aug. 1, 2002), 67 FR 53146 (Aug. 14,
2002) (``2002 Adopting Release''). See also 17 CFR 41.41 through
41.49 (CFTC regulations, hereinafter referred to as ``CFTC Rule
41.42'', ``CFTC Rule 41.43'' et seq.) and 17 CFR 242.400 through
242.406 (SEC regulations, hereinafter referred to as ``SEC Rule
400'', ``SEC Rule 401'' et seq.). CFTC regulations referred to
herein are found at 17 CFR chapter I, and SEC regulations referred
to herein are found at 17 CFR chapter II.
\11\ See CFTC Rule 41.45 and SEC Rule 403. See also CFTC Rule
41.43(a)(29) and SEC Rule 401(a)(1)(29) (both defining the term
``security futures intermediary'' to include a broker-dealer and an
FCM). The term ``security futures intermediary'' includes FCMs that
are clearing members or customers of clearing members. As of
September 18, 2020, the Options Clearing Corporation (``OCC'') was
the only clearinghouse for U.S. exchange-traded security futures.
\12\ Because a security future is both a security and a future,
customers who wish to buy or sell security futures must conduct the
transaction through a person registered both with the CFTC as either
an FCM or an introducing broker (``IB'') and with the SEC as a
broker-dealer.
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The Commissions' rules include requirements governing: Account
administration; type, form, and use of collateral; calculation of
equity; withdrawals from accounts; and the treatment of undermargined
accounts. The Commissions stated that ``the inclusion of these
provisions in the final rules satisfies the statutory requirement that
the margin rules for security futures be consistent with Regulation
T.'' \13\
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\13\ See 2002 Adopting Release, 67 FR at 53155. As indicated
above, Section 7(c)(2)(B)(iv) of the Exchange Act requires that
margin requirements for security futures (other than levels of
margin), including the type, form, and use of collateral, must be
consistent with the requirements of Regulation T.
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The Commissions' rules contemplate that all security futures
intermediaries will pay to or receive from their customers a daily
variation settlement (i.e., the daily net gain or loss on a security
future) as a result of all open security futures positions being marked
to current market value by the clearing organization where the security
futures are cleared.\14\ In addition, the Commissions' rules establish
minimum initial and maintenance margin levels for unhedged security
futures equal to 20% of their ``current market value.'' \15\
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\14\ See CFTC Rules 41.43(a)(32), 41.46(c)(1)(vi) and
(c)(2)(iii), and 41.47(b)(1), and SEC Rules 401(a)(32),
404(c)(1)(vi) and (c)(2)(iii), and 405(b)(1).
\15\ See CFTC Rule 41.45(b)(1) and SEC Rule 403(b)(1). See also
CFTC Rule 41.43(a)(4) and SEC Rule 401(a)(4) (defining the term
``current market value'').
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The Commissions' rules permit a ``self-regulatory authority''
(``SRA''),\16\ as that term is defined in the rules, to set initial and
maintenance margin levels lower than 20% of the current market value
for certain strategy-based offsetting positions involving security
futures and one or more related securities or futures.\17\ The SRA
rules must meet the four criteria set forth in Section 7(c)(2)(B) of
the Exchange Act and must be effective in accordance with Section
19(b)(2) of the Exchange Act and, as applicable, Section 5c(c) of the
CEA.\18\ In connection with these provisions governing SRA rules, the
Commissions published a table identifying offsets for security futures
that were consistent with the offsets permitted for comparable
exchange-traded options (``Strategy-Based Offset Table'').\19\ SRAs
have adopted margin rules that permit strategy-based offsets between
security futures and related positions based on the Strategy-Based
Offset Table.\20\
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\16\ The Commissions' rules define the term ``self-regulatory
authority'' to mean a national securities exchange registered under
Section 6 of the Exchange Act, a national securities association
registered under Section 15A of the Exchange Act, a contract market
registered under Section 5 of the CEA or Section 5f of the CEA, or a
derivatives transaction execution facility registered under Section
5a of the CEA. See CFTC Rule 41.43(a)(30) and SEC Rule 401(a)(30).
The term ``SRA'' as used in this release refers to self-regulatory
organizations (``SROs'') registered under the Exchange Act and self-
regulatory authorities registered under the CEA. The term
``securities SRO'' as used in this release refers only to SROs
registered under the Exchange Act.
\17\ See CFTC Rule 41.45(b)(2) and SEC Rule 403(b)(2). See also
2002 Adopting Release, 67 FR at 53158-61. The initial margin level
is the required amount of margin that must be posted when the trade
is executed. The maintenance margin level is the required amount of
margin that must be maintained while the contract is open.
\18\ Section 19(b)(2) of the Exchange Act governs SRA rulemaking
with respect to SEC registrants, and Section 5c(c) of the CEA
governs SRA rulemaking with respect to CFTC registrants.
\19\ See 2002 Adopting Release, 67 FR at 53158-61.
\20\ See, e.g., FINRA Rule 4210(f)(10) and Cboe Rule 10.3(k).
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The Commissions' rules also enumerate specific exclusions from the
margin requirements for security futures, and those exclusions will
continue under the final rule amendments.\21\ For example, margin
requirements that derivatives clearing organizations (``DCOs'') or
clearing agencies impose on their clearing members are not subject to
the 20% margin level requirement.\22\
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\21\ See CFTC Rule 41.42(c)(2)(i) through (v) and SEC Rule
400(c)(2)(i) through (v).
\22\ See CFTC Rule 41.42(c)(2)(iii) and SEC Rule 400(c)(2)(iii).
The OCC is registered with the SEC as a clearing agency pursuant to
Section 17A of the Exchange Act and registered with the CFTC as a
DCO pursuant to Section 5b of the CEA.
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There also is an exclusion providing that the required 20% initial
and maintenance margin levels do not apply to financial relations
between a customer and a security futures intermediary to the extent
that they comply with a portfolio margining system under rules that
meet the four criteria set forth in Section 7(c)(2)(B) of the Exchange
Act and that are effective in accordance with Section 19(b)(2) of the
Exchange Act and, as applicable, Section 5c(c) of the CEA.\23\
Subsequent to the adoption of the Commissions' rules, and consistent
with this exclusion, two securities SROs implemented portfolio
margining rules that permit a broker-dealer to combine certain of a
customer's securities and security futures positions in a securities
account in order to compute the customer's margin requirements
(``Portfolio Margin Rules'').\24\ As discussed in more detail below,
the Portfolio Margin Rules established a 15% margin level for unhedged
exchange-traded options on an equity security or narrow-based equity
index (sometimes referred to herein as ``exchange-traded equity
options'').\25\ The 15% margin level also applies to unhedged security
futures held in a securities account that is subject to Portfolio
Margin Rules. There is no comparable portfolio margining system for
security futures held in a futures account.\26\ These same unhedged
security futures positions, if held in a futures account, are subject
to the required 20% initial and maintenance margin levels set forth in
the Commissions' rules.
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\23\ CFTC Rule 41.42(c)(2)(i) and SEC Rule 400(c)(2)(i).
\24\ See FINRA Rule 4210(g) and Cboe Rule 10.4. The broker-
dealer would need to be registered with the CFTC (as an FCM) to
include security futures in the securities account. See also 2019
Proposing Release, 84 FR 36437, n.36. FINRA Rule 4210 (Margin
Requirements) was adopted as part of a new consolidated rulebook
effective permanently on December 2, 2010, after the pilot program
was approved and made available on August 1, 2008. Cboe rules on
portfolio margining became effective permanently on July 8, 2008,
after they were approved under a pilot program on April 2, 2007.
\25\ The amendments adopted in this release were motivated, in
part, by changes made to margin requirements for certain exchange-
traded options pursuant to securities SRO pilot programs offering
risk-based portfolio margining rules. Those pilot programs were
later made permanent after review and approval by the SEC. See 2019
Proposing Release, 84 FR 36437, n.34-36.
\26\ For purposes of this rulemaking a ``futures account'' is an
account that is maintained in accordance with the requirements of
Sections 4d(a) and 4d(b) of the CEA. See also 17 CFR 1.3 (CFTC Rule
1.3).
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2019 Proposing Release
In July 2019, the Commissions proposed amending the security
futures margin rules to lower the required initial and maintenance
margin levels for an unhedged security futures position from 20% to 15%
of its current
[[Page 75114]]
market value.\27\ The Commissions sought to align margin requirements
for security futures held in futures accounts and customer securities
accounts that are not subject to the Portfolio Margin Rules with
security futures and exchange-traded options held in customer
securities accounts subject to the Portfolio Margin Rules (``Portfolio
Margin Account'').\28\ The Commissions also proposed certain conforming
revisions to the Strategy-Based Offset Table.\29\ Because the
Commissions' proposal solely related to the reduction in ``levels of
margin'' for security futures, the Commissions stated a preliminary
belief that they did not implicate the requirement of Section
7(c)(2)(B)(iv) of the Exchange Act that the Commissions' rules be
consistent with Regulation T.\30\
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\27\ See Customer Margin Rules Relating to Security Futures,
Exchange Act Release No. 86304 (July 3, 2019), 84 FR 36434 (July 26,
2019) (``2019 Proposing Release''). OneChicago, LLC (``OneChicago'')
filed a rulemaking petition requesting that the minimum required
margin for unhedged security futures be reduced from 20% to 15%. See
Letter from Donald L. Horwitz, Managing Director and General
Counsel, OneChicago, to David Stawick, Secretary, CFTC, and Nancy M.
Morris, Secretary, SEC (Aug. 1, 2008) (``OneChicago Petition''), at
2.
\28\ See 2019 Proposing Release, 84 FR at 36437.
\29\ See 2019 Proposing Release, 84 FR at 36441-43.
\30\ See 2019 Proposing Release, 84 FR at 36440. As discussed
above, Section 7(c)(2)(B)(iv) of the Exchange Act requires that
margin requirements for security futures (other than levels of
margin), including the type, form, and use of collateral, must be
consistent with the requirements of Regulation T (emphasis added).
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The Commissions received a number of comment letters in response to
the proposal.\31\ As discussed below, after considering the comments,
the Commissions are adopting, as proposed, the amendments to the
security futures margin rules to lower the required initial and
maintenance margin levels for an unhedged security futures position
from 20% to 15%. The Commissions also are publishing a revised
Strategy-Based Offset Table as proposed.
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\31\ The comment letters are available at https://www.sec.gov/comments/s7-09-19/s70919.htm and https://comments.cftc.gov/PublicComments/CommentList.aspx?id=3013. The Commissions address
these comments in section II below (discussing the final rule
amendments), and in section IV (including the CFTC's consideration
of the costs and benefits of the amendments and the SEC's economic
analysis (including costs and benefits) of the amendments).
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Subsequent to the issuance of the 2019 Proposing Release,
OneChicago, the only exchange listing security futures in the U.S.,
discontinued all trading operations on September 21, 2020. At this
time, there are no security futures contracts listed for trading on
U.S. exchanges. The final rule amendments in this release, however,
would apply to customer margin requirements for security futures if an
exchange were to resume operations or another exchange were to launch
security futures contracts.
II. Final Rule Amendments
A. Lowering the Minimum Margin Level From 20% to 15%
1. The Commissions' Proposal
As discussed above, the current minimum initial and maintenance
margin levels for an unhedged long or short position in a security
future are 20% of the current market value of the position,\32\ unless
an exclusion applies.\33\ For context, as discussed when adopting the
margin requirements for security futures in 2002, the 20% margin levels
were designed to be consistent with the margin requirements then in
effect for an unhedged short at-the-money exchange-traded option held
in a customer account where the underlying instrument is either an
equity security or a narrow-based index of equity securities.\34\ In
this case, the margin requirement was 100% of the exchange-traded
option proceeds, plus 20% of the value of the underlying equity
security or narrow-based equity index.\35\ This margin requirement on
options continues to apply if the exchange-traded option is held in a
securities account that is not subject to the Portfolio Margin
Rules.\36\
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\32\ See CFTC Rule 41.45(b) and SEC Rule 403(b).
\33\ See CFTC Rule 41.42(c)(2)(i) through (v) and SEC Rule
400(c)(2)(i) through (v).
\34\ See 2002 Adopting Release, 67 FR at 53157 (``The
Commissions believe that a security future is comparable to a short,
at-the-money option . . .''); 2001 Proposing Release, 66 FR at
50725-26 (``The Commissions propose that the initial and maintenance
margin levels required of customers for each security future carried
in a long or short position be 20 percent of the current market
value of such security future because 20 percent is the uniform
margin level required for short, at-the-money equity options traded
on U.S. options exchanges.'') (footnote omitted). In 2002, the
margin requirement for a long exchange-traded equity option with an
expiration exceeding nine months was 75% of the contract's in-the-
money amount plus 100% of the amount, if any, by which the current
market value of the option exceeded its in-the-money amount,
provided the option is guaranteed by the carrying broker-dealer and
has an American-style exercise provision. Otherwise, long exchange-
traded options were not margin eligible and the customer needed to
pay 100% of the purchase price. These requirements remain in place
for long options contracts. See FINRA Rule 4210 and Cboe Rule 10.3.
\35\ This release generally discusses security futures on
underlying equity securities and narrow-based equity security
indexes because, while permitted, no exchange has listed security
futures directly on one or more debt securities. See CFTC Rule
41.21(a)(2)(iii), 17 CFR 41.21(a)(2)(iii), and SEC Rule 6h-2, 17 CFR
240.6h-2 (both providing that a security futures may be based upon a
security that is a note, bond, debenture, or evidence of
indebtedness or a narrow-based security index composed of such
securities).
\36\ See FINRA Rule 4210 and Cboe Rule 10.3.
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However, as a result of the more recent Portfolio Margin Rules, an
unhedged short at-the-money exchange-traded equity option held in a
Portfolio Margin Account is now subject to a lower margin level. More
specifically, under the Portfolio Margin Rules, a broker-dealer can
group options, security futures, long securities positions, and short
securities positions in a customer's account involving the same
underlying security and stress the current market price for each
position at ten equidistant points along a range of positive and
negative potential future market movements using a theoretical option
pricing model that has been approved by the SEC.\37\ In the case of an
option on an equity security or narrow-based equity securities index,
the ten equidistant stress points span a range from -15% to +15% (i.e.,
-15%, -12%, -9%, -6%, -3%, +3%, +6%, +9%, +12%, +15%).\38\ The gains
and losses of each position in the portfolio are allowed to offset each
other to yield a net gain or loss at each stress point.\39\ The stress
point that yields the largest potential net loss for the portfolio is
used to determine the aggregate margin requirement for all the
positions in the portfolio.\40\
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\37\ See FINRA Rule 4210(g) and Cboe Rule 10.4.
\38\ This range of price movements (+/-) 15% is consistent with
the prescribed 15% haircut for most proprietary equity securities
positions under the SEC's net capital rule for broker-dealers. See
17 CFR 240.15c3-1(c)(2)(vi)(J).
\39\ For example, at the -6% stress point, XYZ Company stock
long positions would experience a 6% loss, short positions would
experience a 6% gain, and XYZ Company options would experience gains
or losses depending on the features of the options. These gains and
losses are added up resulting in a net gain or loss at that point.
\40\ Because options are part of the portfolio, the greatest
portfolio loss (or gain) would not necessarily occur at the largest
potential market move stress points ((+/-) 15%). This is because a
portfolio that holds derivative positions that are far out-of-the-
money would potentially realize large gains at the greatest market
move points as these positions come into the money. Thus, the
greatest net loss for a portfolio conceivably could be at any market
move stress point. In addition, the Portfolio Margin Rules impose a
minimum charge based on the number of derivative positions in the
account and that applies if the minimum charge is greater than the
largest stress point charge.
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Under the Portfolio Margin Rules, the margin requirement for a
short at-the-money exchange-traded equity option generally would be 15%
if there were no other products in the account eligible to be grouped
with the option position to form a portfolio (i.e., an unhedged
position). Consequently, the Commissions proposed to lower the required
initial and maintenance margin levels for unhedged security futures
[[Page 75115]]
from 20% to 15%.\41\ In doing so, the Commissions preliminarily viewed
unhedged exchange-traded equity options as comparable to security
futures that may be held alongside the exchange-traded equity options
in a Portfolio Margin Account.\42\ The Commissions stated that Congress
did not instruct the Commissions to set the margin requirement for
security futures at the exact level as the margin requirements for
exchange-traded equity options. Rather, pursuant to Section 7(c)(2)(B)
of the Exchange Act, the Commissions must establish margin requirements
that are ``consistent'' with the margin requirements for ``comparable''
exchange-traded equity options and set initial and maintenance margin
levels that are not lower than the lowest level of margin for the
comparable exchange-traded equity options.
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\41\ See 2019 Proposing Release, 84 FR at 36438-40.
\42\ See 2019 Proposing Release, 84 FR at 36439 (``The
Commissions are proposing to decrease the margin requirement for
unhedged security futures from 20% to 15% in order to reflect the
comparability between unhedged security futures and exchange-traded
options that are held in risk-based portfolio margin accounts.'').
---------------------------------------------------------------------------
Under the proposal, unhedged security futures held in futures
accounts and securities accounts that are not Portfolio Margin Accounts
would be subject to the same initial and maintenance margin levels as
unhedged security futures held in Portfolio Margin Accounts (i.e.,
15%). Thus, the proposed 15% initial and maintenance margin levels for
unhedged security futures would bring security futures held in futures
accounts and securities accounts that are not Portfolio Margin Accounts
into alignment with the required margin level for unhedged security
futures held in Portfolio Margin Accounts. At the same time, the
amendments would not lower the required margin levels for unhedged
security futures below the lowest required margin level for unhedged
exchange-traded equity options (i.e., 15%). As discussed below, margin
levels for exchange-traded equity options are prescribed in rules
promulgated by securities SROs.\43\
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\43\ See 12 CFR 220.12(f); FINRA Rule 4210; Cboe Rule 10.3. See
also infra note 56 and accompanying text (noting securities SROs
typically set margin levels for exchange-traded equity options
through rule filings with the SEC under Section 19(b) of the
Exchange Act).
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2. Comments and Final Amendments
One commenter stated that the proposed amendments would harmonize
margin requirements, be simpler to administer and risk manage, and
better align with customer use of security futures.\44\ This commenter
stated that it has long supported securities portfolio margining and
has found the 15% margin level for unhedged positions sufficiently
robust for intermediaries to risk manage their customer positions.\45\
Other commenters, however, raised concerns with the proposal, as
discussed below.
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\44\ Letter from Walt Lukken, President & Chief Executive
Officer, Futures Industry Association (Aug. 26, 2019) (``FIA
Letter'') at 2.
\45\ FIA Letter at 2.
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Addressing Commenters' Concerns That the Proposal Is Inconsistent With
Section 7(c)(2)(B) of the Exchange Act
When proposing these amendments, the Commissions stated a
preliminary belief that they would be consistent with Section
7(c)(2)(B) of the Exchange Act.\46\ The Commissions noted that, under
that section, customer margin requirements, including the establishment
of levels of margin (initial and maintenance) for security futures,
must be consistent with the margin requirements for comparable options
traded on any exchange registered pursuant to Section 6(a) of the
Exchange Act.\47\ The Commissions stated a preliminary belief that
``[c]ertain types of exchange-traded options, no matter what type of an
account they are in, are comparable to security futures'' and therefore
the ``margin requirements for comparable exchange-traded options and
security futures must be consistent.'' \48\ Finally, the Commissions--
in proposing to lower the margin level for security futures from 20% to
15%--used the margin level for an unhedged exchange-traded equity
option held in a Portfolio Margin Account to ``establish a consistent
margin level for security futures held outside'' of a Portfolio Margin
Account.\49\
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\46\ See 2019 Proposing Release, 84 FR at 36439-40.
\47\ Id.
\48\ Id.
\49\ Id. at 36440.
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Some commenters stated that the 15% margin level in a Portfolio
Margin Account is prudent, given the requirements for these accounts
(e.g., risk management, account approval process, and minimum equity
required).\50\ However, these commenters stated that minimum margin
levels for security futures held outside of a Portfolio Margin Account
do not govern the levels of margin applicable for security futures held
in a Portfolio Margin Account and, similarly, that the rules governing
levels of margin for exchange-traded equity options held outside of a
Portfolio Margin Account do not govern the levels of margin for
exchange-traded equity options held in a Portfolio Margin Account. In
the commenters' view, Section 7(c)(2)(B) of the Exchange Act requires
initial and maintenance margin levels for security futures held outside
of a Portfolio Margin Account to remain at 20% because the initial and
maintenance margin levels for exchange-traded equity options held
outside a Portfolio Margin Account are 20%.
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\50\ Letter from Angelo Evangelou, Chief Policy Officer, Cboe
Global Markets, Inc. and Shelly Brown, EVP, Strategic Planning &
Operations, MIAX Exchange Group (Aug. 26, 2019) (``Cboe/MIAX
Letter'') at 4-7.
---------------------------------------------------------------------------
Some commenters stated that the proposal ``may not be in line with
the spirit or letter'' of the CFMA and asked the Commissions to outline
how the proposal to lower the required initial and maintenance margin
levels from 20% to 15% is consistent with the CFMA.\51\
---------------------------------------------------------------------------
\51\ Letter from the Honorable Mike Bost and Rodney Davis, U.S.
Congress (Nov. 13, 2019) (``Bost/Davis Letter'') at 1.
---------------------------------------------------------------------------
Other commenters, while fully supportive of harmonizing margin
requirements, urged the Commissions to reconsider the proposal or
provide for a corresponding change to margin levels for exchange-traded
equity options to ensure any final rule is consistent with Section
7(c)(2)(B) of the Exchange Act.\52\ In making these comments, these
commenters agreed with (or did not state a disagreement with) the
Commissions' view that security futures are comparable to exchange-
traded equity options in terms of their risk characteristics and uses.
---------------------------------------------------------------------------
\52\ Letter from the Honorable Jerry Moran, Thom Tillis, and M.
Michael Rounds, U.S. Senate (Nov. 22, 2019) (``Moran/Tillis/Rounds
Letter'') at 1-2.
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After considering these comments, the Commissions continue to
believe that it is appropriate to seek to align the required margin
levels for unhedged security futures held in a futures account (or in a
securities account that is not subject to Portfolio Margin Rules) with
the 15% margin level for unhedged exchange-traded equity options held
in a Portfolio Margin Account.\53\ The primary benefit to customers of
holding positions in a Portfolio Margin Account is the lower margin
requirements (i.e., margin levels less than 15%) that can result from
grouping and recognizing the risk-reducing offsets between positions
involving the same underlying equity security or narrow-based equity
securities index. These lower margin requirements also can increase the
amount of leverage available to customers who use Portfolio Margin
[[Page 75116]]
Accounts to trade equity positions. To address the lower margin
requirements and increased leverage that may result from grouping risk
reducing equity positions, Portfolio Margin Accounts are subject to
additional requirements, as compared to non-Portfolio Margin
Accounts.\54\
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\53\ See 2019 Proposing Release, 84 FR at 36439.
\54\ For example, in order to open a Portfolio Margin Account, a
customer must be approved for writing uncovered options and meet
minimum equity requirements (generally ranging from $100,000 to
$500,000). In addition, Portfolio Margin Accounts are subject to
enhanced risk management procedures and additional customer
disclosure requirements. See FINRA Rule 4210(g) and Cboe Rule 10.4;
see also FINRA Portfolio Margin FAQ, available at www.finra.org.
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An exchange-traded equity option that cannot be grouped with any
other risk reducing offsetting equity positions in a Portfolio Margin
Account (i.e., an unhedged position) does not receive the benefit of a
lower margin requirement and is subject to a 15% margin level.
Therefore, the greater leverage that can be achieved by grouping
offsetting positions is not available to the customer in the case of an
unhedged position. Given the absence of risk-reducing offsetting
positions, the risk of the unhedged position held in a Portfolio Margin
Account generally is no different than if the unhedged position was
held outside of a Portfolio Margin Account. The same is true with
respect to an unhedged security futures position held in a Portfolio
Margin Account as compared to an unhedged security futures position
held outside of a Portfolio Margin Account.
Moreover, there is no comparable portfolio margin system for
security futures held in a futures account. Therefore, an unhedged
security futures position held in a futures account is subject to the
required 20% margin level even though the risk of the position is
generally no different than if the position was held in a Portfolio
Margin Account, given the absence of risk-reducing offsetting
positions. In addition, as discussed above, in 2002, securities SROs
had not yet proposed portfolio margin rules for exchange-traded
options. With the adoption of the Portfolio Margin Rules, the lower 15%
margin level for unhedged security futures and exchange-traded options
held in Portfolio Margin Accounts became available as an alternative.
For these reasons, it is appropriate to use the margin level for an
unhedged exchange-traded equity option held in a Portfolio Margin
Account to establish a consistent margin level for security futures
held outside of a Portfolio Margin Account.
In addition, as discussed above, Section 7(c)(2)(B) of the Exchange
Act provides that: (1) The margin requirements for security futures
must be consistent with the margin requirements for comparable options
traded on any exchange registered pursuant to Section 6(a) of the
Exchange Act; and (2) the initial and maintenance margin levels for
security futures must not be lower than the lowest level of margin,
exclusive of premium, required for any comparable exchange-traded
options. The statute requires that the Commissions establish customer
margin requirements that are ``consistent'' with the margin
requirements for ``comparable'' exchange-traded options. This provides
the Commissions with some flexibility in establishing the margin levels
for security futures, provided those margin requirements do not set
initial and maintenance margin levels for security futures lower than
the lowest level of margin, exclusive of premium, required for any
comparable exchange-traded options.
Further, Section 7(c)(2)(B)(iii)(II) of the Exchange Act provides
that the initial and maintenance margin levels for security futures
must not be lower than the lowest level of margin required for any
comparable exchange-traded option. It does not specify that the initial
and maintenance margin levels must not be lower than the lowest level
of margin required with respect to a given type of account. Therefore,
it is appropriate to consider the lowest level of margin for an
unhedged exchange-traded equity option held in a Portfolio Margin
Account when setting initial and maintenance margin levels for security
futures held outside of a Portfolio Margin Account (i.e., held in a
futures account or a securities account that is not a Portfolio Margin
Account).
As discussed above, commenters requested that the Commissions
provide for a corresponding change to margin levels for exchange-traded
equity options to ensure any final rule is consistent with Section
7(c)(2)(B) of the Exchange Act. This comment is outside the scope of
this rulemaking, which is focused on margin levels for security
futures. Margin levels for exchange-traded equity options are set forth
in securities SRO rules.\55\ Securities SROs typically set margin
levels for exchange-traded equity options through rule filings with the
SEC under Section 19(b) of the Exchange Act.\56\
---------------------------------------------------------------------------
\55\ See 12 CFR 220.12(f); FINRA Rule 4210; Cboe Rule 10.3.
\56\ Under Section 19(b) of the Exchange Act, securities SROs
generally must file proposed rule changes with the SEC for notice,
public comment, and SEC approval, prior to implementation. 15 U.S.C.
78s(b). Section 19(b)(1) of the Exchange Act requires each
securities SRO to file with the SEC ``any proposed rule or any
proposed change in, addition to, or deletion from the rules of . . .
[a] self-regulatory organization.'' 15 U.S.C. 78s(b)(1).
---------------------------------------------------------------------------
Some commenters that raised concerns about the proposal's
consistency with Section 7(c)(2)(B) of the Exchange Act also stated
that the proposal would create a competitive advantage for security
futures over exchange-traded equity options through preferential margin
treatment for security futures held outside of a Portfolio Margin
Account.\57\
---------------------------------------------------------------------------
\57\ Cboe/MIAX Letter at 6.
---------------------------------------------------------------------------
These commenters noted that the Commissions recognized in 2001 that
security futures can compete with, and be an economic substitute for,
equity securities, such as equity options, and stated that the CFMA was
specifically designed to avoid regulatory arbitrage between security
futures and exchange-traded options.\58\ These commenters believed that
the proposal implies that exchange-traded options and security futures
are not competing products and that the analysis in the proposal
unfairly underestimates the utility of options.\59\ They also stated
that synthetic futures strategies are an important segment of today's
options market, and could be used to compete with security futures.
They stated that in June 2019 there were over 700,000 contracts traded
on their exchanges that replicate long and short security futures.\60\
---------------------------------------------------------------------------
\58\ Cboe/MIAX Letter at 6. See also 2001 Proposing Release, 66
FR 50721 at n.10.
\59\ Cboe/MIAX Letter at 6.
\60\ Cboe/MIAX Letter at 7.
---------------------------------------------------------------------------
The Commissions acknowledge that security futures and exchange-
traded equity options can have similar economic uses.\61\ However,
reducing the margin level for an unhedged security future held outside
of a Portfolio Margin Account to 15% should not result in a competitive
disadvantage for exchange-traded equity options, if security futures
trading resumes. First, reducing the required margin levels for
unhedged security futures to 15% will result in more consistent margin
requirements between futures and securities accounts. Second, subject
to certain requirements, customers may hold exchange-traded equity
options in a Portfolio Margin Account, in which case the margin level
for an unhedged position is 15%.
---------------------------------------------------------------------------
\61\ For example, commenters noted that to create a synthetic
long (short) futures contract, which requires two options, an
investor would buy (sell) a call option and sell (buy) a put option
on the same underlying security with the same expiration date and
strike price. Cboe/MIAX Letter at 6-7.
