[Federal Register: August 14, 2002 (Volume 67, Number 157)]
[Rules and Regulations]
[Page 53145-53180]
From the Federal Register Online via GPO Access [wais.access.gpo.gov]
[DOCID:fr14au02-31]
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Part IV
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; Joint Final Rules
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COMMODITY FUTURES TRADING COMMISSION
17 CFR Part 41
RIN 3038-AB71
SECURITIES AND EXCHANGE COMMISSION
17 CFR Part 242
[Release No. 34-46292; File No. S7-16-01]
RIN 3235-AI22
Customer Margin Rules Relating to Security Futures
AGENCIES: Commodity Futures Trading Commission and Securities and
Exchange Commission.
ACTION: Joint final rules.
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SUMMARY: The Commodity Futures Trading Commission ("CFTC") and the
Securities and Exchange Commission ("SEC") (collectively,
"Commissions") are adopting rules to establish margin requirements
for security futures. The final rules preserve the financial integrity
of markets trading security futures, prevent systemic risk, and require
that the margin requirements for security futures be consistent with
the margin requirements for comparable exchange-traded option
contracts.
EFFECTIVE DATE: September 13, 2002.
FOR FURTHER INFORMATION CONTACT:
CFTC: Phyllis P. Dietz, Special Counsel; or Michael A. Piracci,
Attorney, Division of Clearing and Intermediary Oversight, Commodity
Futures Trading Commission, Three Lafayette Centre, 1155 21st Street,
NW, Washington, DC 20581. Telephone: (202) 418-5000. E-mail:
([email protected]); or ([email protected]).
SEC: Onnig Dombalagian, Attorney Fellow, at (202) 942-0737;
Theodore R. Lazo, Senior Special Counsel, at (202) 942-0745; Hong-anh
Tran, Special Counsel, at (202) 942-0088; and Lisa Jones, Attorney, at
(202) 942-0063, Division of Market Regulation, Securities and Exchange
Commission, 450 Fifth Street, NW, Washington, DC 20549-1001.
SUPPLEMENTARY INFORMATION: The CFTC is adopting Rules 41.42 through
41.49, 17 CFR 41.42 through 41.49, and the SEC is adopting Rules 400
through 406, 17 CFR 242.400 through 242.406, (the "Final Rules")
under authority delegated by the Federal Reserve Board pursuant to the
Securities Exchange Act of 1934 ("Exchange Act").
I. Background
A. Statutory Provisions
B. Proposed Rules
C. Overview of the Comment Letters
D. Overview of the Final Rules
II. Discussion of the Final Rules
A. Who is Covered by the Final Rules
B. Exclusions from Coverage
1. Financial Relations between a Customer and a Security Futures
Intermediary under a Portfolio Margining System
2. Financial Relations between a Security Futures Intermediary
and a Foreign Person
3. Margin Requirements Imposed by Clearing Agencies or
Derivatives Clearing Organizations
4. Financial Relations between Security Futures Intermediaries
and Broker-Dealers, and Certain Members of National Securities
Exchanges
a. Financial Relations with an Exempted Person
b. Margin Arrangements with a Borrower Otherwise Excluded
Pursuant to Section 7(c)(3) of the Exchange Act
c. Financial Relations between a Security Futures Intermediary
and a Member of a National Securities Exchange or Association in
Connection with Market Making Activities
C. Interpretation of, and Exemptions from, the Final Rules
D. Definitions
E. Application of Regulation T to Security Futures
F. Account Administration Rules
1. Separation and Consolidation of Accounts
2. Accounts of Partners
3. Contribution to a Joint Venture
4. Extensions of Credit
G. Customer Margin Levels for Security Futures
1. Definition of Current Market Value
2. Margin Levels for Unhedged Positions
3. Margin Offsets
4. Higher Margin Levels
5. Procedures for Certain Margin Level Adjustments
H. Satisfaction of Required Margin
1. Type, Form and Use of Collateral
a. Acceptable Collateral Deposits
b. Use of Money Market Mutual Funds
2. Computation of Equity
a. Security Futures
b. Option Value
c. Open Trade Equity
d. Margin Equity Securities
e. Other Securities
f. Foreign Currency
g. Other Components of Equity
h. Guarantees
3. Satisfaction of Required Margin for Positions Other than
Security Futures
I. When Margin May Be Withdrawn
1. Withdrawal of Margin by the Customer
2. Withdrawal of Margin by the Security Futures Intermediary
J. Consequences of Failure to Collect Required Margin
K. CFTC Procedures for Notification of Proposed Rule Changes Related
to Margin
III. Paperwork Reduction Act
A. CFTC
B. SEC
IV. Costs and Benefits of the Final Rules
A. CFTC
B. SEC
1. Costs
a. Compliance with Regulation T
b. Levels of Margin
c. Computation of Margin
d. Undermargined Accounts
2. Benefits
a. Benefits to Security Futures Intermediaries
b. Benefits to Customers
V. Consideration of Burden on Competition, Promotion of Efficiency, and
Capital Formation
VI. Regulatory Flexibility Act
A. CFTC
B. SEC
VII. Statutory Basis
Text of Rules
I. Background
A. Statutory Provisions
The Commodity Futures Modernization Act of 2000 ("CFMA"),\1\
which became law on December 21, 2000, lifted the ban on single stock
and narrow-based stock index futures ("security futures"). In
addition, the CFMA established a framework for the joint regulation of
security futures by the CFTC and the SEC.
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\1\ Appendix E of Pub. L. No. 106-554, 114 Stat. 2763 (2000).
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As part of the statutory scheme for the regulation of security
futures, the CFMA provided for the issuance of rules governing customer
margin for transactions in security futures. Specifically, the CFMA
added a new subsection (2) to section 7(c) of the Exchange Act,\2\
which directs the Board of Governors of the Federal Reserve System
("Federal Reserve Board") to prescribe rules establishing initial and
maintenance customer margin requirements imposed by brokers, dealers,
and members of national securities exchanges for security futures
products. In addition, section 7(c)(2)(B) provides that the Federal
Reserve Board may delegate this rulemaking authority jointly to the
Commissions. On March 6, 2001, the Federal Reserve Board delegated its
authority under Section 7(c)(2)(B) to the Commissions.\3\ Pursuant to
that authority, the SEC and the CFTC have adopted customer
[[Page 53147]]
margin requirements for security futures.\4\
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\2\ 15 U.S.C. 78g(c)(2).