---------------------------------------------------------------------------
Finally, customers can hold security futures in a Portfolio Margin
Account, in which case the required margin level is 15% for an unhedged
position. Nonetheless, the vast majority of
[[Page 75117]]
security futures traded in the U.S. were held in futures accounts
subject to required initial and maintenance margin levels of 20% for
unhedged positions.\62\ Therefore, the relative advantage of a required
15% margin level as compared to a required 20% margin level did not
cause customers to migrate their security futures trading to Portfolio
Margin Accounts.
---------------------------------------------------------------------------
\62\ In its petition, OneChicago stated that ``because of
operational issues at the securities firms, almost all security
futures positions are carried in a futures account regulated by the
CFTC and not in a securities account. The proposed joint rulemaking
would permit customers carrying security futures in futures accounts
to receive margin treatment consistent with that permitted under the
[portfolio] margining provisions of CBOE.'' See OneChicago Petition
at 2 and 2019 Proposing Release 84 FR at 36440, n.67.
---------------------------------------------------------------------------
Some commenters that opposed lowering the required margin levels
from 20% to 15% stated that industry solutions and rule changes that
optimize the portfolio margining of security futures and exchange-
traded equity options, including the portfolio margining of security
futures in both securities and futures accounts, would be a more
appropriate solution.\63\
---------------------------------------------------------------------------
\63\ Cboe/MIAX Letter at 5. More specifically, to the extent
securities accounts are not operationally optimal for security
futures, the options exchanges support industry efforts to make
improvements. Id.
---------------------------------------------------------------------------
As discussed above, lowering the required margin levels from 20% to
15% is appropriate, consistent with Section 7(c)(2)(B) of the Exchange
Act, and should not disadvantage exchange-traded equity options markets
if security futures trading resumes. Moreover, the Commissions remain
committed to continuing to coordinate on issues related to harmonizing
portfolio margining rules and requirements, as well as increasing
efficiencies in the implementation of portfolio margining. Further, to
the extent securities accounts are not operationally suited for holding
security futures, the Commissions support industry efforts to address
this issue. Finally, the realization of any potential harmonization
efforts or operational improvements with respect to portfolio margining
will depend on firms offering such programs to their customers.
Response to Commenters' Request To Use Risk Models To Calculate Margin
In response to the Commissions' request for comments in the 2019
Proposing Release,\64\ some commenters stated that the Commissions'
rules should permit the use of risk models to calculate required
initial and maintenance margin levels for security futures \65\--
similar to how DCOs calculate margin requirements for futures and the
OCC calculates margin requirements for its clearing members.\66\ One of
these commenters--OneChicago--believed that the required margin levels
for security futures and the proposal to modify them were too
conservative.\67\ OneChicago characterized the Commissions' proposal
as--``at best''--``a first-step towards the risk-based margining that
is needed in the [security futures] marketplace.'' \68\ It further
stated that 92% of the security futures traded on its exchange were
``margined at a level greater than is set by the clearinghouse for
comparable products, which are equity swaps'' and that, under the
proposal, 84% would still be margined at a greater level.\69\ According
to OneChicago's analysis, the Commissions' proposal to lower the
required margin levels from 20% to 15% would have resulted in a 25%
reduction in the value of margin collected (from $540 million to $410
million) for the period between September 1, 2018, and August 1, 2019;
whereas using a margin model would have resulted in a 61% reduction
(from $540 million to $210 million).\70\
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\64\ The Commissions asked, ``[a]re there any other risk-based
margin methodologies that could be used to prescribe margin
requirements for security futures? If so, please identify the margin
methodologies and explain how they would meet the comparability
standards under the Exchange Act.'' 2019 Proposing Release, 84 FR at
36441.
\65\ For purposes of this final rule, any references to using
``risk models'' or a ``risk model approach'' to calculate required
initial margin levels is intended to mean the same thing. While
there are different risk-based margin models, a key component of all
such margin regimes is the use of modeling to generate expected
potential future exposures that adjust over time in response to
market conditions, credit risk, and other inputs.
\66\ Letter from Thomas G. McCabe, Chief Regulatory Officer,
OneChicago (Aug. 26, 2019) (``OneChicago Letter''); Letter from
Thomas G. McCabe, Chief Regulatory Officer, OneChicago (Oct. 7,
2019) (``OneChicago Letter 2''); Letter from Thomas G. McCabe, Chief
Regulatory Officer, OneChicago (Apr. 27, 2020) (``OneChicago Letter
3''); OneChicago, April 27, 2020 OneChicago Comment Letter Summary
(``OneChicago Letter 3 Summary''); Letter from Mike Ianni,
individual (Aug. 29, 2019) (``Ianni Letter''); Letter from Scott A.
La Botz, individual (Dec. 4, 2019) (``La Botz Letter'').
\67\ OneChicago Letter at 1.
\68\ OneChicago Letter at 1.
\69\ OneChicago Letter at 1. In this release, the term
``clearinghouse'' may refer to a clearing organization or a clearing
agency.
\70\ OneChicago Letter at 14. However, as discussed in more
detail in section IV of this release, it is possible that under
certain circumstances the margin requirement under a risk-based
margin model may exceed the 15% of the current market value that is
required under the final rules.
---------------------------------------------------------------------------
OneChicago believed that the ``margin regime in place today and the
proposed margin regime incentivizes market participants to transact in
other environments.'' \71\ OneChicago stated that the trading volume on
its exchange ``has been plummeting in recent years.'' \72\ In the
exchange's view, these issues would be addressed if the Commissions
adopted a risk model approach to calculate required margin levels for
security futures. As a more limited alternative, OneChicago suggested
the Commissions could adopt a risk model approach for a class of
security futures paired transactions executed on its exchange and known
as ``securities transfer and return spreads'' (``STARS'').\73\
---------------------------------------------------------------------------
\71\ OneChicago Letter at 2.
\72\ OneChicago Letter at 14.
\73\ OneChicago Letter at 19; see also Memorandum from the SEC's
Division of Trading and Markets regarding a July 16, 2019, meeting
with representatives of OneChicago.
---------------------------------------------------------------------------
Risk models calculate margin requirements by measuring potential
future exposures based on statistical correlations between positions in
a portfolio. For example, the OCC's risk model--known as the System for
Theoretical Analysis and Numerical Simulations (``STANS'')--calculates
a clearing member's margin requirement based on full portfolio Monte
Carlo simulations.\74\ The margin requirements in place today for
exchange-traded equity options do not use risk models to calculate
margin requirements for customer positions.\75\ Rather, current rules
prescribe margin requirements as a percent of a value or other amount
of a single position or combinations of offsetting positions or, in the
case of the Portfolio Margin Rules, stress groups of related positions
across a preset range of potential percent market moves (e.g., market
moves of -15%, -12%, -9%, -6%, -3%, +3%, +6%, +9%, +12%, +15% in the
case of exchange-traded equity options).
---------------------------------------------------------------------------
\74\ More information about the OCC's STANS model is available
at https://www.theocc.com/risk-management/Margin-Methodology/.
\75\ See, e.g., FINRA Rule 4210 and Cboe Rule 10.3.
---------------------------------------------------------------------------
The Commissions' required initial and maintenance margin levels for
security futures (i.e., 20% of the current market value) are based on
the margin requirements for exchange-traded equity options and are
designed to be consistent with those requirements in accordance with
Section 7(c)(2)(B) of the Exchange Act.\76\ Consequently, implementing
a risk model approach to calculate required margin levels for security
futures would substantially alter how the required margin is calculated
(or would be calculated under these amendments) and would substantially
deviate from how customer margin requirements are calculated for
exchange-traded equity options. It also could result in required
[[Page 75118]]
initial and maintenance margin levels for unhedged security futures
that are significantly lower than the 20% margin level for unhedged
exchange-traded equity options held outside a Portfolio Margin Account
as well as the 15% margin level for unhedged exchange-traded equity
options held in a Portfolio Margin Account.
---------------------------------------------------------------------------
\76\ See 2002 Adopting Release, 67 FR at 53156-61.
---------------------------------------------------------------------------
For these reasons, implementing a risk model approach to calculate
margin for security futures would be inconsistent with how margin is
calculated for exchange-traded equity options at this time and may
result in margin levels for unhedged security futures positions that
are lower than the lowest level of margin applicable to unhedged
exchange-traded equity options (i.e., 15%). Consequently, because no
exchange-traded equity options are subject to risk-based margin
requirements, adopting a risk model approach at this time for security
futures would conflict with the requirements of Section 7(c)(2)(B) of
the Exchange Act that: (1) The margin requirements for security futures
must be consistent with the margin requirements for comparable options
traded on any exchange registered pursuant to Section 6(a) of the
Exchange Act; and (2) the initial and maintenance margin levels must
not be lower than the lowest level of margin, exclusive of premium,
required for any comparable exchange-traded options.\77\
---------------------------------------------------------------------------
\77\ In this adopting release, the Commissions are considering
OneChicago's proposed alternative risk model approach for margining
security futures. However, as the discussion herein reflects, this
alternative is not a viable one because the Commissions are not
persuaded that it would satisfy the requirements of Section
7(c)(2)(B) of the Exchange Act at this time.
---------------------------------------------------------------------------
To address the conflict between a risk model approach and Section
7(c)(2)(B) of the Exchange Act, OneChicago argued that the Commissions
could adopt a risk model approach because Section 7(c)(2)(B) of the
Exchange Act can be read to require that the level of protection
provided to the marketplace by the margin requirements for security
futures must be consistent with the level of protection provided by the
margin requirements for exchange-traded options.\78\ Similarly,
OneChicago argued that the statute can be construed to require that the
level of protection provided by the margin requirements for security
futures (rather than the margin levels) must not be lower than the
lowest level of protection provided by the margin requirements for
exchange-traded options.
---------------------------------------------------------------------------
\78\ See OneChicago Letter at 30-35.
---------------------------------------------------------------------------
OneChicago pointed out that Section 7(c)(2)(B)(iii)(I) of the
Exchange Act provides that ``margin requirements'' for a security
future product must be consistent with the margin requirements for
comparable option contracts traded on any exchange registered under the
Exchange Act. OneChicago further noted that Section 7(c)(2)(B)(iv) of
the Exchange Act also uses the phrase ``margin requirements'' but then
qualifies it by excluding ``levels of margin'' from its provisions
regarding consistency with Regulation T. Thus, OneChicago concluded
that the phrase ``margin requirements'' in Section 7(c)(2)(B)(iii)(I)
of the Exchange Act can be read to mean all aspects of margin
requirements, including margin levels and the type, form, and use of
collateral for security futures products.
OneChicago also argued that futures-style margining includes daily
pay and collect variation margining, and options-style margining--in
its view--does not include variation margining.\79\ Consequently,
OneChicago believed that, if Section 7(c)(2)(B)(iii)(I) of the Exchange
Act is read to relate to levels of margin, the Commissions would be
required to implement a daily pay and collect variation margin feature
for options (or to eliminate this feature from the security futures
margin requirements) in order to achieve the consistency required by
the statute. OneChicago argued that this does not make sense and,
therefore, the better reading of the statute is that it requires the
level of protection provided by the security futures margin
requirements to be consistent with and not lower than the lowest level
of protection provided by the margin requirements for comparable
exchange-traded options. And, according to OneChicago, in analyzing the
level of protection provided by futures-style margining, the
Commissions can consider the daily pay and collect variation margin
feature to find that a risk model approach to calculating margin would
be consistent with Section 7(c)(2)(B)(iii) of the Exchange Act.
---------------------------------------------------------------------------
\79\ For purposes of this discussion, the Commissions understand
the phrase ``futures-style margining'' to refer to initial margin
requirements based on the use of risk models, as well as the daily
settlement of variation margin based on marking open positions to
market. ``Options-style margining'' will refer to initial and
maintenance margin requirements for exchange-traded equity options
under the Exchange Act.
---------------------------------------------------------------------------
The Commissions agree with OneChicago that the phrase ``margin
requirements'' in Section 7(c)(2)(B)(iii)(I) of the Exchange Act refers
to all aspects of margin requirements, including margin levels and the
type, form, and use of collateral for security futures products.
However, the Commissions do not agree that the ``consistent with'' and
``not lower than'' restrictions in the statute do not apply to levels
of margin. Section 7(c)(2)(B)(iii)(II) of the Exchange Act states, in
pertinent part, that ``initial and maintenance margin levels for a
security future product [must] not be lower than the lowest level of
margin, exclusive of premium, required for any comparable option
contract traded on any exchange'' registered under the Exchange Act
(emphasis added).\80\
---------------------------------------------------------------------------
\80\ The prefatory text of Sections 7(c)(2)(B)(iii)(I) and (II)
of the Exchange Act also uses the term ``levels of margin.'' In
particular, it provides that the Federal Reserve Board or the
Commissions, pursuant to delegated authority, shall prescribe
``regulations to establish margin requirements, including the
establishment of levels of margin (initial and maintenance) for
security futures products under such terms, and at such levels,'' as
the Federal Reserve Board or the Commissions deem appropriate
(emphasis added).
---------------------------------------------------------------------------
Moreover, the legislative history of the CFMA includes an earlier
bill.\81\ In that earlier bill, the provisions governing the setting of
margin requirements for security futures did not include the
``consistent with'' and ``not lower than'' restrictions in Sections
7(c)(2)(B)(iii)(I) and (II) of the Exchange Act, respectively.\82\
Instead, the earlier bill would have required that the margin
requirements for security futures must ``prevent competitive
distortions between markets offering similar products.'' \83\ The
Senate Report on the earlier bill explained that ``[u]nder the bill,
margin levels on [security future] products would be required to be
harmonized with the options markets.'' \84\ Thus, while the text of the
earlier bill was not as explicit in terms of articulating the
``consistent with'' and ``not lower than'' restrictions, the Senate
Report indicates that the objective was to harmonize margin levels
between security futures and options to prevent competitive
distortions. This objective was clarified in the text of Section
7(c)(2)(B) of the Exchange Act, as enacted. In light of this statutory
text and the legislative history, the best reading of the statute is
that the ``consistent with'' and ``not lower than'' restrictions apply
to levels of margin.
---------------------------------------------------------------------------
\81\ See S. Report 106-390 (Aug. 25, 2000).
\82\ See id. at 39-40.
\83\ Id. at 39.
\84\ Id. at 5 (emphasis added).
---------------------------------------------------------------------------
Consequently, the levels of margin for unhedged security-futures
must be consistent with the margin levels for comparable unhedged
exchange-traded equity options, and not lower than the lowest level of
margin for comparable unhedged exchange-traded equity options.
Currently, the margin levels for comparable unhedged exchange-traded
[[Page 75119]]
equity options are determined through a percent of a value. Therefore,
using a risk model approach for security futures would be inconsistent
with how margin levels are currently determined for comparable
exchange-traded equity options. Further, at this time, the lowest level
of margin for comparable unhedged exchange-traded equity options is
15%. Accordingly, the margin levels for unhedged security futures
cannot be lower than 15%.
OneChicago also cited legislative history to support its reading of
the statute.\85\ First, OneChicago cited statements that it believed
demonstrated that ``Congress intended to prevent the market for
security futures from being ceded to overseas competitors'' and that
``Congress wanted to ensure that U.S. exchanges had the potential to
compete with these product offerings in overseas markets.'' \86\
However, these statements do not bear on whether Sections
7(c)(2)(B)(iii)(I) and (II) of the Exchange Act apply to levels of
margin. Rather, if OneChicago's view of Congressional intent is
correct, it would support the notion that the CFMA was designed to
establish a U.S. market for security futures to compete with overseas
markets.\87\ Further, Sections 7(c)(2)(B)(iii)(I) and (II) require a
comparison of security futures margin requirements to U.S. exchange-
traded option margin requirements--not to requirements of overseas
security futures markets. For these reasons, these statements do not
support OneChicago's reading of the statute or conflict with the
Commissions' reading of the statute.
---------------------------------------------------------------------------
\85\ OneChicago Letter at 30-32.
\86\ OneChicago Letter at 30. The Commissions address comments
relating to the competition with foreign securities markets in
section IV below (including the CFTC's consideration of the costs
and benefits of the amendments and the SEC's economic analysis,
including costs and benefits, of the amendments).
\87\ The CFMA ended the prohibition on trading security futures
in the United States at a time when this product was traded in
overseas markets.
---------------------------------------------------------------------------
Second, OneChicago cited statements that it believed demonstrated
``[t]here was concern, especially from options industry participants
that [security futures] would directly compete with options and
Congress wanted to make sure that participants did not migrate between
futures and options for regulatory reasons'' and that ``Congress wanted
to avoid regulatory arbitrage.'' \88\ It cited the following statements
in support of this view:
---------------------------------------------------------------------------
\88\ OneChicago Letter at 30.
[T]he bill requires that margin treatment of stock futures must
be consistent with the margin treatment for comparable exchange-
traded options. This ensures that margin levels will not be set
dangerously low and that stock futures will not have an unfair
competitive advantage vis-a-vis stock options.\89\
---------------------------------------------------------------------------
\89\ See 146 Cong. Rec. H12497 (daily ed. Dec. 15, 2000)
(Commodity Futures Modernization Act of 2000, speech of Rep.
Dingell, Dec. 15, 2000) (emphasis added).
---------------------------------------------------------------------------
Our bill would also provide for joint jurisdiction with each
agency maintaining its core authorities over the trading of single-
stock users. The legislation would further require that margin
levels on these products be harmonized with the options market.\90\
---------------------------------------------------------------------------
\90\ See S. 2697--The Commodity Futures Modernization Act of
2000, Joint Hearing Before the Committee on Agriculture, Nutrition,
and Forestry United States Senate and the Committee on Banking,
Housing, and Urban Affairs, (June 21, 2000) (``Senate Hearing'') at
3, statement of Sen. Lugar (emphasis added).
---------------------------------------------------------------------------
The SEC has always been charged with protecting investors and
providing full and fair disclosure of corporate market information
and preventing fraud and manipulation. The CFTC regulates commercial
and professional hedging and speculation in an institutional
framework. CFTC cannot regulate insider trading. Margin requirements
are different. I hate to see investors shopping as to which
instrument to use or to buy for that reason. So neither regulation
nor the lack of it should pick winners and losers among products or
exchanges and fair competition should.\91\
---------------------------------------------------------------------------
\91\ See Senate Hearing at 28, statement of Sen. Schumer.
OneChicago argued that these statements indicated that ``[b]ill
sponsors made a point to emphasize that they wanted market forces and
not margin levels to determine winners and losers'' and that ``[m]argin
needed to be set at a level that prevented it from impacting a market
participant's decision on what products to trade.'' \92\ However, the
Congressional concerns and statements identified by OneChicago--that
security futures should not have an unfair competitive advantage over
exchange-traded options--support a reading of Sections
7(c)(2)(B)(iii)(I) and (II) of the Exchange Act that is consistent with
the approach the Commissions are adopting here, namely that the margin
levels for security futures must be consistent with and not lower than
the lowest level of margin for comparable exchange-traded options.
---------------------------------------------------------------------------
\92\ OneChicago Letter at 30-31.
---------------------------------------------------------------------------
Contrary to OneChicago's view, the statute does not provide a
mechanism that would permit the Commissions to recalibrate margin
requirements for security futures to foster greater use of the product.
Rather, it contains restrictions that were designed to ensure that the
margin requirements for these products were consistent with the margin
requirements for comparable exchange-traded options, and not lower than
the lowest level of margin for comparable exchange-traded options. This
reading of the statute is supported by the following statement from the
legislative history of the CFMA that OneChicago did not cite:
A provision in the bill directs that initial and maintenance
margin levels for a security future product shall not be lower than
the lowest level of margin, exclusive of premium, required for any
comparable option contract traded on any exchange registered
pursuant to section 6(a) of the Exchange Act of 1934. In that
provision, the term lowest is used to clarify that in the potential
case where margin levels are different across the options exchanges,
security future product margin levels can be based off the margin
levels of the options exchange that has the lowest margin levels
among all the options exchanges. It does not permit security future
product margin levels to be based on option maintenance margin
levels. If this provision were to be applied today, the required
initial margin level for security future products would be 20
percent, which is the uniform initial margin level for short at-the
money equity options traded on U.S. options exchanges.\93\
---------------------------------------------------------------------------
\93\ See 146 Cong. Rec. E1879 (daily ed. Oct. 23, 2000)
(Commodity Futures Modernization Act of 2000, speech of Rep. Markey,
Oct. 19, 2000) (emphasis added). As discussed above, the Commissions
implemented the CFMA establishing 20% initial and maintenance margin
levels for security futures.
Further, implementing a risk model approach in order to lower the
margin requirements to levels in the way OneChicago suggested could
create an incentive for market participants to trade security futures,
if security futures trading resumes, rather than exchange-traded
options precisely because of the more favorable margin treatment.
Based on the text of Section 7(c)(2)(B) of the Exchange Act and the
legislative history (including the legislative history cited by
OneChicago), the better reading of the statute is that it applies to
levels of margin, and requires that initial and maintenance margin
levels for security futures be: (1) Consistent with margin levels for
comparable exchange-traded options; and (2) not lower than the lowest
level of margin for comparable exchange-traded options. Currently, the
lowest level of margin for an unhedged exchange-traded equity option is
15%. Consequently, a 15% margin level is the lowest level of margin
permitted for an unhedged security future.\94\
---------------------------------------------------------------------------
\94\ OneChicago argued that the Commissions could compare
unhedged security futures to unhedged long option positions. See
OneChicago Letter at 35. In its view, the initial and maintenance
margin requirement for a long option is 0% and, therefore, a margin
level for security futures that is lower than 15% would be
appropriate. As discussed earlier, the margin level is 75% for
certain long unhedged options with maturities greater than 9 months.
However, this margin requirement relates to financing the purchase
of a long option position. Unlike the case with an unhedged short
option, the margin does not serve as a performance bond to secure
the customer's obligations if the option is assigned to be
exercised. Initial margin for a security future serves as a
performance bond. See, e.g., OneChicago Letter at 4. Long options
that do not meet the requirements to be subject to the 75% margin
level must be paid in full. Thus, from a financing perspective, they
have a 100% margin requirement (i.e., they cannot be purchased
through an extension of credit by the broker-dealer). For these
reasons, the margin requirements for unhedged long exchange-traded
options are not comparable to the margin requirements for security
futures.
---------------------------------------------------------------------------
[[Page 75120]]
OneChicago argued further that ``the margins have not been
harmonized and are not consistent'' because security futures ``have
variation pay/collect while options do not, which makes a strict
comparison of initial margin percentages inappropriate.'' \95\
OneChicago stated that the concept of daily variation margin plays a
critical role in the margin framework for security futures, and it
believed that the failure to take variation margin into account biases
the Commissions' margin rule against security futures.\96\ OneChicago
believed that variation margin rather than minimum initial and
maintenance margin levels more effectively protects customers.\97\
OneChicago argued that ``the level of initial and maintenance margin
should be considered not lower than comparable options when it provides
a level of protection against default that is not lower than comparable
options'' and that this ``reading would support the Commissions
considering variation margin when looking at the appropriate level of
initial margin.'' \98\
---------------------------------------------------------------------------
\95\ OneChicago Letter at 31.
\96\ OneChicago at 4-5; OneChicago Letter 2 at 5-6.
\97\ OneChicago Letter at 7.
\98\ OneChicago Letter at 34.
---------------------------------------------------------------------------
The Commissions, when adopting the margin requirements for security
futures in 2002, modified the proposal to incorporate the concept of
daily pay and collect variation margining into the final rules.\99\
Variation settlement is any credit or debit to a customer account, made
on a daily or intraday basis, for the purpose of marking-to-market a
security future issued by a clearing agency or cleared and guaranteed
by a DCO.\100\ Therefore, in prescribing the required initial and
maintenance margin levels for security futures, the Commissions' rules
also account for daily variation margining.\101\
---------------------------------------------------------------------------
\99\ See CFTC Rules 41.43(a)(32), 41.46(c)(1)(vi) and
(c)(2)(iii), and 41.47(b)(1), and SEC Rules 401(a)(32),
404(c)(1)(vi) and (c)(2)(iii), and 405(b)(1).
\100\ See CFTC Rule 41.43(a)(32) and SEC Rule 401(a)(32).
\101\ See 2002 Adopting Release, 67 FR at 53157. See also FRB
Letter (``The authority delegated by the Board is limited to
customer margin requirements imposed by brokers, dealers, and
members of national securities exchanges. It does not cover
requirements imposed by clearing agencies on their members.'') and
2019 Proposing Release, 84 FR at 36435 at n.6 (describing variation
settlement and maintenance margin).
---------------------------------------------------------------------------
The variation margin component of the futures and security futures
margining regimes settles the mark-to-market gains or losses on the
positions on a daily basis with FCMs collecting payments from their
customers and DCOs collecting payments from FCMs. The margin
requirements for exchange-traded equity options also account for daily
mark-to-market gains or losses on an option position. In particular,
margin rules for exchange-traded equity options require that a customer
maintain a minimum level of equity in the account (i.e., an amount that
equals or exceeds the maintenance margin requirement). A mark-to-market
gain will increase account equity and a loss will decrease account
equity potentially generating a requirement for the customer to post
additional collateral to maintain the minimum account equity
requirement (i.e., the maintenance margin requirement). In this way,
the margin requirements for exchange-traded equity options cover the
broker-dealer's exposure to the credit risk that arises when the
customer's position incurs a mark-to-market loss, just as daily pay and
collect variation margining protects the security futures intermediary.
Further, if a customer's security futures position has a mark-to-
market gain, the clearing agency or DCO will pay the amount of the gain
to the security futures intermediary. This is the pay feature of
futures-style variation margining. However, if that variation margin
payment remains in the customer's account at the security futures
intermediary, the customer continues to have credit risk exposure to
the intermediary. Similarly, if a customer's exchange-traded equity
option has a mark-to-market gain that results in the account having
equity above the maintenance margin requirement, the customer will have
credit exposure to the broker-dealer with respect to the excess equity
in the account.
For these reasons, the Commissions do not believe that the
variation margin requirements for futures and security futures are a
unique feature that is absent from the margin requirements for
exchange-traded options insomuch as both requirements address mark-to-
market changes in the value of the positions.\102\ Further, there is no
basis to conclude that the variation settlement process for security
futures when coupled with a risk model approach to calculating required
initial and maintenance margin levels for security futures would be
consistent with the margin requirements for exchange-traded equity
options. The margin requirements for exchange-traded equity options
also account for changes in the mark-to-market value of the options,
but they do not use risk models to calculate initial and maintenance
margin levels.
---------------------------------------------------------------------------
\102\ See, e.g., SEC, Self-Regulatory Organizations;
Philadelphia Stock Exchange, Inc.; Order Approving Proposed Rule
Change and Amendments Thereto, Exchange Act Release No. 22189 (June
28, 1985) at n.10 (``Maintenance margin in the securities industry
and variation margin in the commodities industry are basically
intended to serve the same purposes'').
---------------------------------------------------------------------------
Moreover, as acknowledged by OneChicago, a risk model approach to
calculating required initial and maintenance margin levels for unhedged
security futures could result in margin levels that are significantly
lower than the 20% margin level for exchange-traded equity options held
outside a Portfolio Margin Account as well as the 15% margin level for
exchange-traded equity options held inside a Portfolio Margin
Account.\103\ Consequently, given the ``not lower than restriction'' of
Section 7(c)(2)(B)(iii)(II) of the Exchange Act, it would not be
appropriate to set initial and maintenance margin levels for security
futures using a risk model approach insofar as exchange-traded equity
options are not permitted to rely upon a risk model approach.
---------------------------------------------------------------------------
\103\ See, e.g., OneChicago Letter at 1 and 14.
---------------------------------------------------------------------------
As an alternative to the statutory construction argument discussed
above, OneChicago stated that ``the Commissions can recognize that the
concern at the time of the CFMA, that options and [security futures]
would trade interchangeably, was unfounded as options and [security
futures] are not comparable products.'' \104\ Consequently, Section
7(c)(2)(B)(iii)--in OneChicago's view--``was written into the Exchange
Act in case the products proved comparable; because they have proven to
not be comparable, it no longer needs to bind upon financial markets.''
\105\ Relatedly, OneChicago also argued that there are no exchange-
traded options that are comparable to security futures and, therefore,
the ``consistent with'' and ``not lower than'' restrictions of Section
7(c)(2)(B)(iii) of the Exchange Act are not implicated.
---------------------------------------------------------------------------
\104\ See OneChicago Letter at 35.
\105\ Id.
---------------------------------------------------------------------------
The Commissions stated a preliminary belief when proposing the
reduction of the required margin levels from 20% to 15% that an
unhedged
[[Page 75121]]
security future was comparable to an unhedged exchange-traded equity
option held in a Portfolio Margin Account.\106\ This belief was
grounded on the Commissions' view--when adopting the margin
requirements for security futures--that an unhedged short at-the-money
exchange-traded equity option is comparable to a security future.\107\
---------------------------------------------------------------------------
\106\ See 2019 Proposing Release, 84 FR at 36435, 36438-40.
\107\ See 2002 Adopting Release, 67 FR at 53157; 2001 Proposing
Release 66 FR at 50725-26.
---------------------------------------------------------------------------
OneChicago stated that security futures products are not comparable
to exchange-traded equity options because the latter have different
risk profiles than security futures, including dividend risk, pin risk,
and early assignment risk.\108\ Further, OneChicago stated that
security futures are used for different purposes than exchange-traded
equity options.\109\ In this regard, OneChicago noted that security
futures are delta one derivatives used in equity finance transactions
and that they compete with other delta one transactions such as total
return swaps, master security lending agreements, and master security
repurchase agreements.\110\ OneChicago commented that equity financing
transactions can be used to provide customers with synthetic (long)
exposure to a notional amount of a security, while the financing
counterparty pre-hedges the position by accumulating an equivalent
position in the underlying shares.\111\
---------------------------------------------------------------------------
\108\ OneChicago Letter at 2, 9; OneChicago Letter 2 at 1-2.
\109\ OneChicago Letter at 2-3.
\110\ Delta one derivatives are financial instruments with a
delta that is close or equal to one. Delta measures the rate of
change in a derivative relative to a unit of change in the
underlying instrument. Delta one derivatives have no optionality,
and therefore, as the price of the underlying instrument moves, the
price of the derivative is expected to move at, or close to, the
same rate. See also 2019 Proposing Release, 84 FR 36435, at n.14.
\111\ OneChicago Letter at 2.
---------------------------------------------------------------------------
OneChicago also provided statistical data and analysis to support
its contention that security futures are not comparable to exchange-
traded equity options.\112\ In particular, OneChicago provided
statistical data comparing trade size (number of contacts and notional
value) between options and security futures and comparing security
futures delivery rates with options exercise rates.\113\ OneChicago
stated that the delivery data makes ``clear'' that the ``markets view
and use the products differently.'' \114\ OneChicago also provided
statistical data on correlations between open interest in security
futures and equity options.\115\ OneChicago stated that the data
results show no correlation between changes in open interest in
security futures and options.\116\
---------------------------------------------------------------------------
\112\ The Commissions address the statistical data and analysis
provided by OneChicago in more detail in section IV of this release.
In addition to the statistical data and analysis discussed below,
OneChicago provided statistical data and analysis on possible
correlations between changes in price of the underlying security and
changes in trading activity in security futures and equity options
(i.e., sensitivity to underlying price moves). OneChicago Letter 3
at 12-13. OneChicago stated that the results of this analysis were
ambiguous. OneChicago Letter 3 Summary at 1.
\113\ OneChicago Letter 3 at 9-11.
\114\ OneChicago Letter 3 Summary at 1.
\115\ OneChicago Letter 3 at 14-15.
\116\ OneChicago Letter 3 Summary at 1.
---------------------------------------------------------------------------
After considering these comments, the Commissions note that under
Section 7(c)(2)(b)(iii)(I) of the Exchange Act, customer margin
requirements for security futures must be consistent with the margin
requirements for comparable exchange-traded options. The Commissions
recognize that security futures may not be identical to exchange-traded
equity options and that there are differences between the products in
terms of their risk characteristics and how they are used by market
participants. However, the Commissions continue to believe that the
approach taken in this release, with respect to margin levels, is sound
because these products generally share similar risk profiles for
purposes of assessing margin insofar as both products provide exposure
to an underlying equity security or narrow-based equity security
index.\117\ Thus, both products can be used to hedge a long or short
position in the underlying equity security or narrow-based equity
security index. Each product also can be used to speculate on a
potential price movement of the underlying equity security or narrow-
based equity security index. Consequently, a financial intermediary's
potential exposure to a customer's unhedged security future or unhedged
exchange-traded equity option position is based on the market risk
(i.e., price volatility) of the underlying equity security or narrow-
based equity security index.
---------------------------------------------------------------------------
\117\ Derivatives may be broadly described as instruments or
contracts whose value is based upon, or derived from, some other
asset or metric. See also Risk Disclosure Statement for Security
Futures Contracts, available at https://www.nfa.futures.org/members/member-resources/files/security-futures-disclosure.pdf and
Characteristics and Risks of Standardized Options, available at
https://www.theocc.com/about/publications/character-risks.jsp.
---------------------------------------------------------------------------
In addition, both short security futures positions and certain
exchange-traded options strategies produce unlimited downside risk.
Investors in security futures and writers of options may lose their
margin deposits and premium payments and be required to pay additional
funds. In addition, a very deep-in-the money call or put option on the
same security (with a delta of one) is an option contract comparable to
a security futures contract. Further, as discussed above, one commenter
contends that synthetic futures strategies are an important segment of
today's options markets, that could compete with security futures, if
trading in security futures resumes.
The margin requirements for security futures and short unhedged
exchange-traded equity options are designed to ensure that the customer
can perform on the contractual obligations imposed by these products.
For these reasons, security futures and short exchange-traded equity
options can be appropriately considered to be comparable products for
the purposes of setting appropriate margin levels for security futures
consistent with the provisions of Section 7(c)(2)(B) of the Exchange
Act.\118\ OneChicago also argued that the Commissions should compare
the customer margin requirements for security futures with the margin
requirements for over-the-counter total return swaps, equity index
futures, and security futures traded overseas.\119\ In response,
Section 7(c)(2)(B) of the Exchange Act provides that the margin
requirements for security futures must be consistent with the margin
requirements for comparable options traded on any exchange registered
pursuant to Section 6(a) of the Exchange Act. The statute does not
directly contemplate comparisons with the margin requirements for the
products and markets identified by OneChicago. Rather, it requires
comparisons to comparable exchange-traded options.
---------------------------------------------------------------------------
\118\ See 2019 Proposing Release, 84 FR at 36436.
\119\ OneChicago Letter at 11.
---------------------------------------------------------------------------
In this context, an unhedged security future is comparable to an
unhedged exchange-traded equity option held in a Portfolio Margin
Account for the purposes of setting margin requirements under Section
7(c)(2)(B) of the Exchange Act.
As an alternative to implementing a risk model approach for all
security futures, OneChicago suggested implementing it on a more
limited basis for security futures combinations that result in STARS
transactions.\120\ A STARS transaction combines two security futures to
form a spread position. The front leg of the spread expires on the date
of the STARS
[[Page 75122]]
transaction and the second (or back) leg expires at a distant date.
OneChicago believed that a STARS transaction would be a substitute for
an equity repo or stock loan transaction with the transfer of stock and
cash accomplished through a security future transaction.\121\
OneChicago suggested that it would be appropriate to margin STARS
transactions at risk-based levels since they are exclusively used for
equity finance transactions.\122\ OneChicago also argued that risk-
based margin treatment for a STARS transaction would be consistent with
the Exchange Act and argued that there are no comparable options that
trade as a spread on a segregated platform and no combinations of
options can replicate the mechanics of a STARS transaction.\123\
---------------------------------------------------------------------------
\120\ OneChicago Letter at 19; see also Memorandum from the
Division of Trading and Markets regarding a July 16, 2019, meeting
with representatives of OneChicago (July 29, 2019).
\121\ OneChicago Letter at 19-20. OneChicago noted that the
expiration of the front leg results in a transfer of securities for
cash on the next business day following the trade date (T+1). When
the back leg expires, OneChicago noted that a reversing transaction
takes place that returns both parties to their original positions.
OneChicago Letter at 19.
\122\ OneChicago Letter at 19-20.
\123\ OneChicago Letter at 36.
---------------------------------------------------------------------------
The Commissions note that OneChicago has discontinued trading
operations and is no longer offering STARS transactions. However,
combining security futures into a STARS transaction does not change the
fundamental nature of the security futures involved in the
transaction--they remain security futures. In addition, as noted above,
the front leg of the spread expires on the date of the STARS
transaction, leaving only a single security future position in the
customer's account until the expiration of the back leg at a later
date. Consequently, for the reasons discussed above, it would not be
consistent with Section 7(c)(2)(B) of the Exchange Act to implement a
risk margin approach for security futures that are combined to create a
STARS transaction.
To summarize, the Commissions are not persuaded by OneChicago's
arguments that, at this time, implementing a risk model approach to
calculating margin for security futures would be permitted under
Section 7(c)(2)(B) of the Exchange Act. Moreover, implementing a risk
model approach would substantially alter how the required minimum
initial and maintenance margin levels for security futures are
calculated. It also would be a significant deviation from how margin is
calculated for listed equity options and other equity positions (e.g.,
long and short securities positions). It would not be appropriate at
this time to implement a different margining system for security
futures, given their relation to products that trade in the U.S. equity
markets. Implementing a different margining system for security futures
may result in substantially lower margin levels for these products as
compared with other equity products and could have unintended
competitive impacts.\124\ For these reasons, even if the Commissions
were persuaded at this time that OneChicago's interpretation was
permitted by the statute, the Commissions would not agree that it was
the appropriate interpretation.
---------------------------------------------------------------------------
\124\ See sections IV.A.6. (CFTC--Discussion of Alternatives)
and IV.B.5. (SEC--Reasonable Alternatives Considered) (each
discussing the use of risk-based margin models as an alternative to
the final rule amendments in this release).
---------------------------------------------------------------------------
Consequently, the Commissions are adopting the amendments to reduce
the required initial and maintenance margin levels for an unhedged
security futures position from 20% to 15%, as proposed.\125\
---------------------------------------------------------------------------
\125\ The Commissions continue to believe that these
amendments--because they relate to levels of margin--do not
implicate the requirement in Section 7(c)(2)(B)(iv) of the Exchange
Act that margin requirements for security futures (other than levels
of margin), including the type, form, and use of collateral, must be
consistent with the requirements of Regulation T. The Commissions
did not receive any comments objecting to this view.
---------------------------------------------------------------------------
The Commissions' margin requirements continue to permit SRAs and
security futures intermediaries to establish higher margin levels and
to take appropriate action to preserve their financial integrity.\126\
OneChicago advocated for two modifications to this provision of the
margin rules for security futures.\127\ First, it suggested that only
exchanges and clearinghouses that list and clear security futures
products be given the authority to set higher margin levels, because
they control the margin levels and thus the competitiveness of the
competing venues.\128\ In support of this suggestion, it identified an
exchange that has prescribed 20% margin levels for security futures
even though it does not list any security futures.\129\ Relatedly,
OneChicago recommended that the Commissions require that margin levels
be set higher than the proposed 15% minimum level if justified by the
risk of the security future and noted that while one SRA might set
higher levels based on risk, another SRA may maintain the 15%
levels.\130\
---------------------------------------------------------------------------
\126\ See CFTC Rule 41.42(c)(1) and SEC Rule 400(c)(1). See 2019
Proposing Release, 84 FR at 36440.
\127\ OneChicago Letter at 17.
\128\ OneChicago Letter at 17.
\129\ The NYSE has rules related to margin levels for security
futures, but it does not list any security futures.
\130\ OneChicago Letter at 17.
---------------------------------------------------------------------------
After considering these comments, the Commissions are not
incorporating OneChicago's suggested modifications regarding
establishing higher margin levels. The security futures margin rules
establish minimum levels and do not set any limitations as to maximum
levels. SRAs, including clearinghouses, and security futures
intermediaries are permitted to raise margin requirements above 15% if
justified by the risk of a security futures position. In addition,
security futures intermediaries also are subject to rules that require
them to raise margin requirements where appropriate to manage credit
risk in customer accounts.\131\ These rules provide SRAs and security
futures intermediaries important flexibility to manage risk as they
deem appropriate, including the ability to increase margin requirements
for specific positions or customer accounts. Limiting the ability to
increase margin requirements only to exchanges and clearinghouses that
list and clear security futures would be inconsistent with this
approach. For these reasons, it would not be appropriate to modify the
provisions in the security futures margin requirements permitting SRAs
and security futures intermediaries to set higher margin levels as
suggested by OneChicago.
---------------------------------------------------------------------------
\131\ See e.g., FINRA Rule 4210(d) which requires FINRA members
to establish procedures to: (1) Review limits and types of credit
extended to all customers; (2) formulate their own margin
requirements; and (3) review the need for instituting higher margin
requirements, mark-to-markets and collateral deposits than are
required by FINRA's margin rule for individual securities or
customer accounts; see also FINRA Rule 4210(f)(8) (providing
authority for FINRA, if market conditions warrant, to implement
higher margin requirements). See e.g., 17 CFR 1.11 (CFTC Rule 1.11)
(requiring FCMs to establish risk management programs that address
market, credit, liquidity, capital and other applicable risks,
regardless of the type of margining offered). See also National
Futures Association (``NFA'') Rule 2-26 FCM and IB Regulations,
which states that any member or associate who violates CFTC Rule
1.11 (and other rules) shall be deemed to have violated an NFA
requirement.
---------------------------------------------------------------------------
B. Conforming Revisions to the Strategy-Based Offset Table
1. The Commissions' Proposal
The Commissions' rules permit an SRA to set margin levels that are
lower than 20% of the current market value of the security future in
the case of an offsetting position involving security futures and
related positions.\132\ The SRA rules must meet the four criteria set
forth in Section 7(c)(2)(B) of the Exchange Act and must be effective
in accordance with Section 19(b)(2) of the
[[Page 75123]]
Exchange Act and, as applicable, Section 5c(c) of the CEA.\133\ In
connection with these provisions governing SRA rules, the Commissions
published the Strategy-Based Offset Table.\134\
---------------------------------------------------------------------------
\132\ See CFTC Rule 41.45(b)(2) and SEC Rule 403(b)(2). See also
2002 Adopting Release, 67 FR at 53158-61.
\133\ Section 19(b)(2) of the Exchange Act governs SRA
rulemaking with respect to SEC registrants, and Section 5c(c) of the
CEA governs SRA rulemaking with respect to CFTC registrants.
\134\ See 2002 Adopting Release, 67 FR at 53158-61.
---------------------------------------------------------------------------
The Commissions stated the belief that the offsets identified in
the Strategy-Based Offset Table were consistent with the strategy-based
offsets permitted for comparable offsetting positions involving
exchange-traded options.\135\ The Commissions further stated the
expectation that SRAs seeking to permit trading in security futures
will submit to the Commissions proposed rules that impose levels of
required margin for offsetting positions involving security futures in
accordance with the minimum margin requirements identified in the
Strategy-Based Offset Table. SRAs have adopted rules consistent with
the Strategy-Based Offset Table.\136\
---------------------------------------------------------------------------
\135\ Id. at 53159.
\136\ See, e.g., FINRA Rule 4210(f)(10) and Cboe Rule 10.3(k).
---------------------------------------------------------------------------
The Commissions proposed to re-publish the Strategy-Based Offset
Table to conform it to the proposed 15% required margin levels.\137\
The re-published Strategy-Based Offset Table would incorporate the 15%
required margin levels for certain offsetting positions (as opposed to
the current 20% levels) and would retain the same percentages for all
other offsets.
---------------------------------------------------------------------------
\137\ See 2019 Proposing Release, 84 FR at 36441-36443.
---------------------------------------------------------------------------
2. Comments and the Re-Published Strategy-Based Offset Table
OneChicago recommended several changes to the Strategy-Based Offset
Table, as proposed to be revised. First, OneChicago suggested reducing
the margin requirement for ``delta-neutral'' positions from 5% to the
lower of: (1) The total calculated by multiplying $0.375 for each
position by the instrument's multiplier, not to exceed the market value
in the case of long positions, or (2) 2% of the current market value of
the security futures contract.\138\ These recommended changes would not
be appropriate. The 5% requirement was based on the minimum margin
required by rules of securities SROs for offsetting long and short
positions in the same security.\139\ The 5% margin requirement for this
strategy continues to exist in current securities SRO rules.\140\
Accordingly, lowering the requirement as recommended by OneChicago
would not be consistent with Section 7(c)(2)(B) of the Exchange Act.
---------------------------------------------------------------------------
\138\ OneChicago Letter at 15. This recommendation would apply
to items 4, 10, 13, 17, 18, and 19 in the Strategy-Based Offset
Table, as proposed to be revised. See 2019 Proposing Release, 84 FR
at 36441-43.
\139\ See 2002 Adopting Release, 67 FR at 53158, n.187.
\140\ See, e.g., FINRA Rule 4210(e)(1).
---------------------------------------------------------------------------
OneChicago also requested that the Commissions incorporate total
return equity swaps into the Strategy-Based Offset Table.\141\
OneChicago stated that total return equity swaps are an exact
substitute for security futures. OneChicago did not specify whether it
was referring to cleared or non-cleared total return equity swaps. In
either case, it would not be appropriate to include them in the
Strategy-Based Offset Table. Securities SRO margin rules for options do
not, at this time, recognize offsets involving these products.
Therefore, adding them to the Strategy-Based Offset Table would not be
consistent with Section 7(c)(2)(B) of the Exchange Act.
---------------------------------------------------------------------------
\141\ OneChicago Letter at 16.
---------------------------------------------------------------------------
OneChicago further requested that offset positions margined at 10%
should be lowered to 7.5% to mirror the magnitude of the reduction of
minimum required margin levels from 20% to 15% for unhedged security
futures.\142\ This would make the margin requirements for offsets
recognized in the Strategy-Based Offset Table lower than offsets for
exchange-traded options currently permitted by securities SRO margin
rules. Therefore, modifying the Strategy-Based Offset Table in this
manner would not be consistent with Section 7(c)(2)(B) of the Exchange
Act.
---------------------------------------------------------------------------
\142\ OneChicago Letter at 16. The reduction in margin from 10%
to 7.5% would apply to items 2, 8, 9, 11,12 14, 15 and 16 in the
Strategy-Based Offset Table, as proposed to be revised.
---------------------------------------------------------------------------
Finally, OneChicago suggested that the Commissions could simplify
the Strategy-Based Offset Table by replacing it with an offset
rule.\143\ Under the suggested rule, offset positions would be margined
at the greater of: (1) The total calculated by multiplying $0.375 for
each position by the instrument's multiplier, not to exceed the market
value in the case of long positions; or (2) 15% of the delta exposed
portion of the portfolio. As discussed above, the Strategy-Based Offset
Table is designed to permit offsets that are consistent with offsets
recognized for comparable exchange-traded options under the securities
SRO margin rules. For the reasons discussed above, the rule suggested
by OneChicago would not be consistent with the permitted offsets for
exchange-traded options and, consequently, would not be consistent with
Section 7(c)(2)(B) of the Exchange Act.
---------------------------------------------------------------------------
\143\ OneChicago Letter at 16-17.
---------------------------------------------------------------------------
For the foregoing reasons, the Commissions are re-publishing the
Strategy-Based Offset Table with the proposed revisions.\144\ The
Commissions expect that SRAs will submit to the Commissions proposed
rules that impose levels of required margin for offsetting positions
involving security futures in accordance with the minimum margin levels
identified in the Strategy-Based Offset Table.
---------------------------------------------------------------------------
\144\ Item 1 of the revised Strategy-Based Offset Table lists
the margin percentages for a long security future and a short
security future. These percentages are the baseline, not offsets,
but they are included in the table to preserve consistency with the
earlier offset table.
----------------------------------------------------------------------------------------------------------------
Security underlying Maintenance margin
Description of offset the security future Initial margin requirement requirement
----------------------------------------------------------------------------------------------------------------
1. Long security future or short Individual stock or 15% of the current market 15% of the current market
security future. narrow-based value of the security value of the security
securities index. future. future.
2. Long security future (or basket Individual stock or 15% of the current market The lower of: (1) 10% of
of security futures representing narrow-based value of the long the aggregate exercise
each component of a narrow-based securities index. security future, plus pay price \3\ of the put
securities index \1\) and long for the long put in full. plus the aggregate put
put option \2\ on the same out-of-the-money \4\
underlying security (or index). amount, if any; or (2)
15% of the current
market value of the long
security future.
3. Short security future (or Individual stock or 15% of the current market 15% of the current market
basket of security futures narrow-based value of the short value of the short
representing each component of a securities index. security future, plus the security future, plus
narrow-based securities index aggregate put in-the- the aggregate put in-the-
\1\) and short put option on the money amount, if any. money amount, if any.\5\
same underlying security (or Proceeds from the put
index). sale may be applied.
[[Page 75124]]
4. Long security future and short Individual stock or The initial margin 5% of the current market
position in the same security (or narrow-based required under Regulation value as defined in
securities basket \1\) underlying securities index. T for the short stock or Regulation T of the
the security future. stocks. stock or stocks
underlying the security
future.
5. Long security future (or basket Individual stock or 15% of the current market 15% of the current market
of security futures representing narrow-based value of the long value of the long
each component of a narrow-based securities index. security future, plus the security future, plus
securities index \1\) and short aggregate call in-the- the aggregate call in-
call option on the same money amount, if any. the-money amount, if
underlying security (or index). Proceeds from the call any.
sale may be applied.
6. Long a basket of narrow-based Narrow-based 15% of the current market 15% of the current market
security futures that together securities index. value of the long basket value of the long basket
tracks a broad based index \1\ of narrow-based security of narrow-based security
and short a broad-based security futures, plus the futures, plus the
index call option contract on the aggregate call in-the- aggregate call in-the-
same index. money amount, if any. money amount, if any.
Proceeds from the call
sale may be applied.
7. Short a basket of narrow-based Narrow-based 15% of the current market 15% of the current market
security futures that together securities index. value of the short basket value of the short
tracks a broad-based security of narrow-based security basket of narrow-based
index \1\ and short a broad-based futures, plus the security futures, plus
security index put option aggregate put in-the- the aggregate put in-the-
contract on the same index. money amount, if any. money amount, if any.
Proceeds from the put
sale may be applied.
8. Long a basket of narrow-based Narrow-based 15% of the current market The lower of: (1) 10% of
security futures that together securities index. value of the long basket the aggregate exercise
tracks a broad-based security of narrow-based security price of the put, plus
index \1\ and long a broad-based futures, plus pay for the the aggregate put out-of-
security index put option long put in full. the-money amount, if
contract on the same index. any; or (2) 15% of the
current market value of
the long basket of
security futures.
9. Short a basket of narrow-based Narrow-based 15% of the current market The lower of: (1) 10% of
security futures that together securities index. value of the short basket the aggregate exercise
tracks a broad-based security of narrow-based security price of the call, plus
index \1\ and long a broad-based futures, plus pay for the the aggregate call out-
security index call option long call in full. of-the-money amount, if
contract on the same index. any; or (2) 15% of the
current market value of
the short basket of
security futures.
10. Long security future and short Individual stock or The greater of: 5% of the The greater of: (1) 5% of
security future on the same narrow-based current market value of the current market value
underlying security (or index). securities index. the long security future; of the long security
or (2) 5% of the current future; or (2) 5% of the
market value of the short current market value of
security future. the short security
future.
11. Long security future, long put Individual stock or 15% of the current market 10% of the aggregate
option and short call option. The narrow-based value of the long exercise price, plus the
long security future, long put securities index. security future, plus the aggregate call in the
and short call must be on the aggregate call in-the- money amount, if any.
same underlying security and the money amount, if any,
put and call must have the same plus pay for the put in
exercise price. (Conversion). full. Proceeds from the
call sale may be applied.
12. Long security future, long put Individual stock or 15% of the current market The lower of: (1) 10% of
option and short call option. The narrow-based value of the long the aggregate exercise
long security future, long put securities index. security future, plus the price of the put plus
and short call must be on the aggregate call in-the- the aggregate put out-of-
same underlying security and the money amount, if any, the-money amount, if
put exercise price must be below plus pay for the put in any; or (2) 15% of the
the call exercise price. (Collar). full. Proceeds from the aggregate exercise price
call sale may be applied. of the call, plus the
aggregate call in-the-
money amount, if any.
13. Short security future and long Individual stock or The initial margin 5% of the current market
position in the same security (or narrow-based required under Regulation value, as defined in
securities basket \1\) underlying securities index. T for the long stock or Regulation T, of the
the security future. stocks. long stock or stocks.
14. Short security future and long Individual stock or The initial margin 10% of the current market
position in a security narrow-based required under Regulation value, as defined in
immediately convertible into the securities index. T for the long security. Regulation T, of the
same security underlying the long security.
security future, without
restriction, including the
payment of money.
15. Short security future (or Individual stock or 15% of the current market The lower of: (1) 10% of
basket of security futures narrow-based value of the short the aggregate exercise
representing each component of a securities index. security future, plus pay price of the call, plus
narrow-based securities index for the call in full. the aggregate call out-
\1\) and long call option or of-the-money amount, if
warrant on the same underlying any; or (2) 15% of the
security (or index). current market value of
the short security
future.
16. Short security future, Short Individual stock or 15% of the current market 10% of the aggregate
put option and long call option. narrow-based value of the short exercise price, plus the
The short security future, short securities index. security future, plus the aggregate put in-the-
put and long call must be on the aggregate put in-the- money amount, if any.
same underlying security and the money amount, if any,
put and call must have the same plus pay for the call in
exercise price. (Reverse full. Proceeds from the
Conversion). put sale may be applied.
17. Long (short) a basket of Narrow-based 5% of the current market 5% of the current market
security futures, each based on a securities index. value of the long (short) value of the long
narrow-based securities index basket of security (short) basket of
that together tracks the broad- futures. security futures.
based index \1\ and short (long)
a broad based-index future.
18. Long (short) a basket of Individual stock and The greater of: (1) 5% of The greater of: (1) 5% of
security futures that together narrow-based the current market value the current market value
tracks a narrow-based index \1\ securities index. of the long security of the long security
and short (long) a narrow based- future(s); or (2) 5% of future(s); or (2) 5% of
index future. the current market value the current market value
of the short security of the short security
future(s). future(s).
19. Long (short) a security future Individual stock and The greater of: (1) 3% of The greater of: (1) 3% of
and short (long) an identical narrow-based the current market value the current market value
security future traded on a securities index. of the long security of the long security
different market \6\. future(s); or (2) 3% of future(s); or (2) 3% of
the current market value the current market value
of the short security of the short security
future(s). future(s).
----------------------------------------------------------------------------------------------------------------
\1\ Baskets of securities or security futures contracts replicate the securities that compose the index, and in
the same proportion.
\2\ Generally, unless otherwise specified, stock index warrants are treated as if they were index options.
\3\ ``Aggregate exercise price,'' with respect to an option or warrant based on an underlying security, means
the exercise price of an option or warrant contract multiplied by the numbers of units of the underlying
security covered by the option contract or warrant. ``Aggregate exercise price'' with respect to an index
option means the exercise price multiplied by the index multiplier.
[[Page 75125]]
\4\ ``Out-of-the-money'' amounts are determined as follows: (1) For stock call options and warrants, any excess
of the aggregate exercise price of the option or warrant over the current market value of the equivalent
number of shares of the underlying security; (2) for stock put options or warrants, any excess of the current
market value of the equivalent number of shares of the underlying security over the aggregate exercise price
of the option or warrant; (3) for stock index call options and warrants, any excess of the aggregate exercise
price of the option or warrant over the product of the current index value and the applicable index
multiplier; and (4) for stock index put options and warrants, any excess of the product of the current index
value and the applicable index multiplier over the aggregate exercise price of the option or warrant.
\5\ ``In-the-money'' amounts are determined as follows: (1) For stock call options and warrants, any excess of
the current market value of the equivalent number of shares of the underlying security over the aggregate
exercise price of the option or warrant; (2) for stock put options or warrants, any excess of the aggregate
exercise price of the option or warrant over the current market value of the equivalent number of shares of
the underlying security; (3) for stock index call options and warrants, any excess of the product of the
current index value and the applicable index multiplier over the aggregate exercise price of the option or
warrant; and (4) for stock index put options and warrants, any excess of the aggregate exercise price of the
option or warrant over the product of the current index value and the applicable index multiplier.
\6\ Two security futures are considered ``identical'' for this purpose if they are issued by the same clearing
agency or cleared and guaranteed by the same derivatives clearing organization, have identical contract
specifications, and would offset each other at the clearing level.
C. Other Matters
One commenter urged the Commissions to make clear, where
appropriate, that margin rules of general applicability do not apply to
security futures.\145\ Specifically, this commenter requested
clarification about the intersection of the security futures rules and
CFTC general margin requirements under part 39 of the CFTC's
regulations for DCOs.\146\ The commenter cited to a CFTC rule proposal
related to customer initial margin requirements as an example of a rule
of general applicability that should be addressed by the Commissions.
Earlier this year, the CFTC adopted changes to the DCO core principles,
including 17 CFR 39.13(g)(8)(ii) (CFTC Rule 39.13(g)(8)(ii)) relating
to customer initial margin requirements.\147\ As the CFTC noted in the
2019 Proposing Release \148\ and in the final rule adopting changes to
DCO core provisions,\149\ the CFTC's Division of Clearing and Risk
issued an interpretative letter in September 2012 stating that the
specific initial margin requirements under CFTC Rule 39.13(g)(8)(ii) do
not apply to security futures positions.\150\ CFTC Letter No. 12-08 is
still in effect and may be relied upon by market participants. The CFTC
believes that CFTC Letter No. 12-08 addresses the commenter's concerns,
and the CFTC will not be revising the position taken by the CFTC's
Division of Clearing and Risk in this rulemaking.
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\145\ See FIA Letter at 2.
\146\ See FIA Letter at 2; see also CFTC Letter No. 12-08 (Sept.
14, 2012); 2019 Proposing Release, 84 FR 36437, at n.40.
\147\ See Derivatives Clearing Organization General Provisions
and Core Principles, 85 FR 4800 (Jan. 27, 2020) (amending certain
CFTC regulations applicable to registered DCOs).
\148\ 2019 Proposing Release, 84 FR 36437, at n.40.
\149\ Derivatives Clearing Organization General Provisions and
Core Principles, 85 FR at 4812.
\150\ CFTC Letter No. 12-08 (Sept. 14, 2012) at 10, available at
https://www.cftc.gov/csl/12-08/download.
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III. Paperwork Reduction Act
A. CFTC
The Paperwork Reduction Act of 1995 (``PRA'') \151\ imposes certain
requirements on Federal agencies (including the CFTC and the SEC) in
connection with their conducting or sponsoring any collection of
information as defined by the PRA. The final rule amendments do not
require a new collection of information on the part of any entities
subject to these rules. Accordingly, the requirements imposed by the
PRA are not applicable to these rules.