\3\ 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 (March 6, 2001) ("FRB
Letter").
\4\ Because section 6(h)(6) of the Exchange Act (15 U.S.C.
78f(h)(6)) provides that options on security futures may not be
traded for at least three years after the enactment of the CFMA, the
margin requirements do not address options on security futures.
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Section 7(c)(2) provides that the customer margin requirements for
security futures must satisfy four requirements. First, they must
preserve the financial integrity of markets trading security futures
products. Second, they must prevent systemic risk. Third, they must (a)
be consistent with the margin requirements for comparable option
contracts traded on any exchange registered pursuant to section 6(a) of
the Exchange Act; and (b) provide for initial and maintenance margin
levels that are not lower than the lowest level of margin, exclusive of
premium, required for comparable exchange-traded options. Fourth, they
must be and remain consistent with the margin requirements established
by the Federal Reserve Board under Regulation T.\5\
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\5\ 12 CFR 220 et seq.
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B. Proposed Rules
On September 26, 2001, the CFTC and the SEC issued for public
comment proposed rules (the "Proposed Rules") relating to customer
margin requirements for security futures.\6\ In response to a joint
request from the Futures Industry Association ("FIA") and the
Securities Industry Association ("SIA") for an extension of the
public comment period, the Commissions granted a 30-day extension until
December 5, 2001.\7\
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\6\ Securities Exchange Act Release No. 44853 (September 26,
2001), 66 FR 50720 (October 4, 2001). The FRB Letter was attached as
Appendix B. See id. at 50741.
\7\ See Securities Exchange Act Release No. 44996 (October 29,
2001), 66 FR 55608 (November 2, 2001).
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C. Overview of the Comment Letters
The Commissions received a total of 19 comment letters from
securities and futures industry associations,\8\ exchanges,\9\ a
clearing organization,\10\ financial services firms,\11\ systems
vendors,\12\ a member of the academic community,\13\ and two members of
the public.\14\ In general, the comment letters focused on three major
issues raised by the Proposed Rules: the applicability of Regulation T
and the desirability of an account-specific margin regime; the
appropriateness of the proposed 20% margin level; and the
permissibility of portfolio margining.
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\8\ See letters from Mark E. Lackritz, President, SIA, and John
M. Damgard, President, FIA, dated December 5, 2001 ("SIA/FIA
Letter"); George Ruth, Chairman, Rules and Regulations Committee,
Securities Industry Association Credit Division, dated December 4,
2001 ("SIA Credit Division Letter"); Thomas W. Sexton, Vice
President and General Counsel, National Futures Association, dated
December 5, 2001 ("NFA Letter"); and John G. Gaine, President,
Managed Funds Association, dated January 11, 2002 ("Manager Funds
Letter").
\9\ See letters from James J. McNulty, Chicago Mercantile
Exchange Inc., and David J. Vitale, Board of Trade of the City of
Chicago, Inc., dated December 4, 2001 ("CME/CBOT Letter"); the
American Stock Exchange, Chicago Board Options Exchange, The Options
Clearing Corporation, International Securities Exchange, Pacific
Exchange, and Philadelphia Stock Exchange, dated December 5, 2001
("Options Exchanges Letter"); Kathleen M. Hamm, Director of Market
Regulation, Senior Vice President Regulation and Compliance, Nasdaq
Liffe Markets, LLC, dated December 5, 2001 ("Nasdaq Liffe
Letter"); Kenneth M. Rosenzweig, on behalf of OneChicago, LLC,
dated December 6, 2001 ("OneChicago Letter"); Michael J. Ryan,
Jr., Executive Vice President and General Counsel, American Stock
Exchange, dated December 7, 2001 ("Amex Letter"); and William J.
Brodsky, Chairman and Chief Executive Officer, Chicago Board Options
Exchange, dated December 7, 2001 ("CBOE Letter"). The CBOE also
joined in the Options Exchanges Letter.
\10\ See letter from Susan Milligan, The Options Clearing
Corporation, dated December 14, 2001 ("OCC Letter"). The OCC also
joined in the Options Exchanges Letter.
\11\ See letters from John P. Davidson III, Managing Director,
Morgan Stanley, dated December 5, 2001 ("Morgan Stanley Letter");
James A. Gary, Executive Vice President, ABN AMRO Incorporated,
dated December 5, 2001 ("ABN AMRO Letter"); and Russell R.
Wasendorf, Sr., Chairman and Chief Executive Officer, Peregrine
Financial Group, Inc., dated December 5, 2001 ("Peregrine
Letter").
\12\ See letters from John Munro, Senior Vice President, Product
Design, Rolfe and Nolan Systems Inc ("Rolfe and Nolan Letter");
and Stephen P. Auerbach, Chief Operating Officer, SunGard Futures
Systems, dated December 5, 2001 ("SunGard Letter").
\13\ See letter from Frank Partnoy, Professor of Law, University
of San Diego School of Law, dated October 29, 2001 ("Partnoy
Letter").
\14\ See letter from Robert Drinkard, dated September 28, 2001
("Drinkard Letter"); and letter from Bernard E. Klein, dated
December 18, 2001 ("Klein Letter").
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The majority of commenters expressed the view that Regulation T
should not be applied to futures accounts. They stated their concern
that application of Regulation T to security futures carried in futures
accounts would impose heavy costs on carrying firms in the form of
reprogramming of systems and training of staff. Some believed that it
would discourage futures commission merchants ("FCMs") from trading
security futures. One commenter, however, supported the application of
Regulation T to security futures, regardless of the type of account in
which they are carried. Several commenters identified specific
provisions of Regulation T that would have to be addressed in order to
accommodate carrying security futures in a securities account, e.g.,
rules for variation margin payments.
Ten of the commenters specifically endorsed the concept that the
margin rules should build on the existing regulatory infrastructure and
that, to the extent possible, the rules applicable to security futures
should be determined by the type of account in which the security
futures are carried. Under this "account-specific" approach, for
example, rules relating to acceptable collateral, collateral haircuts,
timing for collection of margin, and calculations of current market
value would be determined in accordance with the rules otherwise
applicable to a securities account or futures account, respectively.