---------------------------------------------------------------------------
\151\ 44 U.S.C. 3501 et seq.
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B. SEC
The PRA \152\ imposes certain requirements on Federal agencies
(including the CFTC and the SEC) in connection with their conducting or
sponsoring any collection of information as defined by the PRA. The
final rule amendments do not contain a ``collection of information''
requirement within the meaning of the PRA. Accordingly, the PRA is not
applicable.
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\152\ Id.
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IV. CFTC Consideration of Costs and Benefits and SEC Economic Analysis
(Including Costs and Benefits) of the Proposed Amendments
A. CFTC
1. Introduction
These final rule amendments will permit customers in security
futures to pay a lower minimum margin level for an unhedged security
futures position. The final rules set required initial margin for each
long or short position in a security future at 15% of the current
market value. In connection with this change, the Strategy-Based Offset
Table will be restated so that it is consistent with the reduction in
the minimum initial margin.
Section 15(a) of the CEA requires the CFTC to consider the costs
and benefits of its actions before promulgating a regulation under the
CEA or issuing certain orders.\153\ Section 15(a) further specifies
that the costs and benefits shall be evaluated in light of five broad
areas of market and public concern: (1) Protection of market
participants and the public; (2) efficiency, competitiveness, and
financial integrity of futures markets; (3) price discovery; (4) sound
risk management practices; and (5) other public interest
considerations. The CFTC considers the costs and benefits resulting
from its discretionary determinations with respect to the Section 15(a)
factors below. Where reasonably feasible, the CFTC has endeavored to
estimate quantifiable costs and benefits. Where quantification is not
feasible, the CFTC identifies and describes costs and benefits
qualitatively.
---------------------------------------------------------------------------
\153\ 7 U.S.C. 19(a).
---------------------------------------------------------------------------
The CFTC requested comments on all aspects of the costs and
benefits associated with the proposed rule amendments. In particular,
the CFTC requested that commenters provide data and any other
information upon which the commenters relied to reach their conclusions
regarding the CFTC's proposed considerations of costs and
benefits.\154\ The Commissions received comments that indirectly
address the costs and benefits of the proposed amendments. Relevant
portions of the comments are discussed in the analysis below.
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\154\ The CFTC sought ``estimates and views regarding the
specific costs and benefits for a security futures clearing
organization, exchange, intermediary, or trader that may result from
the adoption of the proposed rule amendment.'' 2019 Proposing
Release, 84 FR at 36446-47.
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The CFTC's consideration of costs and benefits includes a brief
description of the economic baseline against which to compare the rule
amendments, a summary of the amendments, and separate, detailed
discussions of the costs and benefits of the amendments. Then, the CFTC
examines alternatives offered by commenters. Finally, the CFTC
considers each of the section 15(a) factors under the CEA.
2. Economic Baseline
The CFTC's economic baseline for this analysis is the twenty
percent margin requirement on security futures positions that was
adopted in 2002 and exists today in CFTC Rule 41.45(b)(1), along with
the offsetting positions table under CFTC Rule 41.45(b)(2) (Strategy-
Based Offset Table). In the 2002 Adopting Release, the Commissions
finalized a set of security futures margin rules that complied with the
statutory
[[Page 75126]]
requirements under Section 7(c)(2)(B) of the Exchange Act. The rules
state that, ``the required margin for each long or short position in a
security future shall be twenty (20) percent of the current market
value of such security future.'' \155\ The rules also allow SRAs to set
margin levels lower than the 20% minimum requirement for customers with
``an offsetting position involving security futures and related
positions.'' \156\ In addition, the rules that were finalized under the
2002 Adopting Release permit certain customers to take advantage of
exclusions to the minimum margin requirement for security futures.
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\155\ CFTC Rule 41.45(b)(1), 17 CFR 41.45(b)(1). See CFTC Rule
41.43(a)(4), 17 CFR 41.43(a)(4) (defining the term ``current market
value.'').
\156\ CFTC Rule 41.45(b)(2), 17 CFR 41.45(b)(2).
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The CFTC has considered the costs and benefits of the rule
amendments as compared with the baseline of the current minimum initial
and maintenance margin levels for unhedged security futures, which is
20% of the current market value of such security future. The CFTC notes
that OneChicago, the only exchange listing security futures in the
U.S., discontinued all trading operations on September 21, 2020. At
this time, there are no security futures contracts listed for trading
on U.S. exchanges. This release considers the costs and benefits that
would occur if OneChicago were to resume operations or another exchange
were to launch security futures contracts.
3. Summary of the Final Rules
The final rules lower the required initial and maintenance margin
levels for an unhedged security futures position from 20% to 15% of the
current market value of such a security futures position. In addition,
the final rules make certain revisions to the Strategy-Based Offset
Table in line with the revised margin requirement. These amendments to
the security futures margin rules bring margin requirements for
security futures held in futures accounts, or securities accounts that
are not Portfolio Margin Accounts, into alignment with the required
margin level for unhedged security futures held in Portfolio Margin
Accounts. The final rules do not make any other changes to the security
futures margin requirement regime.
4. Description of Costs
As a general matter, the CFTC believes that if security futures
trading resumes, the final rules will reduce costs relative to existing
CFTC Rule 41.45(b)(1) because the final rules decrease the level of
margin required for an unhedged security futures position from 20% to
15%. The CFTC has determined that, because there is no security futures
trading at this time, there may be new startup costs such as
operational or technology costs associated with calculating security
futures customer margin if a new exchange were to launch security
futures trading. Such costs would be less significant for OneChicago,
if it were to resume operations, given that the infrastructure for
calculating such margin already exists and would not require major
reprogramming or changes beyond costs that would be incurred to
relaunch security futures contracts. One commenter noted that the final
rules' ``margin requirements will be simpler to administer and risk
manage for intermediaries that facilitate trading in the market, and
better aligns with customer use of these products.'' \157\ The
Commissions received no other comments regarding this cost.
---------------------------------------------------------------------------
\157\ See FIA Letter at 2.
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As set forth in the 2019 Proposing Release, the CFTC identified a
number of risk-related costs that could result from the final rules and
discusses each below.
i. Risk-Related Costs for Security Futures Intermediaries and Customers
One risk-related cost to consider, if security futures trading
resumes, is the potential cost to security futures intermediaries and
their customers that would result from a default of either an
intermediary or a customer.\158\ Reducing margin requirements for
security futures could expose security futures intermediaries and their
customers to losses in the event that margin collected is insufficient
to protect against market moves. Pursuant to the OCC's bylaws, any
security futures intermediary that is a clearing member of OCC grants a
security interest to OCC for any account it establishes and maintains,
and therefore a customer's assets may be obligated to OCC upon
default.\159\ As a result, security futures intermediaries that are
FCMs could be exposed to a loss if the 15% margin rate for security
futures is insufficient, to offset losses associated with a customer
default. However, this risk is mitigated by the fact that if the FCM
determines that a 15% margin level is insufficient to cover the
inherent risk of the customer position, the FCM has the authority to
collect additional margin from its customers, in excess of the minimum
requirement, in order to protect its financial integrity.\160\
Moreover, the FCM has an incentive to manage the risk of a customer's
default and could collect additional margin to do that.
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\158\ In this context, an intermediary default describes a
clearing member that experiences a default event under the terms of
a clearinghouse's rules and procedures. Such default events
generally include a failure to deliver funds in a timely manner
(e.g., failure to satisfy a margin call). See OCC Rule 1102(a)--
Suspension, and OCC's Clearing Member Default Rules and Procedures,
available at https://ncuoccblobdev.blob.core.windows.net/media/theocc/media/risk-management/default-rules-and-procedures.pdf.
\159\ See OCC Bylaws, Article VI--Clearance of Confirmed Trades,
Section 3--Maintenance of Accounts, Interpretations and Policies
.07, adopted September 22, 2003, available at https://www.theocc.com/components/docs/legal/rules_and_bylaws/occ_bylaws.pdf.
\160\ See CFTC Rule 41.42(c)(1); SEC Rule 400(c)(1).
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If security futures trading resumes, a similar risk-related cost
might arise where an FCM collects only the minimum margin required from
customers in order to maintain or expand its customer business, when it
has determined or should have determined that additional margin is
required to cover the inherent risk of the customer position. Lower
margin requirements might facilitate an FCM permitting its customers to
take on additional risk in their positions in order to increase
business for the FCM. Such additional risks could put the FCM at risk
if one of its customers defaulted on its payment obligations, and other
customers of the FCM could face losses if the FCM or one of its fellow
customers defaulted.
Another risk-related cost could stem from the possibility of
increased leverage among security futures customers. Customers posting
less initial margin to cover security futures positions might be able
to increase their overall market exposure and thereby increase their
leverage. Increased leverage in the security futures markets could
increase risks to overall financial stability and result in costs to
the broader financial markets insofar as security futures customers,
security futures intermediaries, and DCOs participate in financial
markets other than security futures.
As discussed in the proposal, the CFTC considered two final
potential risk-related costs (incentives for FCMs to collect less
margin and increased leverage at the customer level). The Commissions
received no comments regarding these costs. The CFTC believes these
theoretical costs are mitigated, to some degree, by regulations that
apply to security futures intermediaries that are registered as FCMs.
For example, FCMs are subject to capital requirements under CFTC
regulations,\161\ and in instances where
[[Page 75127]]
the security futures intermediary is jointly registered with the SEC as
a broker-dealer FCM, the SEC's capital rules also apply.\162\ In
addition, FCMs are required to establish a system of risk management
policies and procedures pursuant to CFTC Rule 1.11.\163\ This risk
management program is designed to incentivize the FCM to protect itself
and its customers against a variety of risks, including the risk of
inadequate margin coverage and increased leverage. The regulatory
regime to which FCMs are subject is designed to require them to fully
account for the potential future exposures of their customers' security
futures positions in the form of initial and maintenance margin.
---------------------------------------------------------------------------
\161\ See CFTC Rule 1.17, 17 CFR 1.17.
\162\ See SEC Rule 240.15c3-1, 17 CFR 240.15c3-1.
\163\ Under CFTC Rule 1.11, FCMs are required to establish risk
management programs that address market, credit, liquidity, capital
and other applicable risks, regardless of the type of margining
offered. See also NFA Rule 2-26 FCM and IB Regulations, which states
that any member or associate who violates CFTC Rule 1.11 (and other
rules) shall be deemed to have violated an NFA requirement.
---------------------------------------------------------------------------
Finally, as explained in the 2019 Proposing Release, risk-related
costs to the security futures intermediary have been further mitigated
by the fact that the vast majority of OneChicago's open interest was
held by eligible contract participants (``ECPs''), as defined in
Section 1a(18) of the CEA.\164\ OneChicago provided data to support
this statement prior to the issuance of the 2019 Proposing Release.
Generally speaking, ECPs are financial entities or individuals with
significant financial resources or other qualifications that make them
appropriate persons for certain investments.\165\ The CFTC believes
that because ECPs are well capitalized investors, they may be less
likely to default and transmit risks throughout the financial system.
According to the data provided by OneChicago, over 99% of the notional
value of OneChicago's products was held by ECPs as of March 1, 2016,
and March 1, 2017.\166\ The Commissions received no comments regarding
this data. However, the CFTC notes that an exchange that, in the
future, launches security futures may decide to market such contracts
to retail customers that are not ECPs.
---------------------------------------------------------------------------
\164\ See also CFTC Rule 1.3, 17 CFR 1.3.
\165\ For example, an individual can qualify as an ECP if the
individual has amounts invested on a discretionary basis, the
aggregate of which is in excess of: (i) $10,000,000; or (ii)
$5,000,000 if the individual also enters into an agreement,
contract, or transaction in order to manage the risk associated with
an asset owned or liability incurred, or reasonably likely to be
owned or incurred, by the individual.
\166\ The CFTC sought comments on all aspects of its
considerations of costs and benefits in the 2019 Proposing Release.
In particular, the CFTC requested data and any other information and
did not receive any comments questioning this data, or updated data
from OneChicago. As a result, the CFTC continues to refer to the
data provided by OneChicago relating to time periods in 2016 and
2017.
---------------------------------------------------------------------------
ii. Appropriateness of Margin Requirements
If security futures trading resumes, a possible risk-related cost
of lowering margin requirements for security futures is that a DCO may
not have sufficient margin on deposit to cover the potential future
exposure of cleared security futures positions. However, the risk
management expertise at security futures intermediaries and DCOs, as
well as the general applicability of CFTC Rule 39.13 to security
futures,\167\ supports the conclusion that DCOs and security futures
intermediaries will continue to manage the risks of these products
effectively even with lower minimum margin requirements.\168\
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\167\ As noted above and elsewhere, the general requirements of
CFTC Rule 39.13 (17 CFR 39.13) are applicable to security futures
intermediaries and DCOs with respect to security futures, however,
the specific provision of CFTC Rule 39.13(g)(8)(ii) relating to
customer initial margin requirements has been addressed separately
by CFTC Letter No. 12-08 and that remains unchanged by this final
rule.
\168\ As discussed above, security futures intermediaries are
authorized to collect margin above the amounts required by the
Commissions. However, if security futures trading resumes, security
futures intermediaries could be incentivized to lower their margin
rates in order to compete for customer business as for-profit
entities. If security futures intermediaries were to engage in
competition for business based on margin pricing, it is possible
that security futures intermediaries would collect only the required
level of margin (i.e., 15% under the final rule change), regardless
of the market conditions, which could impair their ability to
protect against market risk and losses.
---------------------------------------------------------------------------
If security futures trading resumes, the risk security futures
customers and/or intermediaries would face from reducing initial and
maintenance margin would be addressed at the clearinghouse level
because there are additional protections under CFTC regulations. For
example, CFTC Rule 39.13(g)(2)(i) requires a DCO to establish initial
margin requirements that are commensurate with the risks of each
product and portfolio.\169\ In addition, CFTC Rules 39.13(g)(2)(ii) and
(iii) require that initial margin models meet set liquidation time
horizons and have established confidence levels of at least 99%.\170\
These DCO initial margin requirements are distinct from the margin
requirements to which customers are subject pursuant to these final
rules and, along with other risk-reducing measures, serve to mitigate
the possibility that a DCO may default (possibly resulting in a
systemic event). In the event that a DCO were to determine that a 15%
margin level for security futures would be insufficient to satisfy a
DCO's obligation under CFTC Rule 39.13, the DCO would be required to
collect additional margin from its clearing members.\171\
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\169\ CFTC Rule 39.13(g)(2)(i) is not addressed in CFTC Letter
No. 12-08.
\170\ CFTC Rules 39.13(g)(2)(ii) and (iii) are not addressed in
CFTC Letter No. 12-08. In accordance with these rules, OCC Rules
601(c) and 601(e) provide for initial margin for segregated futures
customer accounts to be calculated pursuant to the Standard
Portfolio Analysis of Risk (``SPAN'') on a gross basis, as well as
calculating on a net basis initial margin requirements for each
segregated futures accounts using STANS. OCC's scan ranges for the
SPAN margin models provide coverage for a minimum 99% confidence
level.
\171\ The CFTC expects that any difference between the margin
charged at the DCO and the margin charged by the security futures
intermediary will be addressed by additional margin calls, if
necessary. The DCO can require additional margin from its clearing
members (which in some cases will be the security futures
intermediary), to cover changes in market positions. DCOs and
clearing members are familiar with margin call procedures and have
established rules to efficiently transfer funds when needed. If a
customer's account has insufficient funds to meet the margin call,
its clearing member may provide the amount to the DCO and collect it
from the customer at a later time. In this scenario, the clearing
member may take on a liability or additional risk on the customer's
behalf for a short period of time. The CFTC notes that this practice
is the same for security futures as it is for other products subject
to clearing and it does not view this temporary shifting of risk
between the clearing member and the customer as a unique source of
risk to security futures. Furthermore, this amendment lowering the
required margin from 20% to 15% does not alter the relationship
between DCOs and their clearing members, or the relationship between
clearing members and their customers. The CFTC acknowledges that it
is possible that DCOs and security futures intermediaries will
collect different levels of margin, but it is not necessarily a
result of the final rules. Moreover, the difference in margin
collected is not an unmitigated source of risk for the security
futures intermediaries because they have the authority to collect
additional funds from their customers in the event of a margin call
and can choose to set margin levels higher than the minimum level
required by the Commissions.
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The CFTC observes that customer margin requirements for security
futures held by security futures intermediaries are materially distinct
from initial margin requirements for DCOs. The initial margin
requirements used by DCOs typically are risk-based, and CFTC rules are
designed to permit DCOs to use risk-based margin models to determine
the appropriate level of margin to be collected, subject to CFTC
regulations in Part 39, as applicable.
In addition to the initial margin requirements at the DCO level,
clearing members are required to satisfy certain financial resources
requirements, including a ``capital'' requirement, to demonstrate that
they can withstand certain risks under ``extreme but plausible market
conditions.'' \172\
[[Page 75128]]
Furthermore, the DCO is required to maintain its own financial
resources, which may include its own capital, guaranty fund deposits by
clearing members, default insurance, assessments for additional
guaranty fund contributions, and other financial resources, as
permitted.\173\ In combination, financial resource requirements for
clearing members, initial margin contributions, guaranty fund
contributions, and other resources provide additional protections at
the DCO level against the risk that a default by a customer or security
futures intermediary will create systemic risk.
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\172\ 17 CFR 39.12 (CFTC Rule 39.12(a)(2)) (defining the capital
requirement for clearing members with cross-references to the CFTC's
part 1 rules for FCMs and the SEC's rules for broker-dealers).
\173\ See generally 17 CFR 39.11(a) through (e) (CFTC Rule
39.11(a) through (e)). See also 17 CFR 1.12 (CFTC Rule 1.12)
(setting forth minimum financial requirements for FCMs and IBs).
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In the event that a clearing member defaults on its obligations to
the DCO, the DCO has a number of ways to manage associated risks,
including transferring (or porting) the positions of the defaulted
clearing member and using the defaulting clearing member's margin and
other collateral on deposit to cover any losses. In order to cover the
losses associated with a clearing member default, the DCO would
typically draw from (in order): (1) The initial margin posted by the
defaulting clearing member; (2) the guaranty fund contribution of the
defaulting clearing member; (3) the DCO's own capital contribution; (4)
the guaranty fund contribution of non-defaulting clearing members; and
(5) an assessment on the non-defaulting clearing members. In the event
that a DCO could not transfer the positions of the defaulted clearing
member, it could liquidate those positions. Taken together, these
mutualized risk mitigation capabilities are largely unique to
clearinghouses, and help to ensure that they remain solvent when
dealing with defaults of their members, their members' customers, and/
or other periods of stressed market conditions.
As noted in the 2019 Proposing Release, the CFTC reviewed data from
security futures markets under normal market conditions and concluded
that a 15% level of margin would be sufficient to cover daily price
moves in most instances (i.e., more than 99.5%).\174\ This is
consistent with what the CFTC expects from risk-based margin regimes at
DCOs. The Commissions received no comments regarding this data
analysis. In addition, no commenters provided any quantitative data in
support or refutation of the CFTC's risk analysis. Therefore, the CFTC
continues to believe that the final rules will not have a substantial
negative impact on (1) the protection of market participants or the
public, (2) the financial integrity of security futures markets in the
United States, if trading resumes, or (3) sound risk management
practices of DCOs or security futures intermediaries.
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\174\ Conducting a value-at-risk analysis of 74 of the most
liquid security futures contracts during a limited time-frame
(November 2002-June 2010), CFTC staff found that there were 195
instances where a 15% margin was insufficient and 99 instances where
a 20% margin was insufficient. For all observations, a 15% margin
was sufficient for 99.81% of all observations while a 20% margin was
sufficient for 99.91% of all observations. While the period covered
by this study does include the high volatility exhibited in 2008, it
does not include the comparably high volatility exhibited in early
spring 2020.
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iii. Potential Costs Related to Competition and Market Arbitrage
One commenter responded to the 2019 Proposing Release with concerns
that a change in margin requirements for security futures would provide
an advantage to security futures and create a competitive disadvantage
for exchange-traded equity options.\175\ This commenter explained that
exchange-traded equity options are regularly used to establish
synthetic long and short exposures that produce exposures that are
nearly identical to exposure created by security futures.\176\
According to this commenter, there exists the possibility that the
lower margin requirements for security futures could result in
customers shifting from trading in equity options to security futures,
which in turn, could result in decreased liquidity and less price
discovery in the equity options markets.
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\175\ Cboe/MIAX Letter at 2.
\176\ Cboe/MIAX Letter at 6.
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However, another commenter argued there may be reason to doubt that
changes in trading behavior would be precipitated by the lower margin
levels set forth in these final rules. OneChicago provided data to
support its view that security futures (referred to as ``single stock
futures'' in OneChicago Letter 3) and equity options did not trade
interchangeably.\177\ The five analyses that OneChicago conducted were
valuable to the CFTC's consideration of costs and benefits.
---------------------------------------------------------------------------
\177\ OneChicago Letter 3 at 2.
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In particular, OneChicago provided analysis comparing SPX (S&P 500)
options to E-mini S&P 500 futures contracts.\178\ This analysis
indicates that the products do not trade interchangeably and that the
ratios of SPX options open interest to E-mini futures open interest,
and SPX options volume to E-mini futures volume are not correlated with
the margin rate on the E-mini S&P 500 futures contracts.\179\ The CFTC
recognizes that there are many reasons why customers decide to trade in
one product over another (including tax ramifications), and that
security futures and equity options are not perfect substitutes. The
CFTC acknowledges that if security futures trading resumes, lower
margin requirements could increase trading in security futures above
their historical volumes (and some of that activity could be from
customers that previously traded equity options). However, a customer's
choice of trading instrument is not determined solely by margin
requirements.
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\178\ The CFTC notes that the E-mini futures contracts are not
security futures, but are futures regulated solely by the CFTC
(i.e., they are not jointly regulated by the CFTC and SEC). The
comparison between E-mini futures contracts and SPX options is still
helpful to understand the interplay between the futures and equity
options markets.
\179\ According to OneChicago's analysis, there is a
statistically significant negative correlation between SPX options
and E-mini futures. OneChicago Letter 3 at 6.
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Another reason to doubt the negative competitive impact of these
final rules on exchange-traded equity options is that the 2008 adoption
of Portfolio Margin Rules for exchange-traded equity options did not
cause security futures customers to migrate their positions to those
products, even though it arguably provided those options with a
competitive advantage over security futures because of the lower
minimum margin rate.\180\ Moreover, the vast majority of security
futures customers would have been eligible for lower margin
requirements but did not move their positions from futures accounts to
Portfolio Margin Accounts, which were margined under the Portfolio
Margin Rules (i.e., margin required was equal to 15% for an unhedged
position). The CFTC believes that, if trading in security futures
resumes, the final rules' amendments are unlikely to create a
competitive disadvantage for exchange-traded equity options, as the 15%
margin rate is already in effect for positions held in a Portfolio
Margin Account.
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\180\ A competitive advantage for options may have existed
because options are held in a securities account by default. In
contrast, most security futures positions were held in futures
accounts, and in order for a trader to take advantage of the lower
margin rate for a security futures position, such a trader would
have to move those positions into a different type of account (i.e.,
from a futures account to a securities account) with associated
costs.
---------------------------------------------------------------------------
OneChicago's closure after years of much lower trading activity
than in exchange-traded equity options suggests that security futures
in the U.S. may
[[Page 75129]]
have been operating at a competitive disadvantage to related markets.
However, based on publicly available Eurex volume data,\181\ security
futures trading on U.S. stocks in other jurisdictions is lower than
trading in security futures on European companies, even on the Eurex
exchange in Germany where margin requirements are calculated using
risk-based methodologies.\182\ Therefore, factors other than margin
requirements may be influencing demand for security futures (e.g., tax
ramifications or availability of competing products). Nonetheless, the
CFTC expects that lowering the security futures margin requirement to
15% from 20% will help mitigate this competitive disadvantage and could
encourage a resumption of security futures trading in the U.S.
---------------------------------------------------------------------------
\181\ See Eurex statistics published daily, available at https://www.eurexchange.com/exchange-en/data/statistics.
\182\ Trading by U.S. persons in security futures contracts
listed on Eurex is subject to certain conditions under an SEC order
and a CFTC staff advisory. Provided that a number of conditions are
met, only qualified U.S. persons are permitted to trade security
futures on a single security issued by a foreign private issuer or a
narrow-based security index that is listed on a non-U.S. exchange
that is not required to register with the SEC. See SEC's Order under
Section 36 of the Securities Exchange Act of 1934 Granting an
Exemption from Exchange Act Section 6(h)(1) for Certain Persons
Effecting Transactions in Foreign Security Futures and under
Exchange Act Section 15(a)(2) and Section 36 Granting Exemptions
from Exchange Act Section 15(a)(1) and Certain Other Requirements,
Exchange Act Release No. 60194 (June 30, 2009), 74 FR 32200 (Jul. 7,
2009), and Division of Clearing and Intermediary Oversight Advisory
Concerning the Offer and Sale of Foreign Security Futures Products
to Customers Located in the United States, available at https://www.cftc.gov/idc/groups/public/@internationalaffairs/documents/ssproject/fsfpadvisory.pdf (June 8, 2010).
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iv. Costs and Benefits Associated With Requested Changes to the Margin
Offsets Table
The Commissions are updating and restating the table of offsets for
security futures to reflect the new (15%) minimum margin requirement.
The CFTC believes that if security futures trading resumes, lowering
the margin requirements for certain offsets will not increase costs to
customers, security futures intermediaries, or DCOs. The categories of
permissible offsets will remain the same and there is no change to the
inputs used to calculate the offset, other than to decrease the initial
and maintenance margin on all security futures from 20% to 15%.
Moreover, the same risk to the customers and security futures
intermediaries will exist if the Commissions decrease the margin
required for security futures trading combinations eligible for offsets
as it will with security futures without an offset.
As discussed above, OneChicago suggested that the Commissions make
a number of changes to the Strategy-Based Offset Table.\183\ OneChicago
asked that the Offset Table be amended to account for customers holding
delta-neutral positions (e.g., a customer holds an equal and opposite
position in stock and/or a security future).\184\ Although the CFTC
agrees that it would make sense to account for a neutral position when
setting margin levels, the CFTC believes the revised margin offset
table included in this release balances the efficiencies of offsetting
positions against the outstanding risks associated with these financial
products in light of the fact that equity markets and security futures
markets are subject to separate regulatory oversight. In addition, as
explained above, the Commissions determined that lowering the offset
table requirements further is inconsistent with current securities SRO
rules, and thus would be inconsistent with the Exchange Act. For this
reason, the Commissions are not adopting OneChicago's requested
amendments to the Strategy-Based Offset Table.
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\183\ OneChicago Letter at 15-17.
\184\ According to OneChicago's suggestion, margin for delta-
neutral positions should be equal to the lower of: (1) The total
calculated by multiplying $0.375 for each position by the
instrument's multiplier, not to exceed the market value in the case
of long positions, or (2) 2% of the current market value of the
security futures contract. OneChicago Letter at 15.
---------------------------------------------------------------------------
OneChicago also asked that the Commissions add total return equity
swaps to the Strategy-Based Offset Table.\185\ Total return equity
swaps serve a similar, if not identical, economic function to security
futures contracts as commonly used at OneChicago. Providing an offset
for swaps could incentivize customers to trade in either product, or
this combination of products, and could result in increased liquidity.
Adding a new product to the offset table would provide a benefit to
customers trading in total return equity swaps and security futures
because those customers would be subject to lower margin requirements.
However, as stated above, the Commissions have determined that adding a
total return swap offset to the Strategy-Based Offset Table would be
inconsistent with securities SRO rules at this time and thus would be
inconsistent with the Exchange Act. For this reason, the Commissions
are not adopting this suggested change to the Strategy-Based Offset
Table.
---------------------------------------------------------------------------
\185\ OneChicago Letter at 16.
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In addition, OneChicago recommended that the Commissions reduce the
maintenance margin required for certain types of positions from 10% to
7.5%.\186\ A lower margin requirement under the offset table would
provide an individual customer with an offsetting position a small
benefit. However, as stated above, the Commissions have determined that
lowering the margin requirement for certain strategies from 10% to 7.5%
in the Strategy-Based Offset Table would be inconsistent with
securities SRO rules at this time and thus would be inconsistent with
the Exchange Act. For this reason, the Commissions are not adopting
this suggested change to the Strategy-Based Offset Table.
---------------------------------------------------------------------------
\186\ OneChicago Letter at 16. As suggested by OneChicago, the
reduction in margin from 10% to 7.5% would apply to items 2, 8, 9,
11, 12, 14, 15, and 16 in the Strategy-Based Offset Table.
---------------------------------------------------------------------------
Finally, OneChicago requested that the Commissions simplify the
Strategy-Based Offsets Table overall by replacing the table with a
rule. The CFTC has not identified specific benefits associated with
adopting a rule rather than updating the Strategy-Based Offsets Table.
However, the CFTC believes that any structural change to the offset
table that is adopted for the security futures regime but not for the
equity options regime could introduce uncertainty and confusion in the
markets, and could inhibit customers seeking the reduced margin
benefits of offsetting positions. OneChicago stated that the rule
change it identified would not result in margin levels that are lower
than margin levels required under the Strategy-Based Offset Table for
exchange-traded equity options under Portfolio Margin Rules. As stated
above, the Commissions have determined that replacing the Strategy-
Based Offsets Table with a rule would be inconsistent with the
securities SRO rules at this time and thus would be inconsistent with
the Exchange Act. For this reason, the Commissions are not adopting
this suggested change to the Strategy-Based Offset Table.
Although the Commissions are not revising the Strategy-Based Offset
Table as requested by OneChicago, the CFTC believes the offsets
described in this release will, if security futures trading resumes,
offer certain benefits and will not increase costs by materially
decreasing protections or increasing risks. Again, as added assurance
that there are multiple levels of risk protection for security futures,
the CFTC notes that security futures intermediaries and customers will
continue to be required to comply with daily mark-to-market and
variation
[[Page 75130]]
settlement procedures applied to security futures, as well as the large
trader reporting regime that applies to futures accounts.\187\
---------------------------------------------------------------------------
\187\ Under the CFTC's large trader reporting regime, clearing
members and FCMs (as well as foreign brokers) file reports with the
CFTC containing futures and options position information for traders
that have positions at or above certain reporting thresholds. See
part 17 of the CFTC's regulations and 17 CFR 15.03(b) (CFTC Rule
15.03(b)).
---------------------------------------------------------------------------
5. Description of Benefits Provided by the Final Rules
The CFTC believes that the final rules will, if security futures
trading resumes, produce significant benefits by reducing minimum
margin requirements for security futures positions to levels equal to
margin levels for exchange-traded options. The amendment to CFTC Rule
41.45(b)(1) will align customer margin requirements for security
futures held in a futures or a securities account with those that are
held in a Portfolio Margin Account. The CFTC believes this alignment
may increase competition by establishing a level playing field between
security futures carried in a Portfolio Margin Account and security
futures carried in a futures account or a securities account that is
not subject to Portfolio Margin Rules should OneChicago begin offering
these products again or new market entrants emerge.
This benefit is expected to apply most directly to customers with
security futures positions held in futures accounts because they cannot
be margined under Portfolio Margin Rules. According to OneChicago,
because of operational issues, almost all security futures positions
were carried in futures accounts.\188\ As a result, almost all, if not
all, security futures were held in futures accounts and subject to the
CFTC's customer account requirements. Therefore, any reduction in
customer initial and maintenance margin requirements, if security
futures trading resumes, would be expected to benefit all or close to
all security futures customers because they historically held positions
in futures accounts and did not benefit from Portfolio Margin Rules.
---------------------------------------------------------------------------
\188\ See OneChicago Petition at 2.
---------------------------------------------------------------------------
Additionally, the reduced minimum margin level could, if security
futures trading resumes, facilitate more trading in security futures
than would otherwise occur, which could enhance the likelihood a
revival would succeed and increase market liquidity to the benefit of
market participants and the public.\189\ Increased liquidity could
contribute to the financial integrity of security futures markets
overall. For example, market liquidity may be particularly beneficial
in the context of a customer default at an FCM, when the FCM must
manage the defaulting customer's security futures positions through
transferring or liquidating those positions.\190\
---------------------------------------------------------------------------
\189\ OneChicago represented that one of its customers (Jurrie
Reinders, Societe General) believed that the ``uncompetitive''
margin requirements for security futures have reduced trading
volumes. OneChicago Letter at 29.
\190\ As noted above, the FIA Letter stated that the final rules
would help FCMs manage their risk. See FIA Letter, at 2. See also
discussion of CFTC rules under parts 1 and 39, above.
---------------------------------------------------------------------------
The lower minimum margin requirement also could, if security
futures trading resumes, decrease the direct cost of trading in
security futures. In response to the Commissions' request for comments
providing data, OneChicago estimated that for the time period between
September 1, 2018, and August 1, 2019, the notional value of margin
collected on OneChicago positions would be reduced by $130 million if
the lower 15% margin requirement had been in place.\191\ This would
have represented significant savings in the amount of margin required
to be paid by and collected from customers in satisfaction of the
CFTC's part 41 margin requirements. A decrease in trading costs,
through lower minimum margin requirements should OneChicago begin
offering these products again or new market entrants emerge, also may
increase capital efficiency because additional funds would be available
for other uses.
---------------------------------------------------------------------------
\191\ OneChicago estimated that between September 1, 2018, and
August 1, 2019, the notional value of margin collected on OneChicago
positions was approximately $540 million (under a 20% minimum margin
requirement) compared to $410 million that would have been collected
under the final rules (under a 15% minimum margin requirement).
OneChicago Letter at 14.
---------------------------------------------------------------------------
As noted above, the final rules may have beneficial competitive
effects vis-[agrave]-vis domestic markets. In addition, lowering the
minimum margin requirement may enable a U.S. security futures exchange
to better compete in the global marketplace, where security futures
traded on foreign exchanges are subject to risk-based margin model
requirements that are generally lower than those applied to security
futures traded in the U.S.\192\ Apart from OneChicago's letters and a
comment from one of its customers, the Commissions received no comments
regarding benefits associated with increased domestic or global
competition.
---------------------------------------------------------------------------
\192\ OneChicago stated that the Eurex exchange lists futures on
U.S. stocks with risk-based margins that are lower than the 20%
margin for futures on the same stocks that were listed at OneChicago
(OneChicago Letter at 13). However, based on publicly available
data, the volume on Eurex for futures on U.S. stocks is much lower
than occurred at OneChicago even as security futures volume is high
for stocks in European companies.
---------------------------------------------------------------------------
The final rules restate the table of offsets for security futures
to reflect the proposed 15% minimum margin requirement. As discussed in
detail above, these offsets will, if security futures trading resumes,
provide the benefits of capital efficiency to customers because offsets
recognize the unique features of certain specified combined strategies
and would permit margin requirements that better reflect the risk of
these strategies. Moreover, the same benefits of lowering margin costs
for customers and increasing business in security futures could result
from lowering margin requirements for offsetting security futures
positions.
6. Discussion of Alternatives
Although the CFTC did not identify any alternatives in the
proposal,\193\ commenters suggested a number of alternative security
futures margin options, along with other suggestions for the
Commissions to consider. This discussion of those alternatives includes
certain commenter proposals that the Commissions still do not believe
are viable at this time for the reasons discussed by the Commissions in
more detail above.
---------------------------------------------------------------------------
\193\ See 2019 Proposing Release, 84 FR at 36446. In the
proposal, the CFTC stated that it did not believe that there were
any reasonable alternatives to consider given statutory constraints
tied to current practices in the exchange-traded equity options
market. Id. at n. 92.
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i. Reducing Contract Sizes for Security Futures
One commenter, citing a statement by SEC Commissioner Jackson,
indicated that the Commissions failed to consider reasonable
alternatives such as reducing the contract size for security
futures.\194\ According to Commissioner Jackson's Statement, ``reducing
contract size could also increase access to single-stock futures for
the most popular securities and improve efficiency.'' \195\ The CFTC
agrees that changing the contract size for security futures might make
the products more attractive to a wider group of market participants,
resulting in increased liquidity,\196\ but
[[Page 75131]]
would not change the overall amount of margin required for a given
position. Thus, the CFTC believes that this alternative would be less
effective at increasing liquidity than lowering margin requirements.
Reducing the security futures contract size would lower the initial
capital expenditure for a customer and could attract wider
participation, but could possibly increase transaction costs, as a
percentage of overall initial costs in putting on the position.\197\ As
explained above, the Commissions anticipate that these final rules may
produce greater liquidity in security futures, as well as create more
efficient capital distribution. Market participants will be able to
reallocate funds that are saved on lower margin levels. Under this
alternative, market participants would not benefit from any increased
capital efficiencies. Because reducing contract sizes does not provide
the same capital efficiency opportunities to customers, the CFTC does
not believe it offers as many benefits as the final rules.
---------------------------------------------------------------------------
\194\ Letter from the Jeffrey Mahoney, General Counsel, Council
of Institutional Investors (Aug. 26, 2019) (``CII Letter'') at 4.
See also Commissioner Robert J. Jackson Jr., Public Statement,
Statement on Margin for Security Futures (July 3, 2019), available
at https://www.sec.gov/news/public-statement/jackson-statement-margin-security-futures (``Commissioner Jackson's Statement'').
\195\ Commissioner Jackson's Statement.
\196\ A security futures exchange could change the contract size
for security futures by amending terms of the security futures
contract such that one security futures contract represents only 50
shares of the underlying stock instead of 100.
\197\ The increase in transaction costs would be the result of
the fixed cost staying the same, but the initial expenditure being
lower.
---------------------------------------------------------------------------
ii. Rules-Based Margin With Flexible Margin Collection Intervals
One commenter agreed with Commissioner Jackson's concern that the
proposal did not consider other reasonable alternatives such as a
rules-based margin regime that includes flexible margin collection, or
settlement intervals, which is an idea proposed by former SEC
economists.\198\ According to the economists' research paper on this
topic, security futures that are subject to strategy-based margining
may be less sensitive to changes in market conditions.\199\ The
economists analyzed different margin collection time periods to
determine whether risks to customers would be affected by the length of
time that passed between contract execution and settlement. The
economists found that a 1-day margin collection period (i.e., initial
and maintenance margins are required to be collected within 1 day of
the trade) likely would lead to higher margin requirements than would
otherwise be required under a risk-based margin regime. As a
comparison, they also studied a 4-day collection period (i.e., initial
and maintenance margins are required to be collected within 4 days of
the trade) and found that the additional time could lead to both
significant over- and under-margining relative to a risk-based margin
model regime.
---------------------------------------------------------------------------
\198\ See Commissioner Jackson's Statement; see also CII Letter
at 4.
\199\ Hans R. Dutt & Ira L. Wein, On the Adequacy of Single-
Stock Futures Margining Requirements, 10 J. FUTURES MARKETS 989
(2003).
---------------------------------------------------------------------------
This research explores how changes in the date on which margin is
collected could provide different levels of protection for customer
positions in security futures.\200\ The paper suggests that such a rule
change could produce adequate margin coverage, if calibrated correctly,
to protect against default. On the other hand, one commenter opposed
the alternative of changing the margin collection period, arguing that
this could ``build up exposures'' and would remove one of the critical
futures market protections (e.g., paying and collecting margin to
prevent customers from accumulating large exposures).\201\
---------------------------------------------------------------------------
\200\ The CFTC notes that this research paper was published in
2003, before significant changes to the CFTC's regulatory regime
were adopted pursuant to the Dodd-Frank Wall Street Reform and
Consumer Protection Act. It is uncertain whether the alternatives
considered and discussed in the research paper would comply with
current CFTC requirements. Additionally, there are no programs
offering this alternative, and whether such a program could comply
with the statutory constraints under the Exchange Act is uncertain.
\201\ OneChicago Letter at 6.
---------------------------------------------------------------------------
The CFTC has not analyzed a particular program offered by an
exchange or security futures intermediary, nor examined any rulebooks
outlining how such a program would be implemented. However, if such a
change were submitted for review, the CFTC would consider, among other
things, how a change in the date of margin collection would affect how
FCMs manage margin funds. CFTC rules govern FCM practices and require
that FCMs take certain precautions with customer funds.\202\ In some
cases, customers may benefit from a more prompt payment of margin funds
to FCMs because those funds will be subject to certain protections, and
FCMs would encourage prompt payment of margin funds to protect against
customer position risk. The CFTC also observes that changes to the
collection period would depend on changes in contractual provisions
between clearinghouses and their clearing members, and between the
clearing members and their customers, as well as rule changes for
exchange operating procedures.
---------------------------------------------------------------------------
\202\ See 17 CFR 1.20 through 1.30 (CFTC Rules 1.20 through
1.30).
---------------------------------------------------------------------------
The Commissions are adopting the final rules because they produce a
desired policy outcome of aligning the minimum margin requirements for
security futures held in non-Portfolio Margin Accounts with the margin
required for security futures in a Portfolio Margin Account, for the
reasons discussed above. The CFTC believes that any changes to the date
of margin collection period are distinct from this policy objective,
may not be uniformly adopted by security futures markets, and may
result in an accumulation of risk for customers and security futures
intermediaries. Accordingly, changing the margin collection period is
not a viable alternative to the final rules adopted in this release.
iii. Use of Risk-Based Margin Models
In the 2019 Proposing Release, the Commissions specifically
requested comment on ``any other risk-based margin methodologies that
could be used to prescribe margin requirements for security futures.''
In response, a number of commenters expressed a preference for using
risk-based models to margin security futures and argued that such a
regime would be consistent with the Exchange Act.\203\ As discussed in
section II.A. above, implementing a risk model approach to calculate
margin for security futures would be inconsistent with how margin is
calculated for exchange-traded equity options at this time and may
result in margin levels for unhedged security futures positions that
are lower than the lowest level of margin applicable to unhedged
exchange-traded equity options (i.e., 15%). Consequently, because no
exchange-traded equity options are subject to risk-based margin
requirements, adopting a risk model approach at this time for security
futures would conflict with the requirements of Section 7(c)(2)(B) of
the Exchange Act.\204\
---------------------------------------------------------------------------
\203\ See La Botz Letter (``I request the Commission to please
correct the margin discrepancy placed upon the [security futures]
products by going to a risk based margining as utilized by
clearinghouses on other [security futures] products worldwide.'').
See also Ianni Letter, and OneChicago Letter.
\204\ See section II.A. above (discussing a risk model approach
and Section 7(c)(2)(B) of the Exchange Act).
---------------------------------------------------------------------------
The CFTC is considering a risk-based model alternative solely for
purposes of analyzing the potential costs and benefits of the final
rules under a hypothetical future scenario. The CFTC has extensive
familiarity and experience with overseeing entities that use risk-based
margin model regimes for derivatives clearing.\205\ Risk-based margin
models produce efficiencies because the initial margin is calculated
using certain macro-economic risk factor inputs that change with market
[[Page 75132]]
conditions. DCOs successfully manage the initial margin requirements
for clearing members using risk-based margin models. Risk-based margin
model regimes also provide effective protection against default for
customers, intermediaries, and clearinghouses. While the CFTC is
broadly supportive of risk-based margin models and believes there are
benefits to those regimes, in the context of security futures, the
costs and benefits require careful attention.
---------------------------------------------------------------------------
\205\ As a market regulator with jurisdiction over derivatives
clearinghouses, one of the CFTC's primary functions is to supervise
the derivatives clearing activities of DCOs, their clearing members,
and any entities using the DCOs' services. The CFTC supervisory
program takes a risk-based approach.
---------------------------------------------------------------------------
As seen in some of the data provided by OneChicago, risk-based
margin does not necessarily mean that the margin collected will be
lower than under current margin requirements for security futures or
the amended final rules under part 41 of the CFTC's regulations. In
fact, there may be reason to believe that it could be higher.
OneChicago provided an example from the 2008-2010 financial crisis.
During that time period, margin requirements on SPX options remained
constant at 8% (the maximum initial margin), if held in a Portfolio
Margin Account.\206\ However, during that same time period, E-mini
futures contracts were charged margin at levels higher than 8% because
they were subject to risk-based margin and the volatility at the time
required greater margin levels.\207\ In this instance, the margin
required under a risk-based model would be higher than the maximum
initial margin that is set at a constant percentage rate. The CFTC
observes that this comparison is informative, but not dispositive.
---------------------------------------------------------------------------
\206\ OneChicago Letter 3 at 3.
\207\ As noted above, E-mini futures contracts are not jointly
regulated by the CFTC and SEC because they are broad-based equity
index futures and do not fall under the definition of ``security
futures'' under the CEA. However, for purposes of examining the
relationship between futures contracts and options, the comparison
may be relevant.
---------------------------------------------------------------------------
Importantly, because the security futures margin regime includes a
minimum margin requirement only, it is less likely that there would be
an instance in which a risk-based model results in greater margin
levels than the margin charged to a customer under the final rules. As
the Commissions have emphasized throughout this release, FCMs and DCOs
may, if security futures trading resumes, charge additional margin
above the 15% minimum level required, if it would be prudent to protect
against increased risk. In practice, this means that in a period of
market volatility a risk-based model may require higher margin levels
to account for that volatility, but an FCM and/or DCO likely would
require higher margin during such periods of market volatility under
the current rules. Even under the initial and maintenance margin
requirements today, FCMs and DCOs provide a backstop for margin
purposes by being required to collect higher margins if market
conditions or other circumstances change.\208\ Use of a risk-based
margin model would sometimes result in higher margins than the 15%
minimum margin level adopted in this release, but it would not
necessarily change the margin amount posted by a customer.
---------------------------------------------------------------------------
\208\ For example, OneChicago provided a sample dataset that
compares the margin level required under the current security
futures margin rule (20%), the new rule (15%), and under a risk-
based margin approach used by OCC. Out of the 20 security futures,
17 security futures would be subject to lower margin requirements
under risk-based margining. One contract would be subject to a 17.7%
margin requirement under the new rule and the risk-based model,
because that contract is exposed to higher market risks. One
contract would continue to be margined at a 20% level, even under
the new rule and risk-based margining. Finally, one contract would
continue to be margined at a 23% level regardless of the approach
taken to determine margin requirements. Thus, the idea that risk-
based margining would produce lower margin levels for all contracts
at all times is incorrect. OneChicago Letter at 27.
---------------------------------------------------------------------------
The CFTC recognizes there may be savings that can accrue under
risk-based margin models for purposes of initial and maintenance
margin, but notes that variation margining practices will not change
for security futures.\209\ Taken together, the overall margin regime
for security futures under a risk-based margin model regime ultimately
may at various times be equal to, greater than, or less than, the
margin requirements set forth under the final rules.
---------------------------------------------------------------------------
\209\ In the context of security futures, FCMs are required to
continue daily mark-to-market valuations and exchange of variation
margin.
---------------------------------------------------------------------------
However, as discussed in section II.A. above, the CFTC is not
persuaded by commenters' arguments that, at this time, implementing a
risk model approach to calculating margin for security futures would be
permitted under Section 7(c)(2)(B) of the Exchange Act. Moreover,
implementing a risk model approach would substantially alter how the
required minimum initial and maintenance margin levels for security
futures are calculated. It also would be a significant deviation from
how margin is calculated for listed equity options and other equity
positions (e.g., long and short securities positions). It would not be
appropriate at this time to implement a different margining system for
security futures, given their relation to products that trade in the
U.S. equity markets. Further, implementing a different margining system
for security futures may result in substantially lower margin levels
for these products as compared with other equity products and could
have unintended competitive impacts. For this reason, the suggested
alternative to permit risk-based margin models to determine customer
margin requirements for security futures is not viable.
iv. Risk-Based Margin for STARS Transactions
Recognizing that the Commissions may not be able to adopt risk-
based margin for all security futures, OneChicago asked the Commissions
to consider the alternative of adopting risk-based margin for its STARS
transactions only. The CFTC notes that OneChicago has shut down and is
no longer offering STARS transactions. For purposes of this discussion
of suggested alternatives, the CFTC will examine whether subjecting
STARS transactions or similar products that may be offered in the
future to risk-based margin requirements would provide additional costs
or benefits when compared to the final rules.
STARS transactions represented a combination of two security
futures contracts that formed a spread position. After combining the
two legs of the spread in the customer's account, one leg expired, and
a single security future position remained in the account. A STARS
transaction resulted in a hedged transaction that involved two
customers transferring either a stock position or a security futures
position, and once the back leg of the transaction expired the parties
returned to their original positions. According to OneChicago, there
would be cost savings to structuring the transaction this way for
purposes of facilitating equity repo or stock loan transactions.
As stated above, the Commissions have determined that because no
exchange-traded equity options are subject to risk-based margin
requirements, adopting a risk model approach at this time for STARS
transactions would conflict with the requirements of Section 7(c)(2)(B)
of the Exchange Act.\210\ For this reason, as well as the recent
announcements by OneChicago, this alternative is not viable.
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\210\ See section II.A. above (discussing a risk model approach
and Section 7(c)(2)(B) of the Exchange Act).
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7. Consideration of Section 15(a) Factors
This section analyzes the expected results of amending CFTC Rule
41.45(b)(1) to reduce the minimum initial and maintenance margin levels
for each security future from 20% to 15% of the current market value of
such contract, and adopting the Margin Offset Table changes as
proposed, in light of
[[Page 75133]]
the five factors under Section 15(a) of the CEA.
i. Protection of Market Participants and the Public
The CFTC believes that the final rules maintain the protection of
market participants and the public from the risks of a default in the
security futures market, if trading in that market resumes. The CFTC
continues to believe that a 15% minimum initial and maintenance margin
requirement in combination with other protections, such as certain
provisions of CFTC Rule 39.13, applicable to DCOs that offer to clear
security futures products,\211\ will protect U.S. market participants,
including security futures customers and security futures
intermediaries, from the risk of a default in security futures markets.
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\211\ As discussed above, in response to the FIA Letter, under
CFTC Letter No. 12-08, the CFTC's Division of Clearing and Risk
interpreted certain sections of CFTC Rule 39.13 and stated that the
customer margin rule under CFTC Rule 39.13(g)(8)(ii) does not apply
to customer initial margin collected as a performance bond for
customer security futures positions. CFTC Letter No. 12-08 at 10
(Sept. 14, 2012). However, there are other aspects of CFTC Rule
39.13 that offer protections such as other risk controls like risk
limits that may prevent a clearing member from carrying positions
with potential exposures above certain thresholds. See CFTC Rule
39.13(h)(1).
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In addition, security futures intermediaries, such as FCMs, are
authorized to collect additional margin from their customers if the FCM
believes a customer's positions may pose unmanaged risk.\212\ In
addition, any DCOs offering to clear security futures are required to
maintain certain risk management procedures, which include measures to
prevent potential losses from clearing member defaults and methods to
limit risks to the DCO's financial resources.\213\ The objective is
that DCOs will always have sufficient financial resources to manage the
risks presented by security futures.
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\212\ See CFTC Rule 41.42(c)(1) and SEC Rule 400(c)(1). See 2019
Proposing Release, 84 FR at 36440.
\213\ See CFTC Rule 39.13(f) and (h).
---------------------------------------------------------------------------
One commenter expressed a concern that, based on the statutory
criteria prescribed in the Exchange Act for determining security
futures' margin requirements, lowering margin requirements for security
futures could result in ``potential significant risks to the capital
markets and investors.'' \214\ Further, this commenter cited to the
Commissions' discussions in the 2019 Proposing Release regarding
margin's role in risk mitigation and the potential costs associated
with reducing margin levels. As stated above, the CFTC continues to
believe that the reduction in margin requirements under the final rules
will not decrease the protection to market participants or the public
because, although margin requirements are a critical component of any
risk management program for cleared financial products, they are not
the only risk management technique in place for DCOs or their clearing
members.
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\214\ CII Letter at 2.
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ii. Efficiency, Competitiveness, and Financial Integrity of the Markets
The final rules are intended to enhance the efficiency and
competitiveness of the security futures market in the United States by
bringing the initial and maintenance margin requirements for security
futures in line with requirements for security futures subject to
Portfolio Margin Rules. Market participants trading in security futures
will benefit from lower margin requirements. Furthermore, a decrease in
initial and maintenance margin requirements from 20% to 15% of the
current market value of each security futures contract may increase the
attractiveness of security futures and help facilitate the revival of
the security futures markets, whether at OneChicago, or at another
exchange. However, even with lower margin requirements, customer
decisions to trade in security futures would still be influenced by
hedging demands and competition with substitutes or similar products.
The final rules also are expected to improve the competitiveness of
security futures as compared to exchange-traded options. The final
rules' amendments to reduce margin requirements also may facilitate a
more competitive security futures market in the United States as
compared with international markets.\215\ Overall, the CFTC believes
that the final rules will have a positive effect on competition in the
U.S. security futures market without providing an undue competitive
advantage to security futures over comparable exchange-traded equity
options.\216\
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\215\ Data from OneChicago indicates that the risk-based
margining system applied by Eurex (a non-U.S. security futures
exchange), is consistently lower than the 15% margin requirement
adopted in the final rules. See e.g., Figure 2--Margin Levels for
Dow Components at Eurex and OneChicago. OneChicago Letter at 25.
\216\ See also the CFTC's analysis of anti-trust considerations
in section VII. below. The CFTC has identified no anticompetitive
effects of the final rules.
---------------------------------------------------------------------------
The CFTC continues to believe that a 15% margin requirement for
security futures will, if security futures trading resumes, be
sufficient to protect customers and DCOs against the risk of default in
greater than 99% of cases. According to economic data reviewed by CFTC
staff, the CFTC believes that a 15% margin requirement for security
futures will protect other customers and DCOs against most risks of
default.
Furthermore, the final rules could enhance the financial integrity
of any potential security futures market in the United States. Lowering
the amount of initial and maintenance margin required for customers
trading in security futures may facilitate the revival of security
futures markets, and if that revival occurs, increase the number of
customers trading in security futures and/or increase the amount of
trading. An increase in the number of customers in the security futures
market also could increase the number of FCMs offering to clear for
such customers, which could lead to more efficient transfers of
customer positions by a DCO in the event of a clearing member or
customer default. Furthermore, a larger and more diversified customer
base could reduce risks in the security futures market overall. For all
of these reasons, enhanced liquidity would serve to strengthen the
financial integrity of the security futures market.
Again, the CFTC notes that the DCOs that may clear security futures
would be subject to CFTC regulations requiring the DCO to maintain
adequate risk management policies and overall financial resources. DCOs
may require additional margin, in an amount that is greater than 15%,
on certain security futures positions or portfolios if the DCO notes
particular risks associated with the products or portfolios.
Accordingly, the CFTC believes that the final rules will maintain, or
possibly improve, the financial integrity of the security futures
markets in the U.S.
The CFTC believes that the final rules effectively address the need
for market efficiency, competition, and financial integrity consistent
with the statutory requirements under Section 7(c)(2)(B)(iii) of the
Exchange Act. The CFTC also considered alternatives presented by
commenters, as discussed above, but does not believe that there are any
viable alternatives to the final rules at this time.
iii. Price Discovery
The lower margin requirements adopted under the final rules may
facilitate the revival of security futures markets, and if that revival
occurs, could increase competition and result in some new customers
entering the security futures market along with increased trading by
previously existing customers. In addition, trading from foreign
markets could shift to the U.S. security futures market as a result of
the change in margin requirements. All
[[Page 75134]]
things being equal, this increased activity in the U.S. security
futures market could have a positive effect on price discovery in the
security futures market, if trading resumes. However, as the CFTC has
noted before, price discovery in security futures markets most likely
has occurred in the liquid and transparent security markets underlying
previously existing security futures contracts, rather than the
relatively low-volume security futures themselves.\217\
---------------------------------------------------------------------------
\217\ See Position Limits and Position Accountability for
Security Futures Products, 84 FR 51020.
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One commenter, citing to SEC Commissioner Jackson's Statement,
shared the view that a serious economic analysis would have considered
whether reducing margin requirements improves price discovery or,
instead, incentivizes a shift toward futures markets in order to seek
out leverage.\218\ SEC Commissioner Jackson's Statement noted that if
market participants shifted toward futures markets, it could result in
less liquidity in related markets (i.e., equity markets) without
contributing to any additional price discovery. Although some portion
of increased trading in security futures may be the result of customers
switching from equity markets to security futures markets, the lower
margin requirements for security futures may, if security futures
trading resumes, facilitate arbitrage between the underlying security
and security futures markets. This arbitrage between the two markets
may enhance price discovery and provide a benefit to customers.
---------------------------------------------------------------------------
\218\ CII Letter at 4.
---------------------------------------------------------------------------
The CFTC notes that changes in price discovery may be difficult to
measure.\219\ However, the CFTC believes that the final rules'
amendments are unlikely to harm price discovery and indeed may improve
price discovery in the security futures market in the United States if
security futures trading resumes.
---------------------------------------------------------------------------
\219\ One commenter shared SEC Commissioner Jackson's view that
the effects of a lower margin requirement on price discovery in
financial markets could be studied by looking at relevant data. CFTC
staff reviewed trading volume data at OneChicago to determine
whether a change to increase the default maximum level of equity
security futures products' position limits resulted in a change in
trading activity in security futures products, but without
additional data on related equity contracts it is not possible to
draw a definitive conclusion about effects on price discovery.
---------------------------------------------------------------------------
iv. Sound Risk Management Practices
The final rules' amendments will lower the minimum initial and
maintenance margin required for security futures positions. If security
futures trading resumes, this may encourage potential hedgers or other
risk managers to increase their use of security futures for risk
management purposes. Moreover, a lower margin requirement could
encourage new market participants to enter the security futures markets
for potential hedging and risk management purposes. The final rules'
amendments are consistent with sound risk management practices,
especially to the extent that there is increased liquidity in
potentially revived security futures markets.
In addition, as discussed in detail above, margin requirements are
a critical component of any risk management program for cleared
derivatives. Security futures have been risk-managed successfully
through central clearing and initial and maintenance margin
requirements for almost twenty years (including time periods of
historic market volatility).\220\ Current minimum margin requirements
for security futures (20%) are higher than minimum margin requirements
for comparable exchange-traded equity options held in a Portfolio
Margin Account.
---------------------------------------------------------------------------
\220\ The CFTC staff notes that the VIX, which measures market
expectations of near term volatility as conveyed by stock index
option prices, has recently approached peak levels due to increased
market volatility in March 2020 (the VIX measurement on March 16,
2020, was close to 83). Previously high volatility was measured in
October and November 2008 during the financial crisis (when the VIX
measurement reached the 80s). See, e.g., VIX data available from the
Federal Reserve Bank of Saint Louis at https://fred.stlouisfed.org/series/VIXCLS.