Several commenters observed that this would be consistent with the
Commissions' proposed customer funds rules \15\ and would be the most
prudent and cost effective approach.
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\15\ See Securities Exchange Act Release No. 44854 (September
26, 2001), 66 FR 50768 (October 4, 2001).
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Most commenters found the proposed 20% minimum margin level to be
acceptable, although some thought the minimum should instead be 25%.
The SIA/FIA Letter noted that "members of the Associations are
divided" as to whether the minimum level of initial and maintenance
margin should be 20% or 25%. Another commenter expressed the view that
the 20% level could be either too high or too low depending on the
circumstances, and that for certain positions 50% initial margin would
be appropriate.
Eleven commenters supported the implementation of full portfolio
margining for security futures, as soon as possible. Two other
commenters emphasized the need for experience with a proposed pilot
program.\16\ One commenter supported portfolio margining only for
sophisticated customers, with another commenter joining in the view
that portfolio margining might not be appropriate for all customers.
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\16\ See Securities Exchange Act Release No. 45630 (March 22,
2002), 67 FR 15263 (March 29, 2002) (notice of rules proposed by the
CBOE related to customer portfolio and cross-margining
requirements).
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After carefully considering the public comments, the Commissions
have adopted Final Rules that reflect modifications to the Proposed
Rules in response to the views and concerns expressed by the
commenters. The Commissions believe that the Final Rules fulfill the
statutory requirements and that the changes made to the
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Proposed Rules will more effectively promote market efficiency and
liquidity.
D. Overview of the Final Rules
The Commissions have carefully considered the commenters' views,
and have modified the Proposed Rules in various respects. The Final
Rules, among other things:
Establish stand-alone requirements that are consistent
with Regulation T, but do not apply Regulation T in its entirety to
futures accounts.
Establish minimum initial and maintenance margin levels
for unhedged positions in security futures at 20% of their "current
market value."
Permit self-regulatory authorities to set margin levels
lower than 20% of current market value for customers with certain
strategy-based offset positions involving security futures and one or
more related securities or futures.
Identify the types of collateral acceptable as margin
deposits and establish standards for the valuation of such collateral
and other components of equity.
Establish standards for the withdrawal of margin by
customers and security futures intermediaries.
Set forth procedures applicable to undermargined accounts.
Set forth procedures for filing proposed rule changes with
the CFTC.
II. Discussion of the Final Rules
A. Who Is Covered by the Final Rules
The Commissions are adopting the Final Rules under the authority
delegated to them by the Federal Reserve Board under section 7(c)(2) of
the Exchange Act, which applies to brokers, dealers, and members of
national securities exchanges extending credit to or for customers, or
collecting margin from customers, in connection with security futures.
In the Proposed Rules, the Commissions used the term "creditor," as
defined in Regulation T, to delineate those persons who would be
subject to the margin rules.\17\ Because FCMs that effect transactions
in security future products are broker-dealers,\18\ they were included
in the definition of "creditor" under the Proposed Rules.
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\17\ Under Section 220.2 of Regulation T (17 CFR 220.2), the
term "creditor" means any broker or dealer, member of a national
securities exchange, or any person associated with a broker or
dealer other than business entities controlling or under common
control with the broker-dealer.
\18\ See sections 3(a)(4) and 3(a)(5) of the Exchange Act, 15
U.S.C. 78c(a)(4) and 78c(a)(5).
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To avoid characterizing the collection of margin for a security
futures contract as involving an extension of credit, the Final Rules
use the term "security futures intermediary" instead of the term
"creditor." \19\ The term "security futures intermediary" is
intended to include the same persons as are included in the Regulation
T definition of "creditor," but solely with respect to their
financial relations involving security futures. SEC Rule 401(a)(29)
defines security futures intermediary by reference to the term
creditor. For the sole purpose of clarifying the scope of the Final
Rules for market participants that are not subject to Regulation T, the
definition of security futures intermediary in CFTC Rule 41.43(a)(29)
specifies that the term includes FCMs and enumerated affiliated
persons.\20\
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\19\ For the same reason, the Final Rules do not use the term
"borrower" to refer to persons who deposit margin in connection
with security futures transactions.
\20\ See CFTC Rule 41.43(a)(29); SEC Rule 401(a)(29).
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The Commissions believe that the term security futures intermediary
is defined identically for all substantive purposes, and emphasize that
the difference in the language used in the two rules to define a
security futures intermediary is not intended to mean that the scope of
the two rules is different.
In addition, the term "customer" is defined under the Final Rules
as any person or persons acting jointly on whose behalf a security
futures intermediary effects a security futures transaction or carries
a security futures position, or who would be considered a customer of
the security futures intermediary according to the ordinary usage of
the trade.\21\ The definition of customer further includes (i) any
partner in a security futures intermediary that is organized as a
partnership who would be considered a customer of the security futures
intermediary absent the partnership relationship, and (ii) any joint
venture in which a security futures intermediary participates and which
would be considered a customer of the security futures intermediary if
the security futures intermediary were not a participant.\22\ This
definition is derived from the Regulation T definition of customer.\23\
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\21\ See CFTC Rule 41.43(a)(5)(i); SEC Rule 401(a)(5)(i).
\22\ See CFTC Rule 41.43(a)(5)(ii) and (iii); SEC Rule
401(a)(5)(ii) and (iii).
\23\ See 12 CFR 220.2.
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B. Exclusions From Coverage
The Final Rules include specific exclusions for certain categories
of financial relations, substantially as proposed. The exclusions are
described below.
1. Financial Relations between a Customer and a Security Futures
Intermediary Under a Portfolio Margining System
The Proposed Rules provided an exclusion for margin calculated by a
portfolio margining system that has been approved by the SEC and, as
applicable, the CFTC.\24\ The Commissions are adopting this exclusion
substantially as proposed.\25\ The Final Rules add a provision
requiring that the portfolio margining system meet the criteria set
forth in section 7(c)(2)(B) of the Exchange Act.\26\ This addition is
intended to clarify that the portfolio margining system must be
consistent with a risk-based system used for comparable exchange-traded
options. This requirement does not preclude the use of an existing
portfolio margining system that interfaces with an FCM's bookkeeping
system, so long as the portfolio margining system is modified to
produce results that comply with the Final Rules.\27\
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\24\ See Proposed CFTC Rule 41.43(b)(3)(i); Proposed SEC Rule
400(b)(3)(i).