---------------------------------------------------------------------------
The CFTC recognizes the necessity of sound initial and maintenance
margin requirements for DCO and FCM risk management programs. Initial
and maintenance margin collected addresses potential future exposure,
and in the event of a default, such margin protects non-defaulting
parties from losses. The final rules maintain those protections. As
noted above, based on past data, the 15% margin level is likely to
cover more than 99% of the risks of default associated with security
futures positions, if trading resumes.
v. Other Public Interest Considerations
The CFTC has not identified any additional public interest
considerations related to the costs and benefits of the final rules.
B. SEC
1. Introduction
In the following economic analysis, the SEC considers the benefits
and costs, as well as the effects on efficiency, competition, and
capital formation that the SEC anticipates will result from the SEC's
final rules.\221\ The SEC evaluates these benefits, costs, and other
economic effects relative to a baseline, which the SEC takes to be the
current state of the markets for security futures products and the
regulations applicable to those markets. The economic effects the SEC
considered in adopting these rule amendments are discussed below and
have informed the policy choices described throughout this release.
---------------------------------------------------------------------------
\221\ The Exchange Act states that when the SEC is engaging in
rulemaking under the Exchange Act and is required to consider or
determine whether an action is necessary or appropriate in the
public interest, the SEC shall consider, in addition to the
protection of investors, whether the action will promote efficiency,
competition, and capital formation. 15 U.S.C. 78c(f). In addition,
Exchange Act Section 23(a)(2) requires the SEC, when making rules or
regulations under the Exchange Act, to consider, among other
matters, the impact that any such rule or regulation would have on
competition and states that the SEC shall not adopt any such rule or
regulation which would impose a burden on competition that is not
necessary or appropriate in furtherance of the Exchange Act. See 15
U.S.C. 78w(a)(2).
---------------------------------------------------------------------------
The final rule amendments will lower the required initial and
maintenance margin levels for unhedged security futures from the
current level of 20% to 15%. Furthermore, in connection with the SEC's
rules which permit an SRA to set margin levels that are lower than 15%
of the current market value of the security future in the presence of
an offsetting position involving security futures and related
positions, the SEC is re-publishing the Strategy-Based Offset Table
with the proposed revisions, to conform it to the adopted 15% required
margin levels.\222\
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\222\ Conforming reductions to minimum margin percentages on
hedged security futures positions will be reflected in a restatement
of the table of offsets published in the 2002 Adopting Release. The
Strategy-Based Offset Table is not part of the Code of Federal
Regulations.
---------------------------------------------------------------------------
The SEC received a number of comments on the proposal. Some
commenters supported the proposal,\223\ while other commenters raised
concerns.\224\ The SEC has considered these comments, as discussed in
detail in the sections that follow. This adopting release also revisits
the benefits, the costs, and other economic effects identified in the
2019 Proposing Release.\225\ Much of the discussion below on the costs,
benefits, and other effects is qualitative in nature. Wherever possible
the SEC has attempted to quantify potential economic effects,
incorporating data and other information provided by commenters in its
analysis of the economic effects of
[[Page 75135]]
the final rules. In addition to more detailed information on current
activity in the security futures market, the SEC considered information
supplied by commenters on the potential reduction in margin required to
support security futures positions based on current levels of market
activity and on the likelihood that investors migrated to the security
futures market from related markets. However the SEC generally lacks
the data necessary to estimate, among other things, the potential
impact of the final rule amendments on overall investor participation
in the security futures markets and bid-ask spreads in that market and
related markets.
---------------------------------------------------------------------------
\223\ See FIA Letter.
\224\ See OneChicago Letter; OneChicago Letter 2; OneChicago
Letter 3; Cboe/MIAX Letter; CII Letter; Bost/Davis Letter; Moran/
Tillis/Rounds Letter.
\225\ See 2019 Proposing Release, 84 FR at 36447.
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2. Baseline
The SEC evaluates the impact of final rules relative to a baseline
that includes the regulatory regime applicable to the markets for
security futures, as well as the current state of these markets. As
discussed above, the term ``security future'' refers to a futures
contract on a single security or on a narrow-based security index.\226\
More generally, ``security futures product'' refers to security futures
as well as any put, call, straddle, option, or privilege on a security
future.\227\
---------------------------------------------------------------------------
\226\ See supra note 1.
\227\ See Section 1a(45) of the CEA and Section 3(a)(56) of the
Exchange Act (both defining the term ``security futures product'').
---------------------------------------------------------------------------
Unlike futures markets on commodities or ``broad-based'' equity
indexes, security futures have had a limited role in U.S. financial
markets, which may be due in part to uncertainty relating to tax
treatment \228\ and competition from the more developed equity, equity
swap, and options markets.\229\ Incentives to participate in the
security futures markets (rather than the markets for the underlying
security, options, or swap markets) may stem from reduced market
frictions (e.g., short sale constraints), lower cost of establishing a
short position compared to the equity market, and reduced counterparty
risk due to daily resettlement, relative to comparable OTC instruments
(e.g., equity swaps).
---------------------------------------------------------------------------
\228\ Specifically, the proposition that exchange-for-physical
single stock security futures qualify for the same tax treatment as
stock loan transactions under Section 1058 of the Internal Revenue
Code has not been tested. See e.g., Exchange Act Release No. 71505
(Feb. 7, 2014).
\229\ Security futures markets face competition from equity and
options markets because in principle, the payoff from a security
futures position is readily replicated using either the underlying
security, or through options on the underlying security.
---------------------------------------------------------------------------
As with other types of futures, both the buyer and seller in a
security futures transaction can potentially default on his or her
respective obligation. Because of this, an intermediary to a security
futures transaction will typically require a performance bond
(``initial and maintenance margin'') from both parties to the
transaction. The clearing organization will also require such
performance bonds from its clearing members (i.e., the clearing
intermediary of the security futures transaction). Higher margin levels
imply lower leverage, which reduces risk. Private incentives encourage
a broker-dealer that intermediates security futures transactions to
require a level of margin that adequately protects its interests.
However, in the presence of market frictions, private incentives
alone may lead to margin levels that are inefficient. For example,
intermediaries may set margin levels that, while privately optimal, do
not internalize the cost of the negative externalities caused by the
potential high leverage level associated with low margins. Moreover,
even when all parties are fully aware of the risks of leverage,
privately negotiated margin arrangements may be too low. For example,
the risk resulting from higher leverage levels can impose negative
externalities on financial system stability, the costs of which would
not be reflected in privately negotiated margin arrangements. To the
extent that such market failures are not ameliorated by existing market
institutions,\230\ they provide an economic rationale for regulatory
minimum margin requirements.\231\
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\230\ For centrally cleared markets, including the security
futures market, clearinghouses may impose membership and minimum
margin requirements that cause clearing members to internalize a
greater share of the costs associated with customers' higher
leverage.
\231\ Monetary authorities may also rely on regulatory margin
requirements as a policy tool. The SEC does not consider such
motives here.
---------------------------------------------------------------------------
i. The Security Futures Market
Security futures can provide a convenient means of obtaining delta
exposure to an underlying security.\232\ To effectively compete with
other venues for obtaining similar exposures (e.g., equity and equity
options markets), security futures markets must reduce market frictions
or provide more favorable regulatory treatment. Security futures
markets may reduce market frictions by providing a lower cost means of
financing equity exposures. They can simplify taking short positions by
eliminating the need to ``locate'' borrowable securities.\233\ Security
futures can also be used to create synthetic equity repurchase
agreements or equity loans, which carry similar terms as their over-
the-counter counterparts.\234\ Finally, security futures can also
provide an opportunity for customers to gain greater leverage through
lower margin requirements (relative to margin in securities or options
transactions).
---------------------------------------------------------------------------
\232\ The derivative of the theoretical price of a futures
contract with respect to the price of the underlying (i.e., the
``delta'') is 1. For a $1 increase (decrease) in the price of an
underlying security, the theoretical price of its security future
increases (decreases) by $1.
\233\ In these respects, a security future functions like a
cleared total return swap.
\234\ This can be achieved by simultaneously entering into a
security futures position that expires at the end of the trading day
and another security futures position of the same size and on the
same underlying security but in the opposite direction and expiring
at a future date, compared to the other position. See also
Memorandum from the SEC's Division of Trading and Markets regarding
a July 16, 2019, meeting with representatives of OneChicago
(including OneChicago's presentation on STARS as synthetic equity
repos or equity loans).
---------------------------------------------------------------------------
The one U.S. exchange that provided trading in security futures,
OneChicago, discontinued all trading operations on September 21, 2020.
As of the end of 2019, 13,792 security futures contracts \235\ on 1,638
symbols were traded on the exchange. Of these 13,792 contracts, 343 had
open interest at the end of the year. Total open interest at the end of
the year was 602,276 contracts. Annual trading volume in 2019 was close
to 7.4 million contracts, an increase of approximately 4% from the
prior year. At this time, however, no security futures contracts are
listed for trading on U.S. exchanges.
---------------------------------------------------------------------------
\235\ The typical contract is written on 100 shares of
underlying equity.
---------------------------------------------------------------------------
According to OneChicago, prior to the cessation of trading, almost
all security futures positions were carried in futures accounts of
CFTC-regulated FCMs.\236\ Consequently, the SEC believes only a small
fraction of security futures accounts previously fell under the SEC's
customer margin requirements for security futures. The SEC believes
that none of the accounts that were subject to the SEC's security
futures margin rules used the Portfolio Margin Rules.\237\ Therefore,
the SEC believes that all of the securities accounts that previously
fell under the SEC's margin rules would have been subject to the
general initial and maintenance margin requirement of 20% and the
associated Strategy-Based Offset Table.
---------------------------------------------------------------------------
\236\ See OneChicago Petition.
\237\ If security futures positions were held in a Portfolio
Margin Account they would be included in the risk-based portfolio
margin calculation and thus effectively subject to a lower (i.e.,
15%) margin requirement under the baseline. Based on an analysis of
FOCUS filings from year-end 2019, no broker-dealers had collected
margin for security futures accounts in a Portfolio Margin Account.
---------------------------------------------------------------------------
[[Page 75136]]
ii. Regulation
In the U.S., a security future is considered both a security and a
future, so customers who wish to buy or sell security futures must
conduct the transaction through a person registered both with the CFTC
as either an FCM or an IB and the SEC as a broker-dealer.\238\ In
addition, an investor can trade security futures using either a futures
account or a customer securities account.
---------------------------------------------------------------------------
\238\ See supra note 12.
---------------------------------------------------------------------------
As discussed in section I, Section 7(c)(2)(B) of the Exchange Act
provides that the customer margin requirements must satisfy four
requirements. First, they must preserve the financial integrity of
markets trading security futures products.\239\ Second, they must
prevent systemic risk.\240\ Third: (1) They must be consistent with the
margin requirements for comparable options traded on any exchange
registered pursuant to Section 6(a) of the Exchange Act; \241\ and (2)
the initial and maintenance margin levels must not be lower than the
lowest level of margin, exclusive of premium, required for any
comparable exchange-traded equity options.\242\ Fourth, excluding
margin levels, they must be, and remain consistent with, the margin
requirements established by the Federal Reserve Board under Regulation
T.\243\
---------------------------------------------------------------------------
\239\ See Section 7(c)(2)(B)(i) of the Exchange Act.
\240\ See Section 7(c)(2)(B)(ii) of the Exchange Act.
\241\ See Section 7(c)(2)(B)(iii)(I) of the Exchange Act.
\242\ See Section 7(c)(2)(B)(iii)(II) of the Exchange Act.
\243\ See Section 7(c)(2)(B)(iv) of the Exchange Act.
---------------------------------------------------------------------------
Under existing SEC rules, the minimum initial and maintenance
margin requirement for a customer's unhedged security futures position,
not subject to an exemption is 20% of its current market value.\244\
SRAs may allow margin levels lower than 20% for accounts with
``strategy-based offsets'' (i.e., hedged positions).\245\ Strategy-
based offsets can involve security futures as well as one or more
related securities or security futures position, consistent with the
Strategy-Based Offset Table.\246\
---------------------------------------------------------------------------
\244\ See SEC Rule 403(b)(1).
\245\ See SEC Rule 403(b)(2).
\246\ See section II.B. above (discussing the Strategy-Based
Offset Table).
---------------------------------------------------------------------------
Accounts subject to the Portfolio Margin Rules are also exempt from
the customer margin requirements for security futures.\247\ Under
currently approved Portfolio Margin Rules, the effective margin
requirement for an unhedged security futures position or an exchange-
traded option on a narrow-based index or an individual equity is
15%.\248\ Under current rules, only customer securities accounts held
through SEC-regulated broker-dealers could potentially be subject to
the Portfolio Margin Rules; however, the SEC is not aware of any
broker-dealers offering such accounts. Margin requirements for security
futures positions of clearing members (i.e., their accounts at a
clearing agency or DCO) are also exempt from the security futures
margin requirements.\249\
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\247\ See CFTC Rule 41.42(c)(2)(i), 17 CFR 41.42(c)(2)(i); SEC
Rule 400(c)(2)(i), 17 CFR 242.400(c)(2)(i).
\248\ This follows from the methodology of current SRO Portfolio
Margin Rules as applied to delta one securities. There is no
comparable portfolio margining system for security futures held in a
futures account and, therefore, these positions, if unhedged, are
subject to the required 20% initial and maintenance margin levels.
\249\ See SEC Rule 400(c)(2)(i) through (v), 17 CFR
242.400(c)(2)(i) through (v). Clearing members are instead subject
to margin rules of the clearing organization as approved by the SEC
pursuant to Section 19(b)(2) of the Exchange Act, 15 U.S.C.
78s(b)(2).
---------------------------------------------------------------------------
3. Considerations of Costs and Benefits
Under the final rule amendments being adopted in this release, the
initial and maintenance margin requirements for a security futures
position will be reduced from 20% to 15% of the current market value of
the position. This section discusses both the likely economic effects
of the final rule amendments conditional on the resumption of trading
in security futures, and the extent to which the final rule amendments
may affect the likelihood that trading in security futures contracts
resumes.
One commenter expressed concern that the SEC did not present any
substantive analysis of the proposed amendment's possible
benefits.\250\ In response to this comment, as stated in the 2019
Proposing Release, the SEC cannot quantify the benefits to investors
from the potential effects of the final rule amendments on investor
demand, investor participation, price discovery and liquidity.\251\ As
discussed in more detail below, OneChicago provided information about
the likely reduction in initial margin requirements it expected from
the proposed rule amendments. Although this information supports the
SEC's view that the final rule amendments could increase investor
participation in the security futures market if trading resumes, it is
not possible to meaningfully estimate the magnitude of any such
increase, and related implications for the market for exchange-traded
equity options without additional information about investors'
sensitivity of demand for security futures and exchange-traded equity
options positions with respect to changes in margin levels.\252\ This
sensitivity is difficult to estimate because it requires historical
data on positions and associated margins from customer securities
accounts, which broker-dealers currently do not report to the SEC.\253\
While the SEC's analysis of the costs and benefits of the final rule
amendments are qualitative in nature, the inability to quantify certain
benefits and costs does not mean that the overall benefits and costs of
the final rule amendments are any less significant.
---------------------------------------------------------------------------
\250\ See CII Letter at 3.
\251\ See 2019 Proposing Release, 84 FR at 36449.
\252\ This sensitivity is more formally known as the margin
elasticity of demand.
\253\ While the minimum margin requirements are set by
regulation and therefore known, the actual margin associated with a
position is set by a broker-dealer and may be different from the
regulatory minimum.
---------------------------------------------------------------------------
Security futures prices reflect the aggregate demand for security
futures of all participating investors, including those that are
subject to margin requirements and those that are not. Among other
things, this demand depends on the costs associated with margin
requirements, such as the opportunity cost of the margin collateral.
All else equal, higher margin levels may reduce individual demand
because of potential higher trading costs.
As stated above, at the end of 2019, open interest in the U.S.
security futures markets was 602,276 contracts. SEC staff understands
that approximately 2% of these contracts were held in securities
accounts subject to SEC margin requirements.\254\ None of these
accounts is believed to have been subject to Portfolio Margin Rules.
This information, in combination with information supplied by
commenters, can be used to construct a hypothetical estimate of the
effect of the final rules on initial margin collected were security
futures to continue to trade at OneChicago. According to OneChicago,
the total reduction in margin collected (including margin collected on
security futures held in futures accounts,) would have been $130
million.\255\ Because the SEC estimates approximately 2% of these
contracts were held in securities accounts, the margin reduction
attributable to securities accounts would have been approximately $2.6
million.\256\ The SEC expects this may overestimate the impact of the
final rule, as broker-dealers may currently impose
[[Page 75137]]
initial margin requirements exceeding 20% on certain security futures
if they deem higher margin amounts necessary for risk management.\257\
---------------------------------------------------------------------------
\254\ See 2019 Proposing Release, 84 FR at 36449.
\255\ OneChicago Letter at 14.
\256\ Calculated as $130 million x 0.02 = $2.6 million.
\257\ See OneChicago Letter at 14 (stating that as of August 26,
2019, 92% of OneChicago security futures had a risk level above
20%).
---------------------------------------------------------------------------
i. Impact on Investor Participation
By lowering the minimum margin requirement for unhedged security
futures positions held outside Portfolio Margining Accounts, the final
rule amendments may affect participation in the security futures
market, in the event that trading in security futures resumes in the
United States. Reducing the trading costs for investors that hold these
positions outside of Portfolio Margin Accounts may increase demand for
security futures and may benefit investors by reducing the costs of
taking on or laying off risk exposures.
The potential trading cost savings associated with the final rule
amendments may also increase the competitiveness of security futures
relative to certain potential close substitutes that are not directly
affected by the margin requirements of the final rule amendments. As a
result, if security futures trading resumes, the final rule amendments
may encourage higher investor participation in the security futures
market relative to what was previously observed under current initial
margin requirements, to the benefit of financial intermediaries that
offer security futures to their customers and exchanges that list
security futures for trade, while potentially reducing fees earned by
intermediaries and exchanges from services provided in related markets.
In addition to margin requirements, individual demand for security
futures depends on the availability of other financial instruments (or
strategies based on these instruments) that may be viewed by an
investor as close substitutes to security futures. For example, certain
OTC instruments that offer delta one exposure to the underlying
security and certain security futures positions may be viewed as close
substitutes.\258\ Furthermore, certain option spread positions and
certain futures positions may be viewed by some investors as close
substitutes.\259\ These potential substitutes exist on a continuum, and
some alternative strategies have risk profiles and cash flows more
similar to security futures than others.\260\ In the presence of these
alternatives, individual demand for a security futures position depends
on the relative cost of alternative strategies, including the cost of
financing the alternative position (e.g., margin requirements) and the
cost of bearing risk exposures that are incremental to the desired risk
exposure obtainable through security futures.
---------------------------------------------------------------------------
\258\ See OneChicago Letter (describing these OTC instruments,
including equity swaps and stock loans).
\259\ See section IV.B.4.ii.a infra (discussing comparability of
exchange-traded options and security futures).
\260\ One commenter specifically argued that that single stock
futures and equity options are sufficiently distinct that they do
not trade interchangeably, and supplied data to support its claim.
See section IV.B.4.ii.a infra.
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The final rule amendments will also result in more consistent
margining for identical unhedged security futures positions held within
or outside Portfolio Margining Accounts. This will promote regulatory
parity of security futures margin requirements between Portfolio Margin
Accounts and securities accounts that do not offer portfolio margining,
as well as between securities and futures accounts. To the extent that
customers are currently unwilling to bear the costs of opening
Portfolio Margin Accounts, they may decline opportunities to
participate in the security futures market or may instead bear the
costs of holding security futures in their securities accounts. If
trading resumes, parity in margin requirements could result in
efficiencies for customers who might otherwise open separate accounts
to obtain security futures exposure in response to differing margin
requirements across account types.
ii. Impact on use of Leverage and Investor Behavior
If security futures trading resumes, the final rule amendments may
provide investors with opportunities to take on additional leverage.
Because security futures allow investors to acquire 100% exposure in
the underlying security (also known as ``delta one'' exposure) for a
fraction of the cost of funding a position in the cash market, the
final rule amendments may reduce the cost of financing leveraged
exposures through security futures. In particular, the final rule
amendments may increase the attractiveness of security futures as means
to finance delta one exposure.
Increased leverage can result in larger investor losses, and may
exacerbate the potential costs to investors from trading patterns that
reflect behavioral biases. For example, in equity markets, retail
investors may be subject to costs from certain trading patterns that
are consistent with the so-called ``disposition effect''--an aversion
to realize losses. To the extent that the final rule amendments lower
the cost that retail investors bear when they participate in the
security futures market and encourage more participation, the potential
costs associated with the ``disposition effect'' and other behavioral
biases could be exacerbated.
However, the potential costs associated with retail investors'
behavioral biases are likely to be limited in aggregate, because (i)
under the baseline, retail investors are believed to represent a very
small fraction (less than 1%) of open interest in security futures; and
(ii) broker-dealers may still impose higher initial margin requirements
and other measures to manage risk exposures to their customers and meet
clearing organization requirements.
One commenter noted that the daily variation settlement in the
futures market would counter the disposition effect as it relates to
security futures, while the current margining system in the options
markets exacerbate the effect.\261\ The SEC appreciates the analysis
provided by this commenter. However, contrary to the conclusion of this
analysis, both the margin on a futures position and the margin on an
options position move in the same direction (as compared to opposite
directions, as suggested by the commenter), because in the exchange-
traded equity options market, the initial and maintenance margin
generally applies to the short position only.\262\
---------------------------------------------------------------------------
\261\ See OneChicago Letter, Appendix A.
\262\ Thus, when the option position increases in value for the
long investor, the maintenance margin assessed to the short investor
(the seller of the position) increases proportionally. Customers who
buy long exchange-traded options generally must pay for them in
full. See supra note 94 (discussing margin requirements for long
exchange-traded options).
---------------------------------------------------------------------------
iii. Impact on Financial Intermediaries
The final rule amendments may also provide benefits to financial
intermediaries that facilitate trading in security futures, thereby
providing incentives to list security futures. Broker-dealers and
exchanges generally charge fees for purchases and sales of listed
securities and derivatives contracts. To the extent that the final rule
amendments increase future participation in security futures markets if
trading resumes, security futures exchanges and broker-dealers that
offer customers the ability to trade security futures in securities
accounts may earn higher fees from security futures activity, than
would be the case in the absence of the final rule amendments, although
an increase in revenues in the security futures market may reduce fees
earned from activity in related markets.
[[Page 75138]]
In turn, opportunities to earn higher fees from enabling transactions
in security futures may encourage exchanges to list security futures.
As a result, the final rule amendments could incrementally increase the
likelihood that trading in security futures contracts resumes.
Lowering the regulatory minimum margin requirements for security
futures margin could also impose costs on broker-dealers, their
customers, and counterparties. To the extent that lower regulatory
margin requirements cause some broker-dealers to impose lower margin
requirements on customers if trading resumes, the final rule amendments
could increase the default risk of the broker-dealer, and a broker-
dealer default would likely impact the defaulting broker-dealer's
customers and counterparties. However, broker-dealers participating in
security futures markets would be subject to clearing organizations'
margin requirements and the SEC's broker-dealer financial
responsibility rules (including minimum capital requirements).\263\
Such requirements are reasonably designed to mitigate the risk of a
broker-dealer's default. In addition, in the event of such a default,
the SEC's customer protection rule would protect customers' assets held
in a securities account.\264\
---------------------------------------------------------------------------
\263\ 17 CFR 240.15c3-1.
\264\ 17 CFR 240.15c3-3. The SEC acknowledges that any security
futures held in futures accounts would benefit from the CFTC's
customer protection rules found in part 1 of the CFTC's regulations.
---------------------------------------------------------------------------
iv. Resumption of Trading in the U.S. Security Futures Market
The final rule amendments may increase investors' willingness to
participate in the security futures markets to an extent that is
sufficient to result in resumption in exchange trading of security
futures in the U.S. Although we expect the final rule amendments to
have, at most, an incremental effect on the likelihood that trading
resumes, the potential revitalization of the U.S. security futures
market could produce economic consequences for investors,
intermediaries, and financial markets.
A liquid U.S. security futures market could result in both costs
and benefits for investors. Access to security futures could benefit
investors by reducing the costs that investors incur to obtain risk
exposures or finance other transactions. As discussed earlier, security
futures can allow investors to obtain low-cost exposure to underlying
securities.\265\ In particular, security futures can simplify the
process of taking short positions by eliminating the need to locate
borrowable securities. Moreover, security futures can be combined to
produce synthetic equity loans or equity repurchase agreements.\266\
These activities, however, have attendant risks. As discussed above, an
investor that uses security futures to obtain leveraged exposure to
underlying securities also is exposed to the risk of larger losses.
---------------------------------------------------------------------------
\265\ See section IV.B.2.i.
\266\ Id.
---------------------------------------------------------------------------
Resumption of trade in the U.S. security futures market could
permit intermediaries to earn additional revenues by serving investors
that participate in the security futures market. Whether revenues from
transaction services increase depends on whether investors transact in
security futures in addition to cash market securities rather than
simply reallocating their cash market activities to security futures
markets.
v. Effects of Revisions to Strategy-Based Offset Table
As discussed in section II.B. above, the revised Strategy-Based
Offset Table is being re-published as proposed.\267\ The re-published
Strategy-Based Offset Table incorporates the 15% required margin levels
for certain offsetting positions and retains the same percentages for
all other offsets. The revisions to the Strategy-Based Offset Table
would promote consistency with the lower margin levels on unhedged
security futures positions of the final rule amendments. If security
futures trading resumes, the revisions would generally benefit
investors from the lower cost of carrying offset positions. The SEC
also expects any additional costs incurred by broker-dealers to
incorporate the revised Strategy-Based Offset Table into their existing
policies and procedures to be similarly insubstantial.
---------------------------------------------------------------------------
\267\ See 2019 Proposing Release, 84 FR at 36441-43.
---------------------------------------------------------------------------
4. Effects on Efficiency, Competition, and Capital Formation
In addition to the specific costs and benefits discussed above, the
reductions to minimum margin requirements on unhedged security futures
that the SEC is adopting may have broader effects on efficiency,
competition, and capital formation.
i. Efficiency
Should trading in security futures resume, the SEC expects the
final rule amendments to result in incremental improvements in
efficiency to the extent that they permit investors to obtain the risk
exposures they desire at lower cost. The final rule amendments may also
improve liquidity in the security futures market and impact the
informational efficiency of security futures prices, as well as the
prices for related financial instruments. Reducing minimum margin
requirements could also impact the financial system more broadly
though, as discussed below, we do not expect such effects to be
substantial.
a. Efficiency and Transactions Costs
Under the current minimum margin requirements two identical
security futures positions may be subject to different margin levels
because they are held in different types of accounts. A potential
concern with the current margin requirements in these situations, and
more generally, is whether they can result in price distortions or
introduce inefficiencies in how investors allocate funds.
Current margin requirements may not necessarily result in price
distortions. This is because certain participating investors, such as
market makers,\268\ are exempt from the current margin requirements
(which would still apply to any positions held on behalf of a
customer), and they may step in to become the ``marginal investor'' in
situations where current margin requirements might otherwise distort
prices.\269\ For example, if security futures trading resumes investors
trading from outside a Portfolio Margin Account, who are not exempt
from margin requirements, would face trading costs associated with
margin requirements that may hinder their ability to trade with each
other. A seller and a buyer who agree on the value of a security
futures product may nevertheless fail to agree on a transaction price
because the buyer demands a discount to compensate herself for the cost
of meeting margin requirements, while the seller demands a premium to
compensate herself for the same costs. On their own, these distortions
would result in wider bid-ask spreads in security futures markets.
However, because market participants such as market makers, who are
exempt from margin requirements, bear minimal costs to transact, these
investors have the ability to provide quotes that are
[[Page 75139]]
generally more competitive than the quotes provided by other types of
investors, reducing uncertainty in the value of security futures.
---------------------------------------------------------------------------
\268\ Market makers are subject to exemptions from margin
requirements. See CFTC Rule 41.42(c)(2)(v); SEC Rule 400(c)(2)(v).
\269\ A market participant or investor is considered
``marginal'' if they are willing to buy or sell security futures
even for small deviations between the price of a security futures
contract and the contract's fundamental value and thus sets the
price of the contract. Such activities may be more profitable for
market makers if they encounter lower trading frictions (including
margin requirements) relative to other market participants.
---------------------------------------------------------------------------
Nevertheless, current margin requirements may result in potential
allocative inefficiencies. Trading costs associated with the current
margin requirements may impact investor demand, and therefore
willingness to take on or lay off risk exposures using security
futures. In particular, risk sharing under the regulatory minimum
margin requirements may be different relative to the case where margin
levels are optimally determined to reflect the risks of security
futures positions. The difference between the allocation of financial
risk that result from current margin requirements and the allocation
associated with the margin requirements that are optimally determined
may be viewed as an allocative inefficiency. Allocative inefficiency
may also manifest if trading costs in security futures drive investors
to use alternative products to obtain financing or manage risk, which
are less suited to their needs.
If security futures trading resumes, certain investors could reduce
these potential allocative inefficiencies by trading out of a Portfolio
Margin Account,\270\ where margin requirements can result in much lower
margin levels compared to those that apply outside such accounts.
However, as of the fourth quarter of 2019, no investors appeared to be
trading in security futures out of Portfolio Margin Accounts, despite
the fact that they did trade significantly in exchange-traded equity
options out of these accounts. This observation may indicate that
investors that qualify for Portfolio Margin Accounts have not traded
security futures.\271\ Alternatively, such investors may have chosen to
trade security futures outside of Portfolio Margin accounts, implying
that the costs they faced as a result of the current margin
requirements were not sufficiently large to discourage their
participation or to persuade them to open a Portfolio Margin Account.
---------------------------------------------------------------------------
\270\ Not all investors are eligible to open a Portfolio Margin
Account. See Cboe/MIAX Letter at 4.
\271\ With the exception of investors that are exempt from
margin requirements, the investors that hold or are eligible to open
a Portfolio Margin Account are best positioned to trade security
futures at margin levels that could be substantially below the
current minimum margin requirements. The extent to which they face
low margin levels on a new security futures position depends on any
offsetting positions--either security futures or exchange-traded
options positions--that they hold in their Portfolio Margin Account
at that time when they seek to enter the new security future
position.
---------------------------------------------------------------------------
Nevertheless, because opening Portfolio Margin Accounts entails
costs, not all investors can trade out of these accounts,\272\
therefore some investors may face barriers to participation in the
security futures market, if trading resumes. The potential
inefficiencies associated with these barriers arise when the margin
levels associated with current minimum margin requirements for security
futures are larger than the margin levels associated with margin
requirements that are optimally determined, and not because similar
positions are margined differently in other markets.
---------------------------------------------------------------------------
\272\ See Cboe/MIAX Letter (describing potential costs and
requirements associated with opening a Portfolio Margining Account).
---------------------------------------------------------------------------
The final rule amendments will lower the minimum initial margin
requirements for certain security futures positions, and in turn reduce
the trading costs for these positions. To the extent trading costs
result in inefficiencies, the final rule amendments, by lowering
trading costs, may reduce potential inefficiencies associated with the
current initial margin requirements.
Furthermore, as discussed above, lower trading costs in certain
security futures positions may increase investor demand for security
futures, and may encourage greater market participation in this market
if trading in security futures resumes. Greater participation may
increase competition over prices, which in turn may result in improved
price discovery and liquidity in the security futures market. However,
the effect of the final rule amendments on price discovery and
liquidity may be limited because, as discussed above, the marginal
participant in this market is likely one that is currently exempt from
the customer margin requirements for security futures and therefore,
able to supply liquidity at relatively low cost.
One commenter stated that the lower minimum margin requirements
combined with investors' search for sources of leverage, may increase
liquidity in the security futures market while simultaneously reducing
liquidity and price efficiency in other related markets.\273\ The SEC
acknowledges that the final rule amendments may encourage resumption of
trading in the U.S. security futures market and, if trading resumes,
may encourage arbitrageurs to rely more on the security futures market
to take advantage of potential mispricing compared to other markets, or
may increase the risk of adverse selection in equity markets if it
encourages less-informed investors to migrate to the security futures
market to obtain leveraged equity exposure at low cost.\274\ However,
the SEC does not believe that the resumption of trading in security
futures or heightened focus on the security futures market would
necessarily reduce informational efficiency or liquidity in aggregate
across related markets. Markets that support trade in financial
instruments that reference the same underlying security tend to be
interconnected to a high degree.\275\ Furthermore, investors may access
security futures quotes and post-trade information. As such, even if
trading in security futures resumes and the final rule amendments shift
price discovery from related markets to the security futures market,
information impounded in security futures prices may inform trading in
those related markets.\276\
---------------------------------------------------------------------------
\273\ See CII Letter at 3.
\274\ See Stewart Mayhew, Atulya Sarin & Kuldeep Shastri, The
Allocation of Informed Trading Across Related Markets: An Analysis
of the Impact of Changes in Equity-Option Margin Requirements, 50 J.
FIN. 1635 (1995) (showing that a reduction in options margin
requirements decreased options market bid/ask spreads and increased
option market depth-of-book, while increasing equity market bid/ask
spreads and decreasing equity market depth-of-book).
\275\ See, e.g. Sugato Chakravarty, Huseyin Gulen & Stewart
Mayhew, Informed Trading in Stock and Option Markets, 59 J. FIN.
1253 (2004) (showing that price discovery takes place both in the
equity market and the equity options market, with the latter
contributing by about 17%). Similarly, another study documents
informational flows between credit default swap markets, equity
options markets and equity markets. See Antje Berndt & Anastaysia
Ostrovnaya, Do Equity Markets Favor Credit Market News over Options
Market News?, 4(2) Q. J. FIN. 1 (2014).
\276\ See, e.g. David Easley, Maureen O'Hara & P. S. Srinivas,
Option Volume and Stock Prices: Evidence on Where Informed Traders
Trade, 53 J. FIN. 431 (1998) and Jun Pan & Allen Poteshman, The
Information in Option Volume for Future Stock Prices, 19 REV. FIN.
STUD. 871 (2006) (both showing that equity options trading provide
valuable information for equity markets).
---------------------------------------------------------------------------
b. Systemic Considerations
The final rule amendments may also impact efficiency through their
impact on risk management. As discussed above, broker-dealers likely
weigh the costs associated with customer defaults against the benefits
of lower margin requirements when setting margin requirements for their
customers. Although such private considerations would produce market-
determined margin levels that were optimal from a broker-dealer's
perspective, market imperfections could lead broker-dealers to impose
margin requirements on customers that are not efficient for the
financial system as a whole. The relevant market imperfections in the
context of margin requirements relate to
[[Page 75140]]
externalities on financial stability arising from excessive
leverage.\277\
---------------------------------------------------------------------------
\277\ The SEC acknowledges that other market imperfections
(e.g., asymmetric information, adverse selection) may also play a
role, although the SEC believes these to be less relevant to this
context. Asymmetric information about market participants' quality
can lead privately negotiated margin levels to be inefficient. For
example, competition among broker-dealers may lead to a ``race to
the bottom'' in margin requirements when customers' ``quality'' is
not perfectly observable. See e.g., Tano Santos & Jose A.
Scheinkman, Competition among Exchanges, 116 Q. J. ECON. 1027
(2001). Alternatively, problems of adverse selection (e.g.,
potential to re-invest customer margin in risky investments) or
moral hazard (e.g., expectations of government rescue) may also
create incentives for broker-dealers to offer margin requirements
that are too low. Asymmetric information about broker-dealer quality
may make it impossible for customers to provide sufficient market
discipline, leading to a problem similar to that faced by bank
depositors. See Mathias Dewatripont & Jean Tirole, Efficient
Governance Structure: Implications for Banking Regulation, in
CAPITAL MARKETS AND FINANCIAL INTERMEDIATION 12 (Colin Mayer &
Xavier Vives eds., 1993).
---------------------------------------------------------------------------
Historically, a key aspect of the rationale for regulatory margin
requirements on securities transactions was the belief that such
requirements could improve efficiency by limiting stock market
volatility resulting from ``pyramiding credit.'' \278\ Leveraged
exposures built up during price run-ups could lead to the collapse of
prices when a small shock triggers initial and maintenance margin calls
and a cascade of de-leveraging. The utility of such margin requirements
in limiting such ``excess'' volatility and the contribution of
derivatives markets to such volatility have been a perennial topic of
debate in the academic literature, rekindled periodically by crisis
episodes.\279\ Most recently, the 2007-2008 financial crisis saw
similar concerns (i.e., procyclical leverage, margin call-induced
selling spirals) raised in the securitized debt markets.\280\ While
lower margin requirements can increase the risk and severity of market
dislocations--given the current limited scale of the security futures
markets and the limited role played by SEC registrants in these
markets--the adopted reductions to minimum margin requirements are
unlikely to present a material financial stability concern.
---------------------------------------------------------------------------
\278\ See Thomas Gale Moore, Stock Market Margin Requirements,
74 J. POL. ECON. 158 (1966).
\279\ See id. See also Stephen Figlewski, Futures Trading and
Volatility in the GNMA Market, 36 J. FIN. 445 (1981). See also
Franklin R Edwards, Does Futures Trading Increase Stock Market
Volatility?, 44 FIN. ANALYSTS J. 63 (1988). See also Paul H Kupiec,
Margin Requirements, Volatility, and Market Integrity: What Have We
Learned Since the Crash?, 13 J. FIN. SERVICES RES. 231 (1998).
\280\ See e.g., Tobias Adrian & Hyun Song Shin, Liquidity and
Leverage, 19 J. FIN. INTERMEDIATION 418 (2010).
---------------------------------------------------------------------------
One commenter expressed concern that the criteria for prescribing
margin requirements under the Exchange Act to preserve the financial
integrity of markets trading security futures products and preventing
systemic risk appear to indicate potential significant risks to the
capital markets and investors by lowering margin requirements.\281\
This commenter noted that the 2019 Proposing Release specifically
acknowledged that margin requirements are a critical component of any
risk management program for cleared financial products and that higher
margin levels imply lower leverage, which reduces risk.\282\ As
described in the baseline, the vast majority of security futures
positions were held in futures accounts at CFTC-regulated entities,
and, consequently, only a small fraction of the security futures
accounts were subject to the SEC's margin rules. Therefore, even if
trading in security futures resumes and participation in security
futures markets were to increase modestly as a result of the final rule
amendments, the adopted reductions to minimum margin requirements are
unlikely to have a significant impact on the financial integrity of the
security futures market and are unlikely to lead to systemic risk.\283\
---------------------------------------------------------------------------
\281\ See CII Letter at 2.
\282\ See CII Letter at 2.
\283\ See 2019 Proposing Release, 84 FR at 36438, and 36449-50.
---------------------------------------------------------------------------
ii. Competition
The SEC has considered the potential impact of the final rule
amendments on competition. This section discusses those impacts in
detail and considers the views of commenters on the extent to which
reducing minimum margin requirements for certain accounts introduces or
eliminates competitive disparities between markets for different types
of financial instruments and markets in different jurisdictions.
a. Competition Among Related Markets
The 2019 Proposing Release stated that the proposed initial and
maintenance margin requirements would establish a more level playing
field between options exchanges and security futures exchanges, and
between broker-dealers/securities accounts and FCMs/futures
accounts.\284\ Although the SEC continues to expect the final rule
amendments to place these exchanges and account types on a more level
footing, some commenters took issue with this view. One commenter
argued that the final rule amendments would give unhedged security
futures a competitive advantage over exchange-traded equity options
when held outside a Portfolio Margining Account.\285\ This commenter
suggested that subjecting security futures and exchange-traded equity
options to different margin requirements in this way may disrupt the
regulatory parity that currently exists between security futures and
exchange-traded equity options as the proposal would create
preferential margin levels for unhedged security futures held outside
of a Portfolio Margin Account.\286\ This commenter also believed that
the proposal implies that exchange-traded equity options and security
futures are not competing products, stating that currently there is
significant trading in option spread positions that ``replicate long
and short security futures'' outside Portfolio Margin Accounts.\287\
---------------------------------------------------------------------------
\284\ See 2019 Proposing Release, 84 FR at 36451.
\285\ See Cboe/MIAX Letter at 6-8.
\286\ See Cboe/MIAX Letter at 2.
\287\ See Cboe/MIAX Letter at 6-8.
---------------------------------------------------------------------------
The SEC agrees that security futures and exchange-traded equity
options can have similar economic uses. Nevertheless, for the reasons
discussed in section II.A.2 of this release, reducing the margin levels
for an unhedged security future held outside of a Portfolio Margin
Account to 15% is unlikely to result in a competitive disadvantage for
exchange-traded equity options in practice if trading in security
futures resumes.
The SEC acknowledges that because the adopted margin requirements
apply only to unhedged security futures positions held outside
Portfolio Margining Accounts, the final rule amendments may result in
different margin requirements across security futures positions and
exchange-traded equity options positions held in this type of account.
To the extent some investors view a security futures position and an
option spread position that replicates the contractual payoffs of the
security futures position as close substitutes, the final rule
amendments may result in different costs for these positions when held
outside of a Portfolio Margining Account and may cause these investors
to prefer the security futures position to the option spread position.
From this perspective, the final rule amendments may potentially have
an adverse competitive effect on exchange-traded equity options if
trading in security futures resumes in the U.S. However, this potential
adverse competitive impact likely would be small as a substantial
portion of exchange-traded equity options are traded in Portfolio
Margin Accounts where the margin requirement for an unhedged exchanged-
traded option on a
[[Page 75141]]
narrow-based index or single-equity is 15%.\288\
---------------------------------------------------------------------------
\288\ See 2019 Proposing Release, 84 FR 36450.
---------------------------------------------------------------------------
OneChicago disagreed with the notion that security futures and
exchange-traded equity options strategies could be comparable, noting
that because security futures provide an investor with 100% exposure
(i.e., delta one exposure) to the underlying security, security futures
should instead be compared to other financial instruments that offer
delta one exposure, such as uncleared OTC equity swaps and cleared OTC
stock loans.\289\
---------------------------------------------------------------------------
\289\ OneChicago Letter.
---------------------------------------------------------------------------
OTC total return equity swaps and stock loans may compete with
security futures to provide delta one exposure at lower cost compared
to outright acquisition of the underlying security. From this
perspective, to the extent that security futures compete with these OTC
instruments, the final rule amendments would increase the
competitiveness of security futures relative to these OTC instruments.
However, this potential competitive effect is limited, because, as
OneChicago noted, under certain conditions, the costs of financing
delta one exposure through OTC equity swaps and stock loans can be
substantially smaller compared to the cost of security futures.\290\
---------------------------------------------------------------------------
\290\ OneChicago Letter. In addition, as discussed in section
II.A. of this release, Section 7(c)(2)(B) of the Exchange Act
provides that the margin requirements for security futures must be
consistent with the margin requirements for comparable exchange-
traded options. The Exchange Act does not directly contemplate
comparisons with the margin requirements for the products and
markets identified by OneChicago. Rather, it requires comparisons to
comparable exchange-traded options.
---------------------------------------------------------------------------
OneChicago further argued that the risk profile of a security
futures position cannot be replicated with exchange-traded equity
options, and on this basis challenged the argument that lower margin
requirements for security futures would reduce the competitiveness of
exchange-traded equity options.\291\ OneChicago stated that security
futures products are not comparable to exchange-traded equity options
because they have different risk profiles; exchange-traded equity
options are subject to dividend risk, pin risk, and early assignment
risk, while security futures are not.\292\ Further, OneChicago
challenged the concerns raised by other commenters that the proposed
margin requirements would result in ``regulatory arbitrage,'' arguing
that the many salient differences between security futures and
exchange-traded equity options make it virtually impossible to
replicate a security futures position using exchange-traded equity
options.\293\ OneChicago suggested that the comparison between a
security futures position and an option spread position that
``replicates'' the security futures cannot be limited to a comparison
between the contractual payoffs of these two positions. In particular,
this commenter argued that a proper comparison should include payoffs
that may occur throughout the life of the position, including payoffs
from the security future's daily settlement of variation margin (i.e.,
marking-to-market and paying or collecting variation margin) that
differs from initial and maintenance margin requirements in options
markets.\294\
---------------------------------------------------------------------------
\291\ See OneChicago Letter; OneChicago Letter 2.
\292\ OneChicago Letter at 2, 9; OneChicago Letter 2 at 1-2.
\293\ See OneChicago Letter 2.
\294\ See also OneChicago Letter (providing a more in depth
analysis of these issues together with some data that outlines
various payoff structures for different strategies based on
currently traded contracts).
---------------------------------------------------------------------------
The SEC acknowledges that even if the contractual payoffs of a
security futures position could be perfectly replicated with the
payoffs of an option spread position,\295\ the risk profiles of the two
positions may still be different.\296\ For example, the daily variation
margin settlement of the security futures position may give rise to
payoffs throughout the life of the positions that could expose the
holders of the position to funding risk. Similarly, the exchange of
variation margin for the options spread position also exposes investors
to funding risk, but to a lesser degree compared to a security futures
position.\297\ As noted by OneChicago, unlike a security futures
position, an option spread position may be subject to a number of risks
that reflect potential strategic behavior that is commonplace in the
options markets, including dividend risk, assignment risk, and pin
risk.\298\ Because funding risks and the risks that reflect strategic
behavior in options markets may affect the security futures and the
option spread positions differently, the two positions may not have the
same risk profile.
---------------------------------------------------------------------------
\295\ It is well known that in theory a long security futures
position can be perfectly replicated with an option spread position
consisting of a long European call and a short European put. Both
options have the same expiration, and each has a strike price equal
to the futures price. This result is also known as the put-call
parity. See, e.g. JOHN C. HULL, FUNDAMENTALS OF FUTURES AND OPTIONS
MARKETS, (Pearson Prentice Hall, 2017).
\296\ A number of practical factors challenge the extent to
which security futures can be perfectly replicated using an options
spread position. First, most stock options currently trading are
American style rather than European style. American style options
typically sell at a premium relative to European style options
because of the value of exercising early. Second, if the strike
price of these options (which is set to equal the futures price)
falls outside the range currently trading, liquidity may be limited
and these options may sell at a premium (or at a discount if short).
Third, certain features of the futures and options markets may
introduce payoffs throughout the life of these positions that may
further complicate the replication strategy. For example, the daily
settlement process in the futures market may result in additional
payments or payouts to the holder of the futures position, relative
to the contractual payoffs of the position. Similarly, the practice
of exchanging variation margin in the options market may result in
additional payments/payouts to the holder of the options positions.
These additional payments generally help reduce the potential loss
due to a counterparty failure, but may also expose a counterparty to
funding risk. Finally, the option spread position may be subject to
a number of risks that reflect potential strategic behavior that is
commonplace in the options markets, including dividend risk,
assignment risk, and pin risk (for definitions of dividend risk,
assignment risk and pin risk, see OneChicago Letter 3, at n.23, 24,
and 25). The futures position may also be exposed to some of these
risks through the daily settlement process (for example, the price
of a futures contract on a dividend-paying stock would reflect an
unanticipated change in the dividend policy at the time when this
change in policy is made public). The factors outlined above point
to potential price disparities between the security futures and the
option spread positions that cannot be arbitraged away. The last two
factors also point to sources of potential risks, and therefore
sources of potential losses, that may impact the two positions
differently. In general, these factors may cause the risk profile of
the security futures and the risk profile of the option spread
positions to drift apart.
\297\ The margin on the security futures position is calculated
on the current market value of the position, while the margin on the
option spread position is generally calculated on the value of the
short leg of the position, outside of a Portfolio Margin Account.
\298\ See supra note 296 (describing what these risks are). See
also OneChicago Letter 3, at n.23-25.
---------------------------------------------------------------------------
Notwithstanding these differences, under certain conditions, the
risk profiles of the two positions may be sufficiently similar for some
investors, and may be viewed by these investors as close (but not
necessarily perfect) substitutes. These strategies are economic
equivalents to a certain degree because both provide exposure to an
underlying equity security or narrow-based equity security index
outside the cash equity market.\299\ Thus, both strategies can be used
to hedge, at least partially, a long or short position in the
underlying equity security or narrow-based equity security index.
Similarly, each strategy can also be used to speculate on a potential
price movement of the underlying equity security or narrow-based equity
security index. Furthermore, both short security futures positions and
certain exchange-traded equity options strategies produce unlimited
downside risk. Investors in security futures and writers of options may
lose their initial and maintenance
[[Page 75142]]
margin on deposit and premium payments and be required to pay
additional funds in the event of a default of a broker-dealer or
clearinghouse.
---------------------------------------------------------------------------
\299\ See supra note 117.
---------------------------------------------------------------------------
In addition, a deep-in-the money call or put option on the same
security can have a delta approaching one if the underlying security
takes values in a certain range of outcomes. Over such a range of
outcomes, equity option contracts may be comparable to a security
futures contract. Further, as stated by one commenter, synthetic
futures strategies are an important segment of today's options markets
competing everyday with security futures.\300\
---------------------------------------------------------------------------
\300\ See Cboe/MIAX Letter at 6-7.
---------------------------------------------------------------------------
OneChicago provided empirical analyses to support its claim that
changes to security futures margin rates would not impact exchange-
traded equity options. In one analysis, OneChicago observed data
inconsistent with a statistically positive correlation between the E-
mini margin rates and either the ratio of SPX (S&P 500) options open
interest to E-mini S&P 500 futures open interest or the ratio of SPX
trading volume to E-mini trading volume.\301\ In another analysis,
OneChicago provided statistical data on the correlation in open
interest between security futures and exchange-traded equity options.
This analysis shows that there is no significant correlation between
the two types of open interest, and OneChicago saw this finding as
supporting their conclusion that market participants have discrete uses
for security futures and ``equity options and that the derivatives are
not interchangeable.'' \302\
---------------------------------------------------------------------------
\301\ OneChicago Letter 3 at 12-15.
\302\ OneChicago Letter 3 at 15.
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The SEC appreciates the empirical analyses provided by OneChicago,
while also noting that the inferences in these analyses are subject to
multiple limitations that make it difficult to conclude on the basis of
these analyses that reducing minimum initial and maintenance margin
requirements for security futures would not reduce the use of
comparable options strategies. It is unclear to what degree results
from the SPX options market and the E-mini futures market can be
generalized to exchange-traded equity options and security futures.
Unlike their single-stock counterparts, derivatives that are based on
broad-based indices can be used by a wide range of institutional and
retail investors for purposes broader than obtaining exposure to
individual equities or obtaining cash to finance other positions.
Participants in these markets may seek to efficiently hedge market risk
or express views on the direction or volatility of equity indices.
Moreover, the markets for futures and options that track the S&P 500
index or track an investable portfolio of S&P 500 equities include more
than just the products that OneChicago analyzed. This makes it
difficult to extrapolate results from these markets to the markets for
exchange-traded options and security futures. Furthermore, OneChicago's
analysis of security futures and exchange-traded equity options
compares security futures to all equity options contracts, without
focusing on those segments of the equity options market most comparable
to security futures, such as strategies that approximate delta one
exposure.
The final rule amendments may improve the ability of security
futures intermediaries and exchanges to compete in the market for other
financial services. Certain analyses submitted by OneChicago to the
comment file support this view with evidence that security futures
would be used for different purposes than exchange-traded equity
options.\303\ For example, OneChicago compared trade size (number of
contacts and notional value) in security futures with trade size in
options markets and security future delivery rates with options
exercise rates,\304\ and concluded that the higher trade size and
higher delivery rates in security futures markets indicated that
investors use the security futures market for financing purposes. When
summarizing its findings, OneChicago stated that the delivery data
makes ``clear'' that the ``markets view and use the products
differently.'' \305\ OneChicago further asserted that certain security
futures strategies represent exchange-traded substitutes for securities
lending and equity repo transactions.\306\
---------------------------------------------------------------------------
\303\ OneChicago Letter at 2-3.
\304\ OneChicago Letter 3 at 9-12.
\305\ OneChicago Letter 3 Summary at 1.
\306\ OneChicago Letter 3, at 22.
---------------------------------------------------------------------------
b. Foreign Markets for Security Futures
Finally, OneChicago noted that U.S. security futures markets faced
competition from foreign markets that rely on risk-based initial margin
that, in contrast to Portfolio Margin Accounts, do not have a strategy-
based floor and in which ``naked positions are margined at risk-based
levels.'' \307\ OneChicago supplied initial margin requirements for
security futures written on Dow Jones Industrial Average components at
Eurex on July 25, 2019, ranging from 6.64% to 14.71%. The SEC
acknowledges that other jurisdictions may choose to implement initial
margin requirements for security futures under local legal regimes that
differ from those of the United States. To the extent that customers
may access a number of different markets, higher initial margin
requirements in one jurisdiction may place intermediaries and exchanges
regulated by that jurisdiction at a competitive disadvantage relative
to others.\308\ However, as discussed above, the SEC is not persuaded
by arguments that implementing a risk model approach to calculating
margin for security futures would at this time be permitted under U.S.
law and, furthermore, notes that the final rule amendments may reduce
the degree of competitive disadvantage if trading resumes in the U.S.,
at least insofar as foreign markets would draw away customers that
would otherwise trade security futures outside of Portfolio Margin
Accounts.\309\
---------------------------------------------------------------------------
\307\ OneChicago Letter, at n.54 and accompanying text.
\308\ OneChicago submitted a customer letter supporting this
point. See OneChicago Letter, Appendix C.
\309\ See supra note 182 in section IV.A.4. (CFTC--Description
of Costs) (noting that trading by U.S. persons in security futures
contracts listed on Eurex is subject to certain conditions under an
SEC order and a CFTC staff advisory).
---------------------------------------------------------------------------
iii. Capital Formation
As discussed above, the potential benefits to investors that flow
from the final rule amendments including a lower cost of obtaining
underlying securities, the opportunity to take on more leverage
(relative to the baseline), and the potential increase in price
competitiveness, may increase investor demand for access to security
futures contracts. To the extent security futures trading resumes in
the U.S., and investor participation causes the market for security
futures to grow, the final rule amendments would have an impact on
capital formation. An active security futures market can reduce the
frictions associated with shorting equity exposures (making it easier
for negative information about a firm's fundamentals to be incorporated
into security prices) or financing securities exposures. This could
promote more efficient capital allocations by facilitating the flow of
financial resources to their most productive uses.
5. Reasonable Alternatives Considered
In the 2019 Proposing Release, the SEC stated it did not believe
there are reasonable alternatives to the proposal to reduce minimum
margin levels for unhedged security futures.\310\ Two
[[Page 75143]]
commenters took issue with this observation and suggested several
alternatives for the SEC to consider.\311\ One commenter suggested two
alternatives: (1) Reduce the size of security futures contracts; and
(2) rule-based margin with flexible settlement intervals.\312\ The
other commenter suggested two additional alternatives: (1) Risk-based
margins for all security futures products; and (2) risk-based margins
for select security futures products involving STARS transactions.\313\
---------------------------------------------------------------------------
\310\ 2019 Proposing Release, 84 FR at 36451.
\311\ See CII Letter at 4; OneChicago Letter.
\312\ See CII Letter at 4; see also Commissioner Jackson's
Statement.
\313\ See OneChicago Letter; OneChicago Letter 2; OneChicago
Letter 3; see also Ianni Letter; La Botz Letter.
---------------------------------------------------------------------------
The SEC addresses the suggested alternatives below. The discussion
of those alternatives includes certain commenter proposals that the
Commissions still do not believe are viable at this time for the
reasons discussed by the Commissions in more detail above.
i. Reduce the Size of the Security Futures Contract
One commenter suggested that an alternative to lowering the margin
on security futures could be to reduce the size of a security futures
contract.\314\ This commenter noted that a similar reduction in the
size of the S&P e-mini futures contract that led to the creation of S&P
micro e-mini futures could increase access to single-stock futures for
the most popular securities and improve efficiency.\315\ The SEC
acknowledges that one way to reduce the dollar value of margin required
for a position in a given contract is to reduce the size of the
contract. However, an investor is more likely to determine her optimal
exposure in terms of notional value or as a proportion of her available
financial resources, rather than as a number of contracts. This
alternative would not change the amount of margin that would be
assessed on such an investor's optimal exposure. For example, if the
size of the contract were reduced by half, so would the value of margin
required, subject to certain caveats,\316\ but the investor would need
twice as many contracts to establish her optimal exposure. Thus, the
total margin for this exposure would not change significantly from the
baseline. However, a reduction in contract size is known to encourage
market participation, and therefore, this alternative may spur demand
for security futures.\317\
---------------------------------------------------------------------------
\314\ See CII Letter at 4; see also Commissioner Jackson's
Statement.
\315\ See CII Letter at 4.
\316\ There may be other factors that may affect whether the
margin scales up or down with the size of the contract, in a linear
fashion.
\317\ See, e.g., Lars Nord[eacute]n, Does an Index Futures Split
Enhance Trading Activity and Hedging Effectiveness of the Futures
Contract, 26 J. FUTURES MARKETS 1169 (2006).
---------------------------------------------------------------------------
ii. Rule-Based Margins With Flexible Margin Settlement Intervals
The same commenter suggested another alternative that would
maintain the current minimum margin requirements and reduce margins by
changing the margin settlement intervals for security futures.\318\
This alternative is based on the findings of one study, which
quantifies the extent to which current margin requirements overmargin
or undermargin a futures position relative to a risk-based margin
requirement (e.g., traditional futures).\319\ This study finds that
current margin requirements are overly conservative, and that
increasing the length of the margin settlement interval may help
alleviate the problem. The study further suggested that exchanges
should be allowed to set the length of the margin settlement interval
as a means of competing with one another.
---------------------------------------------------------------------------
\318\ See CII Letter at 4.
\319\ Hans R. Dutt & Ira L. Wein, On the Adequacy of Single-
Stock Futures Margining Requirements, 10 J. FUTURES MARKETS 989
(2003).
---------------------------------------------------------------------------
While changing the length of the margin settlement interval may
provide another way of reducing margins, it is not clear how feasible
this method would be in practice. Allowing exchanges to set different
margin settlement intervals for different products and update these
over time would increase complexity and potentially impose operation
costs on market participants. Because this alternative is not used
currently in any equity markets (to the SEC's knowledge), and because
there is uncertainty about how to calibrate the mechanism to deliver
margin requirements in this context, the operational costs of this
alternative could be large.
Moreover, the SEC recognizes that daily margin settlement is an
important risk management tool in the markets for security futures,
especially in light of recent market volatility. OneChicago--the only
exchange trading security futures at the time the rule amendments were
proposed--also cited risk management concerns, arguing that such an
approach would remove a critical protection in futures markets.\320\
---------------------------------------------------------------------------
\320\ OneChicago Letter at 6.
---------------------------------------------------------------------------
Finally, the Commissions are adopting the final rules because they
produce a desired policy outcome of aligning the minimum margin levels
for security futures held in non-Portfolio Margin Accounts with the
margin levels for security futures in a Portfolio Margin Account, for
the reasons discussed in section II.A. above. Modifying margin
settlement intervals would not accomplish this policy outcome.