\25\ See CFTC Rule 41.42(c)(2)(i); SEC Rule 400(c)(2)(i).
\26\ See CFTC Rule 41.42(c)(2)(i); SEC Rule 400(c)(2)(i).
Section 7(c)(2)(B) requires that the margin requirements for
security futures (i) be consistent with the margin requirements for
comparable exchange-traded security options (and that margin levels
for security futures not be lower than the levels of margin required
for comparable exchange-traded options), and (ii) be and remain
consistent with Regulation T of the Federal Reserve Board. 15 U.S.C.
78g(c)(2)(B).
\27\ Under the Final Rules, a portfolio margining system can be
used to compute required initial or maintenance margin that results
in margin levels that are equal to or higher than the margin levels
required by the Final Rules. In this regard, for example, the
minimum margin requirement for unhedged security futures positions
must be 20%, and the system cannot recognize any offset for
combination positions that is not permitted under self-regulatory
authority rules, as provided in CFTC Rule 41.45(b)(2) and SEC Rule
403(b)(2). See discussion of margin offsets, Section II.G.3. below.
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Portfolio margining establishes margin levels by assessing the
market risk of a "portfolio" of positions in securities or
commodities. Under a portfolio margining system, the amount of required
margin is determined by analyzing the risk of each component position
in a customer account (e.g., a class of option with the same expiration
date) and by recognizing any risk offsets in an overall portfolio of
positions (e.g., across options and futures on the same underlying
instrument). So that adequate margin is deposited to cover
extraordinary market events, one or more additional adjustments may be
applied in calculating a customer's required margin. A portfolio
margining system may also be used in conjunction with a risk-based
margining system,
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which assesses margin based on the historical performance of individual
instruments, rather than as a fixed percentage of current market value.
Depending upon the risks attributable to one or more positions, the
amount of required margin in a portfolio margining system may be
greater than or less than the margin levels currently required for
securities positions in a fixed-percentage, strategy-based margining
system.
The Commissions received 14 comment letters that addressed the
issue of portfolio margining, all of which supported the concept of
portfolio margining for security futures.\28\ Ten of the commenters
strongly supported the implementation of full portfolio margining for
security futures as soon as possible.\29\
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\28\ See SIA Credit Division Letter; Options Exchanges Letter;
CME/CBOT Letter; SunGard Letter; SIA/FIA Letter; OCC Letter;
Peregrine Letter; Nasdaq Liffe Letter; NFA Letter; Morgan Stanley
Letter; OneChicago Letter; ABN AMRO Letter; Rolfe and Nolan Letter;
and Managed Funds Letter.
\29\ See CME/CBOT Letter; SunGard Letter; SIA/FIA Letter;
Peregrine Letter; Nasdaq Liffe Letter; NFA Letter; OneChicago
Letter; ABN AMRO Letter; Rolfe and Nolan Letter; and Managed Funds
Letter.
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Five commenters observed that portfolio margining recognizes the
market risk associated with a specific position more accurately than a
fixed-percentage margin scheme.\30\ One commenter criticized the
Proposed Rules for limiting customers to an "archaic strategy-based
system." \31\
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\30\ See SIA/FIA Letter at 2; Morgan Stanley Letter at 3;
OneChicago Letter at 7-8; NFA Letter at 4-5; and Nasdaq Liffe Letter
at 4.
\31\ CME/CBOT Letter at 5.
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One commenter stated its opinion that portfolio margining should be
allowed immediately for security futures, and that the higher margin
levels collected under a strategy-based approach would make it
difficult for U.S. markets to attract liquidity in security
futures.\32\ This commenter raised concerns that strategy-based
margining would disadvantage U.S. markets and would encourage investors
to seek foreign markets.\33\ Another commenter supported portfolio
margining for security futures, securities, and securities options to
promote global competitiveness.\34\ It observed that portfolio
margining has become the international standard for major futures
markets and without it, the U.S. markets will be at a disadvantage.\35\
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\32\ SunGard Letter at 2.
\33\ Id.
\34\ Nasdaq Liffe Letter at 5-6.
\35\ Id.
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One commenter expressed the view that portfolio margining should
not be approved for security futures before it is approved for options,
and stated that it was critical that any portfolio margining system
applicable to security futures apply to all related products, including
options and the underlying securities.\36\ Another commenter supported
implementation of a portfolio margining framework under which the
margin requirements for portfolios comprised of securities and security
futures would be determined through a risk-based analysis.\37\
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\36\ Options Exchanges Letter at 4.
\37\ SIA/FIA Letter at 11. This commenter also recommended that
the Commissions permit FCMs to use the Standard Portfolio Analysis
of Risk ("SPAN") system for establishing the initial and
maintenance margin requirements for security futures maintained in a
futures account as long as the resulting margin levels are
consistent with the margin requirements for security futures held in
a securities account. Id. at 12.
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Two other commenters, while strongly supporting the concept of
portfolio margining, expressed the opinion that portfolio margining was
not necessarily appropriate for all investors, and that it might be
appropriate to limit the use of portfolio margining for security
futures to sophisticated investors.\38\
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\38\ See SIA Credit Division Letter at 2; Morgan Stanley Letter
at 4.
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The SEC and the CFTC have approved the use of portfolio margining
systems for certain purposes. The CFTC has approved portfolio margining
using the SPAN system for all currently traded futures contracts, at
both the clearing level and the customer level.\39\ The SEC has
approved portfolio margining using The Options Clearing Corporation's
("The OCC") Theoretical Intermarket Margin System ("TIMS") for
margin collected by The OCC for the options positions of its clearing
members.\40\ The SEC and CFTC also have approved self-regulatory
organization ("SRO") rules that permit the use of SPAN and TIMS in
connection with certain cross-margining arrangements involving futures
and securities.\41\ In addition, as noted previously, on March 22,
2002, the SEC published notice of a proposed rule change filed by the
CBOE to implement a portfolio margining system on a pilot basis for
certain customers.\42\
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\39\ The CFTC also has approved SPAN margining for all options
on futures contracts.