For these reasons, the SEC is not adopting an approach that
includes rules-based margin requirements with flexible settlement
intervals in this release.
iii. Risk-Based Margin for All Security Futures Products
OneChicago suggested the alternative of using risk-based margin
requirements for security futures products. OneChicago stated that
risk-based margin requirements would give security futures the best
chance to compete with other products that provide delta one exposure
to an underlying security, including products traded in overseas
markets and that are subject to similar risk-based margin
requirements.\321\ According to OneChicago's analysis, the Commissions'
proposal to lower the required margin levels from 20% to 15% would have
resulted in a 25% reduction in the value of initial margin collected
(from $540 million to $410 million); whereas using a risk-based margin
model would have resulted in a 61% reduction (from $540 million to $210
million).\322\ This suggests that the margin savings to investors from
risk-based margin requirements may be economically significant.
---------------------------------------------------------------------------
\321\ See OneChicago Letter at 12-13.
\322\ OneChicago Letter at 14.
---------------------------------------------------------------------------
OneChicago also supported its position that the Commissions should
permit risk-based margin for security futures, presenting analysis that
estimated that 92% of OneChicago products were ``overmargined'' (in the
sense that the minimum margin requirement was greater than the level
that would result from a risk-based margin calculation) at a 20%
minimum margin requirement and 84% of OneChicago products would be
``overmargined'' at a 15% minimum margin requirement. This analysis
suggests that the final rule amendments would set margin requirements
for 8% of OneChicago products equal to the margin levels that would
arise from risk-based margining but that a substantial majority of
OneChicago products would have minimum margin requirements above risk-
based levels, if security
[[Page 75144]]
futures trading at OneChicago resumes.\323\
---------------------------------------------------------------------------
\323\ Id.
---------------------------------------------------------------------------
The SEC acknowledges that risk-based initial margin requirements
may result in more efficient levels of margin being collected compared
with margin requirements based on fixed margin levels. Moreover, moving
to risk-based margin requirement would likely achieve a larger
reduction in competitive frictions between security futures and
alternative means of financing delta one exposure (e.g., use of OTC
equity swaps and stock loans) than the final rules.
However, as discussed in section II.A. above, the SEC is not
persuaded by OneChicago's arguments that, at this time, implementing a
risk model approach to calculating initial margin for security futures
would be permitted under Section 7(c)(2)(B) of the Exchange Act given
that such risk-based margin models are not currently used to set
initial margin for customers in the equity options markets. Moreover,
implementing a risk model approach would substantially alter how the
required minimum initial and maintenance margin levels for security
futures are calculated. It also would be a significant deviation from
how margin is calculated for listed equity options and other equity
positions (e.g., long and short securities positions). It would not be
appropriate at this time to implement a different margining system for
security futures, given their relation to products that trade in the
U.S. equity markets. Further, implementing a different margining system
for security futures may result in substantially lower margin levels
for these products as compared with other equity products and could
have unintended competitive impacts. For these reasons, this suggested
alternative to permit risk-based margin models to determine customer
margin requirements for security futures is not viable.
iv. Risk-Based Margin for a Subset of Security Futures Products
OneChicago suggested the alternative of using risk-based margin
requirements for STARS transactions.\324\ OneChicago stated that risk-
based margin requirements would allow STARS transactions to compete
with other transactions that market participants currently use to
finance their activities.
---------------------------------------------------------------------------
\324\ OneChicago Letter at 19; see also Memorandum from the
SEC's Division of Trading and Markets regarding a July 16, 2019,
meeting with representatives of OneChicago.
---------------------------------------------------------------------------
The SEC's consideration of this alternative is similar to the
alternative of permitting risk-based initial margin requirements for
all security futures transactions. While the SEC acknowledges that
risk-based initial margin requirements may be more efficient than
margin requirements based on fixed margin levels, the SEC is not
persuaded by OneChicago's arguments that, at this time, implementing a
risk model approach to calculating initial margin for STARS
transactions would be permitted under Section 7(c)(2)(B) of the
Exchange Act. For this reason, as well as the recent announcements by
OneChicago, this suggested alternative for STARS transactions is not
viable.
V. Regulatory Flexibility Act
A. CFTC
The Regulatory Flexibility Act (``RFA'') requires that Federal
agencies, in promulgating rules, consider the impact of those rules on
small entities.\325\ The final rules would affect designated contract
markets, FCMs, and customers who trade in security futures, if security
futures trading resumes. The CFTC has previously established certain
definitions of ``small entities'' to be used by the CFTC in evaluating
the impact of its rules on small entities in accordance with the
RFA.\326\
---------------------------------------------------------------------------
\325\ 5 U.S.C. 601 et seq.
\326\ Policy Statement and Establishment of Definitions of
``Small Entities'' for Purposes of the Regulatory Flexibility Act,
47 FR 18618, 18618-21 (Apr. 30, 1982).
---------------------------------------------------------------------------
In its previous determinations, the CFTC has concluded that
contract markets are not small entities for purposes of the RFA, based
on the vital role contract markets play in the national economy and the
significant amount of resources required to operate as SROs.\327\ The
CFTC also has determined that notice-designated contract markets are
not small entities for purposes of the RFA.\328\
---------------------------------------------------------------------------
\327\ Id. at 18619.
\328\ Designated Contract Markets in Security Futures Products:
Notice-Designation Requirements, Continuing Obligations,
Applications for Exemptive Orders, and Exempt Provisions, 66 FR
44960, 44964 (Aug. 27, 2001).
---------------------------------------------------------------------------
The CFTC has previously determined that FCMs are not small entities
for purposes of the RFA, based on the fiduciary nature of FCM-customer
relationships as well as the requirements that FCMs meet certain
minimum financial requirements.\329\ In addition, the CFTC has
determined that notice-registered FCMs,\330\ for the reasons applicable
to FCMs registered in accordance with Section 4f(a)(1) of the CEA,\331\
are not small entities for purposes of the RFA.\332\
---------------------------------------------------------------------------
\329\ Supra note 326 at 18619.
\330\ A broker or dealer that is registered with the SEC and
that limits its futures activities to those involving security
futures products may notice register with the CFTC as an FCM in
accordance with Section 4f(a)(2) of the CEA (7 U.S.C. 6f(a)(2)).
\331\ 7 U.S.C. 6f(a)(1).
\332\ 2002 Adopting Release, 67 FR at 53171.
---------------------------------------------------------------------------
Finally, the CFTC notes that according to data from OneChicago, 99%
of all customers that transacted in security futures as of March 1,
2016, and March 1, 2017, qualified as ECPs. The CFTC has found that
ECPs should not be considered small entities for the purposes of the
RFA.\333\ Based on this information, an overwhelming majority of the
customers that traded security futures in the past were ECPs and not
small entities. Although it is possible that an exchange that launches
security futures trading in the future may market these contracts to
retail customers that are not ECPs, the CFTC believes that it is still
unlikely that the final rules will affect small entities. Therefore, a
change in the margin level for security futures is not anticipated to
affect small entities.
---------------------------------------------------------------------------
\333\ Opting Out of Segregation, 66 FR 20740, 20743 (Apr. 25,
2001).
---------------------------------------------------------------------------
Accordingly, the CFTC Chairman, on behalf of the CFTC, hereby
certifies pursuant to 5 U.S.C. 605(b), that the final rules will not
have a significant economic impact on a substantial number of small
entities.
B. SEC
The RFA requires that Federal agencies, in promulgating rules,
consider the impact of those rules on small entities.\334\ Section 3(a)
\335\ of the RFA generally requires the SEC to undertake a regulatory
flexibility analysis of all proposed rules to determine the impact of
such rulemaking on small entities unless the SEC certifies that the
rule amendments, if adopted, would not have a significant economic
impact on a substantial number of small entities.\336\
---------------------------------------------------------------------------
\334\ 5 U.S.C. 601 et seq.
\335\ 5 U.S.C. 603.
\336\ 5 U.S.C. 605(b). The final rule amendments are discussed
in detail in section II. above. The SEC discusses the economic
consequences of the amendments in section IV. (Economic Analysis)
above. As discussed in section III. (Paperwork Reduction Act) above,
the final rule amendments do not contain a ``collection of
information'' requirement within the meaning of the PRA.
---------------------------------------------------------------------------
Pursuant to Section 605(b) of the RFA,\337\ the SEC certified in
the 2019 Proposing Release, that the proposed amendments to reduce the
required margin for security futures from 20% to 15% would not have a
significant economic impact on any ``small entity'' for purposes of the
RFA.\338\ The SEC solicited comment on the RFA analysis
[[Page 75145]]
in the 2019 Proposing Release.\339\ The SEC received no comments in
response to this request. The SEC is adopting the amendments in this
release, as proposed.
---------------------------------------------------------------------------
\337\ See 5 U.S.C. 605(b).
\338\ See 2019 Proposing Release, 84 FR at 36452.
\339\ Id.
---------------------------------------------------------------------------
For purposes of SEC rulemaking in connection with the RFA,\340\ a
small entity includes a broker-dealer that had total capital (net worth
plus subordinated liabilities) of less than $500,000 on the date in the
prior fiscal year as of which its audited financial statements were
prepared pursuant to 17 CFR 240.17a-5(d),\341\ or, if not required to
file such statements, a broker-dealer with total capital (net worth
plus subordinated liabilities) of less than $500,000 on the last day of
the preceding fiscal year (or in the time that it has been in business,
if shorter); and is not affiliated with any person (other than a
natural person) that is not a small business or small
organization.\342\ The final rule amendments will reduce the required
margin for security futures from 20% to 15%. The final rule amendments
will affect brokers, dealers, and members of national securities
exchanges, including FCMs required to register as broker-dealers under
Section 15(b)(11) of the Exchange Act, relating to security
futures.\343\
---------------------------------------------------------------------------
\340\ Although Section 601 of the RFA defines the term ``small
entity,'' the statute permits agencies to formulate their own
definitions. The SEC has adopted definitions for the term ``small
entity'' for the purposes of SEC rulemaking in accordance with the
RFA. Those definitions, as relevant to this rulemaking, are set
forth in SEC Rule 0-10 (under the Exchange Act), 17 CFR 240.0-10.
See Statement of Management on Internal Accounting Control, Exchange
Act Release No. 18451 (Jan. 28, 1982), 47 FR 5215 (Feb. 4, 1982).
\341\ SEC Rule 17a-5(d) (under the Exchange Act).
\342\ See 17 CFR 240.0-10(c).
\343\ See SEC Rule 400(a), 17 CFR 242.400(a).
---------------------------------------------------------------------------
IBs and FCMs may register as broker-dealers by filing Form BD-
N.\344\ However, because such IBs may not collect customer margin they
are not subject to these rules. In addition, the CFTC has concluded
that FCMs are not considered small entities for purposes of the
RFA.\345\ Accordingly, there are no IBs or FCMs that are small entities
for purposes of the RFA that would be subject to the final rule
amendments.
---------------------------------------------------------------------------
\344\ These notice-registered broker-dealers are not included in
the 873 small broker-dealers discussed below, because they are not
required to file FOCUS Reports with the SEC. See SEC Rule 17a-
5(m)(4), 17 CFR 240.17a-5(m)(4).
\345\ See 47 FR 18618, 18618-21 (Apr. 30, 1982). See also 66 FR
14262, 14268 (Mar. 9, 2001).
---------------------------------------------------------------------------
In addition, all members of national securities exchanges
registered under Section 6(a) of the Exchange Act are registered
broker-dealers.\346\ The SEC estimates that as of December 31, 2019,
there were approximately 873 broker-dealers that were ``small'' for the
purposes of SEC Rule 0-10. Of these, the SEC estimates that there are
approximately ten broker-dealers that are carrying broker-dealers
(i.e., can carry customer margin accounts and extend credit).\347\
However, based on December 31, 2019, FOCUS Report data, none of these
small carrying broker-dealers carried debit balances.\348\ This means
these ``small'' carrying firms are not extending margin credit to their
customers, and therefore, the final rule amendments likely will not
apply to them. Finally, OneChicago was the only U.S. national
securities exchange listing security futures until it discontinued all
trading operations on September 21, 2020. Therefore, while some small
broker-dealers could be affected by the final rule amendments, the
amendments will not have a significant impact on a substantial number
of small broker-dealers.
---------------------------------------------------------------------------
\346\ National securities exchanges registered under Section
6(g) of the Exchange Act--notice registration of security futures
product exchanges--may have members who are floor brokers or floor
traders who are not registered broker-dealers; however, these
entities cannot clear securities transactions or collect customer
margin, and, therefore, the final rule amendments will not apply to
them.
\347\ These small broker-dealers file a FOCUS Report Part II on
a monthly basis, which is required to be filed by broker-dealers
that clear transactions or carry customer accounts and do not use
models to calculate net capital. See 17 CFR 240.17a-5(a)(2)(ii).
\348\ In addition, based on December 31, 2019, FOCUS Report
data, none of these small broker-dealers posted margin to a clearing
agency/DCO related to security futures positions written, purchased
or sold in customer accounts (FOCUS Report, Line 4467).
---------------------------------------------------------------------------
Accordingly, the SEC certifies that the final rule amendments will
not have a significant economic impact on a substantial number of small
entities for purposes of the RFA.
VI. Other Matters
Pursuant to the Congressional Review Act,\349\ the Office of
Information and Regulatory Affairs has designated these rules as not a
``major rule,'' as defined by 5 U.S.C. 804(2).
---------------------------------------------------------------------------
\349\ 5 U.S.C. 801 et seq.
---------------------------------------------------------------------------
If any of the provisions of these final rules, or the application
thereof to any person or circumstance, is held to be invalid, such
invalidity shall not affect other provisions or application of such
provisions to other persons or circumstances that can be given effect
without the invalid provision or application.
VII. Anti-Trust Considerations
Section 15(b) of the CEA requires the CFTC to take into
consideration the public interest to be protected by the antitrust laws
and endeavor to take the least anticompetitive means of achieving the
purposes of the CEA, in issuing any order or adopting any CFTC rule or
regulation (including any exemption under Section 4(c) or 4c(b)), or in
requiring or approving any bylaw, rule, or regulation of a contract
market or registered futures association established pursuant to
section 17 of the CEA.\350\ The CFTC believes that the public interest
to be protected by the antitrust laws is generally to protect
competition.
---------------------------------------------------------------------------
\350\ 7 U.S.C. 19(b).
---------------------------------------------------------------------------
The CFTC has determined that the final rules are not
anticompetitive and have no anticompetitive effects. In the proposal,
the CFTC requested comment on whether there are less anticompetitive
means of achieving the relevant purposes of the CEA. The objective of
the proposal was to bring margin requirements for security futures held
in futures accounts or securities accounts that are not Portfolio
Margin Accounts, into alignment with the required margin level for
unhedged security futures held in Portfolio Margin Accounts.
One commenter argued that the final rules could create a
competitive disadvantage for exchange-traded equity options.\351\ As
explained in more detail above, if security futures trading resumes,
these final rules will reduce the margin level for an unhedged security
future held outside of a Portfolio Margin Account to 15% and should not
result in a competitive disadvantage for exchange-traded equity
options, as the 15% margin rate is already in effect for exchange-
traded options held in a Portfolio Margin Account.
---------------------------------------------------------------------------
\351\ Cboe/MIAX Letter at 2 and 6.
---------------------------------------------------------------------------
A different commenter argued that the current strategy-based margin
regime does not level the playing field with options, but rather, acts
as a barrier to entry for competition and puts security futures at a
competitive disadvantage.\352\ The CFTC notes that, given the statutory
constraints that require the margin requirements for security futures
to be consistent with the margin requirements for comparable exchanged-
traded equity options, the CFTC has not identified any less
anticompetitive means of achieving the purposes of the CEA.
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\352\ OneChicago Letter at 2.
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VIII. Statutory Basis
The SEC is amending SEC Rule 403(b)(1) pursuant to the Exchange
Act, particularly Sections 3(b), 6, 7(c), 15A and 23(a). Further, these
amendments are adopted pursuant to the authority
[[Page 75146]]
delegated jointly to the SEC, together with the CFTC, by the Federal
Reserve Board in accordance with Exchange Act Section 7(c)(2)(A).
List of Subjects
17 CFR Part 41
Brokers, Margin, Reporting and recordkeeping requirements, Security
futures products.
17 CFR Part 242
Brokers, Confidential business information, Reporting and
recordkeeping requirements, Securities.
COMMODITY FUTURES TRADING COMMISSION
17 CFR Part 41
For the reasons discussed in the preamble, the Commodity Futures
Trading Commission amends 17 CFR part 41 as set forth below:
PART 41--SECURITY FUTURES PRODUCTS
0
1. The authority citation for part 41 continues to read as follows:
Authority: Sections 206, 251 and 252, Pub. L. 106-554, 114
Stat. 2763, 7 U.S.C. 1a, 2, 6f, 6j, 7a-2, 12a; 15 U.S.C. 78g(c)(2).
0
2. In Sec. 41.45, republish paragraph (b) heading and revise paragraph
(b)(1) to read as follows:
Sec. 41.45 Required margin.
* * * * *
(b) Required margin--(1) General rule. The required margin for each
long or short position in a security future shall be fifteen (15)
percent of the current market value of such security future.
* * * * *
SECURITIES AND EXCHANGE COMMISSION
17 CFR Part 242
In accordance with the foregoing title 17, chapter II, part 242 of
the Code of Federal Regulations is amended as follows:
PART 242--REGULATIONS M, SHO, ATS, AC, NMS, AND SBSR AND CUSTOMER
MARGIN REQUIREMENTS FOR SECURITY FUTURES
0
3. The authority citation for part 242 continues to read as follows:
Authority: 15 U.S.C. 77g, 77q(a), 77s(a), 78b, 78c, 78g(c)(2),
78i(a), 78j, 78k-1(c), 78l, 78m, 78n, 78o(b), 78o(c), 78o(g),
78q(a), 78q(b), 78q(h), 78w(a), 78dd-1, 78mm, 80a-23, 80a-29, and
80a-37.
0
4. Section 242.403 is amended by revising paragraph (b)(1) to read as
follows:
Sec. 242.403 Required margin.
* * * * *
(b) * * *
(1) General rule. The required margin for each long or short
position in a security future shall be fifteen (15) percent of the
current market value of such security future.
* * * * *
By the Securities and Exchange Commission.
Dated: October 22, 2020.
Vanessa A. Countryman,
Secretary.
Issued in Washington, DC, on October 29, 2020, by the Commodity
Futures Trading Commission.
Christopher Kirkpatrick,
Secretary of the Commission.
Note: The following appendices will not appear in the Code of
Federal Regulations.
CFTC Appendices to Customer Margin Rules Relating to Security Futures--
Commission Voting Summary and Commissioners' Statements
Appendix 1--CFTC Voting Summary
On this matter, Chairman Tarbert and Commissioners Quintenz,
Behnam, Stump, and Berkovitz voted in the affirmative. No
Commissioner voted in the negative.
Appendix 2--Statement of Support of CFTC Commissioner Brian Quintenz
I am pleased to support today's final rule lowering the minimum
margin requirement to hold security futures, from 20% to 15% of a
position's market value.\1\ The lower margin requirement would apply
to security futures held in a futures account and to positions held
in a securities account not subject to portfolio margin rules. The
new margin requirement would be consistent with the current margin
requirements both for security futures positions held in a
securities account subject to portfolio margin rules and for
exchange-traded equity options.
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\1\ Amended CFTC regulation 41.45(b) and SEC rule 242.403(b).
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I note that today's final rule indicates that OneChicago, the
only exchange that has listed security futures in the United States,
has recently discontinued trading operations. This underscores the
determinative impact statutory provisions can have on the viability
of both products and whole business lines. The Securities Exchange
Act requires security futures to be margined comparably to options
traded on an exchange registered with the SEC.\2\ While the intent
of that provision is understandable, the economics underlying it
appear to be severely sub-optimal. Today's lowering of the required
minimum margin, consistent with the Securities Exchange Act, should
make trading this product more cost effective than it has been, but
it still may not be sufficiently cost effective to make the product
economically viable. From that perspective, I hope policy makers
revisit this provision, to ensure its ultimate effect is consistent
with its intent. I believe financial markets policy should
appropriately balance concerns of safety and soundness with
promoting a range of innovative products, and more can certainly be
done in that regard on this issue.
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\2\ Section 7(c)(2)(B) of the Securities Exchange Act.
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Finally, as I noted above, this rule serves as a positive
example of productive cooperation between the CFTC and the SEC, and
I hope that additional joint actions arise in the future.
Appendix 3--Statement of CFTC Commissioner Dawn D. Stump
I am pleased to be a part of today's Joint Open Meeting of the
Commodity Futures Trading Commission (``CFTC'') and the Securities
and Exchange Commission (``SEC''). I commend:
Chairmen Tarbert and Clayton for holding this Meeting
to provide transparency into our work in jointly addressing issues
of mutual interest to both our agencies;
Commissioner Quintenz at the CFTC and Commissioner
Peirce at the SEC for laying the groundwork for this Joint Meeting
through their efforts to harmonize the regulatory regimes of the
agencies, as these harmonization efforts benefit not only those we
regulate, but also the public we all serve; and
The staff of the agencies for putting before us a Joint
Final Rule that will lower the margin level for an unhedged security
futures position from 20% to 15%, which I firmly believe is sound
public policy.
And yet, while I don't want to rain on today's parade, I
nevertheless feel compelled to express a few regrets.
I regret, for example, that the Commissions did not take the
common-sense step of reducing the security futures margin level from
20% to 15% years ago. After all, OneChicago, the only U.S. exchange
that made a long-term effort to develop a market for security
futures, asked us to take this step 12 years ago in 2008. And the
self-regulatory organization rules establishing a 15% margin level
for unhedged security futures held in a securities portfolio margin
account (with which the action we are taking will align) have been
in effect for at least 10 years since 2010. I appreciate that the
global financial crisis and the ensuing regulatory focus on swaps
and other reforms diverted attention from security futures. But it
is nonetheless disappointing that it took the Commissions a decade
to take the step we take today--and even more disappointing given
that OneChicago did not survive to see it, as it discontinued all
trading operations about a month ago on September 21.
I also regret that the adopting release does not recognize the
unique circumstances presented by the recent exit of OneChicago and
the fact that no U.S. exchange currently lists security futures for
trading, and thus issues opinions on hypothetical questions that I
do not believe we should be addressing here. By way of background,
when the Commissions proposed to reduce the margin level of an
unhedged security futures position from 20% to 15%, we also
requested comment on whether there are any other risk-
[[Page 75147]]
based margin methodologies that could be used to prescribe margin
requirements for security futures.\1\ In response, OneChicago urged
the Commissions to permit the use of risk-based margin models for
security futures--similar to what is done for other futures
contracts. I am in complete agreement that we should not adopt such
a sweeping change to the manner in which margin is calculated for
security futures based solely on the response to a single request
for comment in a proposal designed to address a wholly different
type of margin calculation rule.
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\1\ Customer Margin Rules Relating to Security Futures, 84 FR
36434, 36441 (July 26, 2019). The proposing release also asked
commenters, if their answer to this question was yes, to ``please
identify the margin methodologies and explain how they would meet
the comparability standards under the [Securities] Exchange Act [of
1934].'' Id.
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Unfortunately, though, the adopting release goes further, and
rejects OneChicago's arguments regarding the Commissions' authority
to adopt risk-based margining for security futures. Some of these
arguments are fact-based, and thus a future change in facts could
yield a different conclusion, which is appropriate.\2\ But the
adopting release also rejects OneChicago's interpretive arguments
that the Commissions can adopt risk-based margining for security
futures even absent a change in factual circumstances.\3\ I think
that is unfortunate, for three reasons.
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\2\ The Securities Exchange Act of 1934 (``Exchange Act'')
provides that margin levels for security futures must, among other
things, be: (i) Consistent with the margin requirements for
comparable options traded on any exchange registered pursuant to
Section 6(a) of the Exchange Act; and (ii) not lower than the lowest
level of margin, exclusive of premium, required for any comparable
exchange-traded options. See Sections 7(c)(2)(B)(iii)(I)-(II) of the
Exchange Act (emphasis added). The adopting release concludes that
risk-based margining for security futures is inappropriate, in part,
because it would substantially deviate from how margin requirements
are calculated for exchange-traded equity options at this time. If
risk-based margining were permitted for such equity options in the
future, then risk-based margining for security futures might follow,
too.
\3\ OneChicago's interpretive arguments included that: (i) The
Commissions' reading of Sections 7(c)(2)(B)(iii)(I)-(II) of the
Exchange Act as focusing on margin levels is incorrect; and (ii)
security futures contracts are not ``comparable'' to equity options
and, therefore, the ``consistent with'' and ``not lower than''
margin restrictions in Sections 7(c)(2)(B)(iii)(I)-(II) of the
Exchange Act do not apply.
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First, I do not believe that we should be offering advisory
opinions on interpretive questions that, in light of the demise of
OneChicago, no CFTC- or SEC-registered exchange is currently asking.
In my view, these hypothetical questions are not material given the
circumstances before us, and should therefore be left to future CFTC
and SEC Commissioners, to be decided in the context of a live
request to list and trade security futures.
Second, risk-based margining for security futures is permitted
in Europe, and while factors other than margin requirements may
influence demand for security futures, its rejection in the adopting
release creates a potential competitive disadvantage for U.S.
exchanges vs. their international counterparts. The Commodity
Exchange Act (``CEA'') specifies that one of its purposes is ``to
promote responsible innovation and fair competition among boards of
trade, other markets and market participants.'' \4\ The
interpretation in the adopting release fails to fulfill that
purpose.
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\4\ CEA section 3(b), 7 U.S.C. 5(b) (emphasis added).
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Third, it should be remembered that the trading of security
futures on U.S. exchanges before the year 2000 was prohibited due to
jurisdictional disputes over the treatment of products that have
attributes of both SEC-regulated securities and CFTC-regulated
derivatives. In the Commodity Futures Modernization Act of 2000
(``CFMA''), Congress repealed that prohibition and permitted
security futures to trade on U.S. exchanges pursuant to a framework
of joint regulation by the CFTC and the SEC.\5\ Yet, the rejection
of risk-based margining in the adopting release risks stifling the
very security futures market that the CFMA intended to promote.
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\5\ Commodity Futures Modernization Act of 2000, Public Law 106-
554, 114 Stat. 2763 (2000).
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Nevertheless, it is my sincere hope that while the reduction in
margin level for an unhedged security futures position from 20% to
15% may have come too late for OneChicago, it will incentivize
another U.S. exchange to launch security futures. And in that event,
it is my further hope that the Commissions will bring an open mind
to any interpretive arguments the exchange may advance if it
requests recognition of risk-based margining for its contracts.
In the meantime, I support the Joint Final Rule that is before
us.
Appendix 4--Supporting Statement of CFTC Commissioner Dan M. Berkovitz
I support today's final rule on customer margin requirements for
security futures (``Final Rule''), issued jointly with the
Securities and Exchange Commission (``SEC''). The Final Rule ensures
that margin requirements for unhedged security futures will be
consistent regardless of the type of customer account in which they
are held. The Final Rule presents no new risks to the financial
system, and is an overdue effort to align margin requirements for
security futures.\1\
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\1\ Congress established a framework for the trading and joint
regulation of security futures in the Commodity Futures
Modernization Act of 2000 (``CFMA''). Among other requirements, the
CFMA specified that customer margin requirements for security
futures products must be consistent with the margin requirements for
comparable options traded on a registered securities exchange, and
that the initial and maintenance margin levels must not be lower
than the lowest level of margin, exclusive of premium, required for
any comparable exchange-traded options.
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Unhedged security futures held in a ``portfolio margin'' account
have been subject to a 15 percent minimum margin amount since
certain securities self-regulatory organizations (``SROs'') launched
portfolio margining pilot programs starting in 2007.\2\ In contrast,
prior to this Final Rule, such unhedged security futures held in a
futures account or in a securities customer account that is not
subject to portfolio margining were subject to a 20 percent margin
requirement. This structure produced disparate treatment of security
futures based solely on the customer account class in which they
were held.
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\2\ Portfolio margining allows a broker-dealer to combine
certain of a customer's securities and security futures positions
held in a securities account for purposes of determining the margin
requirements for those positions. Such portfolio margining began
with a 2007 pilot program pursuant to the rules of CBOE Exchange.
The program became permanent in 2008. FINRA adopted its own
portfolio margining rules in 2010. Portfolio margining for security
futures is not available in a futures customer account. Thus, prior
to this Final Rule, the 15 percent treatment available to security
futures held in a portfolio margined account was unavailable to
security futures held in a futures account.
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The Final Rule addresses this disparate treatment with no
increased risks to the financial system. It brings all unhedged
security futures to the same 15 percent margin requirement,
consistent with existing margin requirements for security futures
and equity options held in portfolio margin accounts that have been
in place for over a decade.
I support the two Commissions' efforts in today's Final Rule to
address one aspect of trading in security futures, consistent with
the CFMA's statutory requirements. Unfortunately, these efforts are
too late to be of any near-term benefit. Notably, the only U.S.
derivatives exchange that offered security futures products
discontinued trading in September, 2020.
I look forward to continuing to work with staff and my fellow
Commissioners at both the CFTC and the SEC on a viable margin regime
for security futures going forward.
I thank my fellow Commissioners at the CFTC and the SEC, as well
as staff of the two agencies, for their work on this Final Rule.
[FR Doc. 2020-24353 Filed 11-23-20; 8:45 am]
BILLING CODE 6351-01-8011-01-P