\40\ See Securities Exchange Act Release No. 28928 (March 1,
1991), 56 FR 9995 (March 8, 1991); Securities Exchange Act Release
No. 23167 (April 22, 1986), 51 FR 16127 (April 30, 1986).
\41\ To date, the Commissions have approved cross-margining
programs between The OCC and the following futures clearing
organizations: The Intermarket Clearing Corporation (1988); Chicago
Mercantile Exchange ("CME") (1989); Board of Trade Clearing
Corporation ("BOTCC") (1991); Kansas City Board of Trade Clearing
Corporation (1992); and Comex Clearing Association (1992). The
Commissions also have approved cross-margining programs between the
Government Securities Clearing Corporation and the following futures
clearing organizations: the New York Clearing Corporation (1999);
BOTCC (2001); and CME (2001).
\42\ See supra note 16 and accompanying text.
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Section 7(c)(2)(B)(iii) of the Exchange Act \43\ provides that the
margin requirements for security futures must be consistent with the
margin requirements for comparable exchange-traded options, and that
the initial and maintenance margin levels for security futures may not
be lower than the lowest level of margin, exclusive of premium,
required for any comparable exchange-traded option. After considerable
deliberation about the application of this standard to security futures
margin, the Commissions have determined that risk-based portfolio
margining for security futures will not be permitted until a similar
methodology is introduced for comparable exchange-traded options.
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\43\ 15 U.S.C. 78g(c)(2)(B)(iii).
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Three commenters expressed opinions regarding the future selection
and use of SPAN or TIMS as a portfolio margining system.\44\ The
Commissions will consider issues related to the use of any particular
portfolio margining system at such time as the Commissions consider the
actual implementation of portfolio margining for security futures.
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\44\ See CME/CBOT Letter at 5; SIA/FIA Letter at 12-13 and
Appendix I, Q 15; OCC Letter.
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The Commissions strongly encourage the efforts of market
participants to develop a portfolio margining proposal for security
futures, and are committed to working with these participants to
resolve any outstanding issues as quickly as feasible. Such a portfolio
margining system would be in keeping with current practices in the
futures industry and would be responsive to the Federal Reserve Board's
desire to encourage the development of more risk-sensitive, portfolio-
based approaches to margining security futures products.\45\
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\45\ In its delegation letter, the Federal Reserve Board
requested that "the Commissions provide an assessment of progress
toward adopting more risk-sensitive, portfolio-based approaches to
margining security futures products." The Federal Reserve Board
further stated that "[t]he Board has encouraged the development of
such approaches by, for example, amending its Regulation T so that
portfolio margining systems approved by the [SEC] can be used in
lieu of the strategy-based system embodied in the Board's
regulation. The Board anticipates that the creation of security
future products will provide another opportunity to develop more
risk-sensitive, portfolio based approaches for all securities,
including security options and security futures products." FRB
Letter at 2.
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[[Page 53150]]
2. Financial Relations Between a Security Futures Intermediary and a
Foreign Person
The Proposed Rules provided an exclusion from the margin
requirements for financial relations between a foreign branch of a
creditor and a foreign person involving foreign security futures.\46\
This exclusion was intended to be consistent with the way Regulation T
treats financial relations between a foreign branch of a creditor and a
foreign person involving foreign securities.\47\ The Commissions are
adopting this exclusion with two modifications.\48\
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\46\ See Proposed CFTC Rule 41.43(b)(3)(ii); Proposed SEC Rule
400(b)(3)(ii).
\47\ See 12 CFR 220.1(b)(3)(iv).
\48\ See CFTC Rule 41.42(c)(2)(ii); SEC Rule 400(c)(2)(ii).
---------------------------------------------------------------------------
First, in response to concerns raised by a commenter,\49\ the scope
of the exclusion is being expanded so that it applies to the U.S.
offices as well as foreign branch offices of a security futures
intermediary. This commenter expressed the view that the exclusion, as
proposed, would create a competitive disadvantage for U.S. firms whose
existing foreign futures customers would likely migrate to foreign
offices or competing foreign firms to obtain the margin levels
available on the foreign exchange. After considering the commenter's
view, the Commissions have concluded that expanding the exclusion is
appropriate and, in light of the potential competitive issues, is not
inconsistent with Regulation T.
---------------------------------------------------------------------------
\49\ Meeting between SEC and CFTC staff and representatives of
SIA/FIA (February 6, 2000).
---------------------------------------------------------------------------
The second modification clarifies the scope of this exclusion.
Because the Proposed Rules did not define the term "foreign security
future," the Final Rules provide that the exclusion applies to
financial relations between a security futures intermediary and a
foreign person involving "security futures traded on or subject to the
rules of a foreign board of trade." Thus, the exclusion applies
regardless of whether the underlying security is issued in the United
States or a foreign country.\50\
---------------------------------------------------------------------------
\50\ This exclusion does not address the application of Section
6(h)(1) of the Exchange Act (15 U.S.C. 78f(h)(1)) to transactions in
security futures that are traded on or subject to the rules of a
foreign board of trade.
---------------------------------------------------------------------------
3. Margin Requirements Imposed by Clearing Agencies or Derivatives
Clearing Organizations
The Proposed Rules provided an exclusion from the margin
requirements for margin collected by registered clearing agencies from
their members.\51\ The Commissions received no comments relating to
this provision. The text of the proposed exclusion has been revised to
specify that the Final Rules exclude clearing agencies registered under
section 17A of the Exchange Act and derivatives clearing organizations
registered under Section 5b of the CEA.\52\ These textual changes do
not affect the meaning of the provision and, therefore, the Commissions
have effectively adopted the provision as proposed.
---------------------------------------------------------------------------
\51\ See Proposed CFTC Rule 41.43(b)(3)(iii); Proposed SEC Rule
400(b)(3)(iii).
\52\ See CFTC Rule 41.42(c)(2)(iii); SEC Rule 400(c)(2)(iii).
---------------------------------------------------------------------------
Section 7(c)(2) of the Exchange Act directs the Federal Reserve
Board to prescribe rules regarding customer margin for security futures
products, but it does not confer authority over margin requirements for
clearing agencies and derivatives clearing organizations. Accordingly,
the Federal Reserve Board stated in its delegation letter that "[t]he
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 margin requirements imposed by
clearing agencies on their members." The margin rules of clearing
agencies registered with the SEC are approved by the SEC pursuant to
section 19(b)(2) of the Exchange Act.\53\ The CFTC has authority to
ensure compliance with core principles for derivatives clearing
organizations registered with the CFTC under Sections 5b and 5c of the
CEA.\54\ This exclusion clarifies that margin requirements that
clearing agencies registered with the SEC or derivatives clearing
organizations registered with the CFTC impose on their members are not
subject to the Final Rules.
---------------------------------------------------------------------------
\53\ 15 U.S.C. 78s(b)(2).
\54\ 7 U.S.C. 7a-1; 7 U.S.C. 7a-2.
---------------------------------------------------------------------------
4. Financial Relations Between Security Futures Intermediaries and
Broker-Dealers, and Certain Members of National Securities Exchanges
a. Financial Relations with an Exempted Person. The Proposed Rules
provided an exclusion from the margin requirements for credit
arrangements between a creditor and a borrower that is a member of a
national securities exchange or is a registered broker-dealer
(including an FCM registered as a broker-dealer under section 15(b)(11)
of the Exchange Act) if the creditor made a good faith determination
that the borrower was an "exempted borrower" under Regulation T.\55\
The Regulation T criteria for an "exempted borrower" establish
standards for the exception from federal margin regulation for exchange
members and registered brokers and dealers, a substantial portion of
whose business consists of transactions with persons other than brokers
or dealers.\56\ In addition, the Proposed Rules provided that a person
that ceased to qualify for the exempted borrower exclusion would be
required to notify the creditor of this fact before establishing any
new security futures positions.\57\ Any security futures positions
subsequently established by that person would be subject to the
Commissions' customer margin requirements.
---------------------------------------------------------------------------
\55\ See Proposed CFTC Rule 41.43(b)(3)(iv)(A); Proposed SEC
Rule 400(b)(3)(iv)(A).
\56\ The term "exempted borrower" is defined in Section 220.2
of Regulation T as a member of a national securities exchange or a
registered broker or dealer, a substantial portion of whose business
consists of transactions with persons other than brokers or dealers,
and includes a borrower who: (1) Maintains at least 1,000 active
accounts on an annual basis for persons other than brokers, dealers,
and persons associated with a broker or dealer; (2) earns at least
$10 million in gross revenues on an annual basis from transactions
with persons other than brokers, dealers, and persons associated
with a broker or dealer; or (3) earns at least 10% of its gross
revenues on an annual basis from transactions with persons other
than brokers, dealers, and persons associated with a broker or
dealer. 12 CFR 220.2. section 7(c)(3)(A) of the Exchange Act (15
U.S.C. 78g(c)(3)(A)) provides an exception from federal margin
regulation for members of national securities exchanges and
registered broker-dealers, "a substantial portion of whose business
consists of transactions with persons other than brokers or
dealers."
\57\ See Proposed CFTC Rule 41.45(e); Proposed SEC Rule 402(e).
---------------------------------------------------------------------------
One commenter addressed the exclusion, asserting that an FCM or
floor broker whose only securities business consists of trading
security futures would not likely qualify as an exempted borrower under
Regulation T.\58\ The commenter asked the Commissions to clarify that
the scope of the exclusion includes FCMs or floor brokers that do not
have a substantial securities or security futures business, as long as
they have a substantial customer futures business.
---------------------------------------------------------------------------
\58\ OneChicago Letter at 8-9.
---------------------------------------------------------------------------
After considering the commenter's view, the Commissions have
adopted the exclusion with several modifications to clarify the
application of the exclusion.\59\ As a preliminary matter, the
Commissions are replacing the term "exempted borrower" with the new
term, "exempted person," to avoid characterizing the collection of
margin for a security futures contract as involving an extension of
credit.
---------------------------------------------------------------------------
\59\ See CFTC Rule 41.42(c)(2)(iv); SEC Rule 400(c)(2)(iv).
---------------------------------------------------------------------------
Consequently, the Commissions are also adding to the Final Rules a
definition of "exempted person." The Commissions believe that the
definition of exempted person is consistent with
[[Page 53151]]
the definition of exempted borrower in Regulation T. More specifically,
the Final Rules define an exempted person as a member of a national
securities exchange, a registered broker or dealer, or a registered
futures commission merchant, a substantial portion of whose business
consists of transactions in securities, commodity futures, or commodity
options with persons other than brokers, dealers, futures commission
merchants, floor brokers, or floor traders, including a person who:
Maintains at least 1000 active accounts on an annual basis
for persons other than brokers, dealers, persons associated with a
broker or dealer, futures commission merchants, floor brokers, floor
traders, and persons affiliated with a futures commission merchant,
floor broker, or floor trader that are effecting transactions in
securities, commodity futures, or commodity options;
Earns at least $10 million in gross revenues on an annual
basis from transactions in securities, commodity futures, or commodity
options with persons other than brokers, dealers, persons associated
with a broker or dealer, futures commission merchants, floor brokers,
floor traders, and persons affiliated with a futures commission
merchant, floor broker, or floor trader; or
Earns at least 10 percent of its gross revenues on an
annual basis from transactions in securities, commodity futures, or
commodity options with persons other than brokers, dealers, persons
associated with a broker or dealer, futures commission merchants, floor
brokers, floor traders, and persons affiliated with a futures
commission merchant, floor broker, or floor trader.\60\
---------------------------------------------------------------------------
\60\ See CFTC Rule 41.43(a)(9); SEC Rule 401(a)(9).
---------------------------------------------------------------------------
Although the commenter recommended that floor brokers as well as
FCMs be permitted to qualify as exempted borrowers, the Commissions
have not included floor brokers in the definition of exempted person.
This is because the exemption cannot readily be applied to floor
brokers given that they do not carry the type of customer accounts
contemplated by the Regulation T exempted borrower provision. The
Commissions note that, although floor brokers are not included in the
definition of exempted person, they may still qualify for an exclusion
from the security futures margin requirements if they meet the criteria
for a market maker under the Final Rules, as discussed below.\61\
---------------------------------------------------------------------------
\61\ See CFTC Rule 41.42(c)(2)(v); SEC Rule 400(c)(2)(v).
---------------------------------------------------------------------------
The Final Rules also set forth an express definition of "persons
affiliated with" a futures commission merchant, floor broker, or floor
trader,\62\ which parallels the definition in the Exchange Act of
"person associated with a broker or dealer." \63\ The purpose of this
definition is to establish consistency with the Regulation T definition
of exempted borrower, which excludes transactions with "persons
associated with a broker or dealer," as that term is defined in
section 3(a)(18) of the Exchange Act.\64\ The phrase "persons
affiliated with" has been used in the definition with respect to
transactions with FCMs, floor brokers and floor traders, and the phrase
"persons associated with" has been used with respect to transactions
with brokers and dealers. This is not intended to create a substantive
difference in the provisions applicable to the securities and futures
industries. Rather, it is intended to avoid confusion insofar as the
CFTC's definition of "affiliated person" (which includes corporate
affiliates) \65\ more closely matches the Exchange Act definition of
"persons associated with a broker or dealer," than does the CFTC
definition of "associated person," which is a registration
category.\66\
---------------------------------------------------------------------------
\62\ See CFTC Rule 41.43(a)(9)(ii); SEC Rule 401(a)(9)(ii).
\63\ See CFTC Rule 41.43(a)(23); SEC Rule 401(a)(23).
\64\ 15 U.S.C. 78c(a)(18).
\65\ See 17 CFR 155.1; Section 4f(c)(1)(i) of the CEA, 7 U.S.C.
6f(c)(1)(i).
\66\ See 17 CFR 1.3(aa).
---------------------------------------------------------------------------
The Final Rules clarify that a person may qualify as an exempted
person based on transactions in commodity futures and commodity
options, as well as securities. For purposes of the "1000 active
accounts" threshold, an FCM or broker or dealer that clears a bona
fide customer omnibus account for another FCM or broker or dealer may
treat that account as a single customer account. For purposes of the
$10 million and 10% thresholds, the gross revenues from transactions
for bona fide customer omnibus accounts may be included in the
computation. An omnibus account will not be considered a bona fide
customer account if it is used to clear transactions for market
professionals that would otherwise be excluded from the exempted person
computation. A fully disclosed customer account will be considered a
single customer account of the clearing firm, as well as the
introducing firm.
The exempted person provision further states that a member of a
national securities exchange or a registered broker, dealer, or futures
commission merchant that has been in existence for less than one year
may meet the definition of exempted person based on a six-month
period.\67\ This incorporates the standard set forth in Regulation
T.\68\
---------------------------------------------------------------------------
\67\ See CFTC Rule 41.43(a)(9)(iii); SEC Rule 401(a)(9)(iii).
\68\ See 12 CFR 220.3(j)(1).
---------------------------------------------------------------------------
In response to one commenter's suggestion,\69\ the Commissions are
also defining the term "good faith," consistent with the definition
of that term in Regulation T,\70\ for the purposes of determining what
steps a security futures intermediary must take to assure itself that a
person is an exempted person.\71\ The Final Rules further provide that
a person who ceases to qualify as an exempted person must notify the
security futures intermediary of that fact, and become subject to the
provisions of the Final Rules, but only before entering into any new
security futures transaction or related transaction that would require
additional margin to be deposited.\72\ This would permit a person to
enter into new offsetting transactions that reduce the required margin
in an account without triggering higher margin requirements.
---------------------------------------------------------------------------
\69\ Meeting between SEC and CFTC staff and representatives of
SIA/FIA (February 6, 2002).
\70\ See 12 CFR 220.2.
\71\ See CFTC Rule 41.43(a)(15); SEC Rule 401(a)(15).
\72\ See CFTC Rule 41.44(f); SEC Rule 402(f).
---------------------------------------------------------------------------
b. Margin Arrangements with a Borrower Otherwise Excluded Pursuant
to section 7(c)(3) of the Exchange Act. The Proposed Rules included an
exclusion for credit extended, maintained, or arranged by a creditor to
or for a registered broker-dealer, or member of a national securities
exchange (including an FCM registered as a broker-dealer under section
15(b)(11) of the Exchange Act) that is otherwise excluded under section
7(c)(3) of the Exchange Act.\73\ The Commissions have decided not to
adopt this exclusion.
---------------------------------------------------------------------------
\73\ See Proposed CFTC Rule 41.43(b)(3)(iv)(B); Proposed SEC
Rule 400(b)(3)(iv)(B).
---------------------------------------------------------------------------
Under section 7(c)(3)(B) of the Exchange Act,\74\ the financing of
the market making or underwriting activities of a member of a national
securities exchange or a registered broker-dealer is excluded from the
scope of federal margin regulation. The Federal Reserve Board has
expressed the view that floor traders on open-outcry futures exchanges
act as market makers and therefore would be excluded from the margin
requirements for security futures pursuant to Section 7(c)(3)(B).\75\
[[Page 53152]]
The proposed exclusion was intended to codify this view.
---------------------------------------------------------------------------
\74\ 15 U.S.C. 78g(c)(3)(B).
\75\ In its delegation letter, the Federal Reserve Board stated
that "[i]n the current open-outcry environment, the Board believes
that floor traders act as market makers and therefore would be
exempt [under section 7(c)(3) of the Exchange Act]." FRB Letter at
2.
---------------------------------------------------------------------------
One commenter addressed this exclusion and maintained that the
exclusion was confusing because the Commissions did not provide any
guidance as to the factors under which a broker-dealer would qualify
for the exclusion.\76\ The commenter asked the Commissions to clarify
the circumstances under which a floor trader on an open outcry exchange
qualifies for the market maker exclusion.
---------------------------------------------------------------------------
\76\ CBOE Letter.
---------------------------------------------------------------------------
The Commissions have not adopted the proposed exclusion. As noted
above, the Federal Reserve Board has taken the position that floor
traders on open-outcry futures exchanges qualify for the statutory
market maker exception. However, any further interpretation of section
7(c)(3) of the Exchange Act is within the purview of the Federal
Reserve Board. As a result, the Commissions would not be able to
provide specific guidance as requested by the commenter as to the
circumstances under which Section 7(c)(3) applies to floor traders on
an open-outcry futures exchange. The Commissions emphasize that any
person excluded from federal margin regulation under section 7(c)(3) of
the Exchange Act is not subject to the rules adopted by the Commissions
today. The Commissions encourage market participants to seek
interpretive guidance from the Federal Reserve Board regarding the
circumstances in which the exception under section 7(c)(3) of the
Exchange Act applies.
c. Financial Relations between a Security Futures Intermediary and
a Member of a National Securities Exchange or Association in Connection
with Market Making Activities. The Commissions proposed to exclude from
the scope of the margin requirements credit extended, maintained, or
arranged to or for members of a national securities exchange or a
national securities association in connection with market making
activities.\77\ As proposed, the exclusion had two conditions. First,
the borrower could not directly or indirectly accept or solicit
customer orders or provide advice to any customer in connection with
the trading of security futures. Second, the borrower had to be
registered with the exchange or association as a security futures
dealer, pursuant to regulatory authority rules that require the
borrower: (a) To be registered as a floor trader or floor broker with
the CFTC, or as a dealer with the SEC; (b) to comply with applicable
SEC or CFTC net capital requirements; (c) to maintain records
sufficient to demonstrate compliance with the exclusion and the rules
of the exchange or association; (d) to hold itself out as willing to
buy and sell security futures for its own account on a regular or
continuous basis; and (e) to be subject to disciplinary action if it
failed to comply with the Commissions' margin rules or the rules of the
exchange or association.\78\ The Commissions are adopting this
exclusion with modifications in light of commenters' views.\79\
---------------------------------------------------------------------------
\77\ See Proposed CFTC Rule 41.43(b)(3)(iv)(C); Proposed SEC
Rule 400(b)(3)(iv)(C).
\78\ Id.
\79\ See CFTC Rule 41.42(c)(2)(v); SEC Rule 400(c)(2)(v). The
Commissions note that the Final Rules include a definition of the
term "member," which clarifies the applicability of that term to
persons with trading privileges on an exchange, even if that
exchange does not have a "membership" structure. More
specifically, the term "member" has the meaning provided in
section 3(a)(3) of the Exchange Act and includes persons registered
under section 15(b)(11) of the Exchange Act that are permitted to
effect transactions on a national securities exchange without the
services of another person acting as executing broker. See CFTC Rule
41.43(a)(21); SEC Rule 401(a)(21).
---------------------------------------------------------------------------
The Commissions received four comments on the exclusion.\80\ These
comments generally supported the proposed exclusion, but suggested that
the Commissions clarify certain aspects of the conditions.
---------------------------------------------------------------------------
\80\ See Amex Letter; CBOE Letter; OneChicago Letter; SIA/FIA
Letter. In addition, the ABN AMRO Letter endorsed the comments in
the SIA/FIA Letter.
---------------------------------------------------------------------------
One commenter expressed the view that a person is a market maker in
security futures if it provides liquidity on a regular basis, even if
it is not under an affirmative obligation to do so.\81\ Based on that
view, the commenter suggested two alternatives to the Commissions'
proposal to determine whether a trader is a liquidity provider. First,
the commenter recommended that the Commissions consider a person to be
a liquidity provider solely because that person is registered with
either the SEC or the CFTC as a trading professional (e.g., as a
broker-dealer or FCM) and is a member of an exchange. In the
alternative, the commenter recommended that the Commissions consider a
trader to be a liquidity provider if that person can demonstrate
through its business activity that it is a professional liquidity
provider, regardless of its regulatory status or membership in an
exchange.\82\ This commenter further stated that the net capital
requirements for persons acting as market makers in security futures
should be uniform in order to prevent security futures market makers
subject to CFTC financial responsibility rules from obtaining an unfair
competitive advantage over security futures market makers (or security
options market makers) subject to SEC financial responsibility
rules.\83\
---------------------------------------------------------------------------
\81\ CBOE Letter at 2-3.
\82\ Id. at 4.
\83\ Id. at 5-6.
---------------------------------------------------------------------------
Another commenter asked the Commissions to modify the condition to
the exclusion for exchange members that requires that the member "hold
itself out as being willing to buy and sell security futures for its
own account on a regular or continuous basis." \84\ The commenter
maintained that market makers on a screen-based trading system either
should have an enforceable obligation to provide liquidity or should
meet an objective standard for supplying liquidity.\85\ Specifically,
the commenter suggested that the condition be narrowed further with
respect to members of screen-based trading systems so that it would
apply only to members of such systems that: (1) have a continuous,
affirmative obligation to quote a two-sided market; or (2) effect more
than two-thirds of their security futures trades on that exchange with
persons other than registered market makers on that exchange.\86\
---------------------------------------------------------------------------
\84\ Amex Letter.
\85\ Id. at 2, 4.
\86\ Id. at 4.
---------------------------------------------------------------------------
A third commenter asked the Commissions to eliminate the condition
to the exclusion for exchange members that requires that the member not
"directly or indirectly accept or solicit orders from any customer or
provide advice to any customer in connection with the trading of
security futures." \87\ The commenter maintained that a broker-dealer
acting as a market maker should not be precluded from also carrying out
a customer securities business.
---------------------------------------------------------------------------
\87\ SIA/FIA Letter at 14, n.25; Appendix I, Q 17(a).
---------------------------------------------------------------------------
The fourth commenter asked the Commissions to confirm that
registered floor brokers and floor traders would qualify for the
exclusion even if they are not subject to a net capital requirement
under CFTC rules.\88\ In support of this request, the commenter stated
that market makers in options are exempt from the SEC's net capital
rule.\89\
---------------------------------------------------------------------------
\88\ OneChicago Letter at 9.
\89\ Id.
---------------------------------------------------------------------------
After considering the commenters' views, the Commissions have
adopted the exclusion with certain modifications. First, the
Commissions are clarifying that the provision relating
[[Page 53153]]
to accepting or soliciting customer orders was not intended to bar a
member from engaging in such activities. That provision was intended to
limit the exclusion from the margin requirements to circumstances where
the member was trading for its own account, not for the account of
others. Accordingly, the rule has been modified to make clear that the
exclusion is available to a member only with respect to trading
activity for its own account.\90\ Thus, the member may conduct a
customer business and still qualify for the exclusion from the
Commissions' margin requirements for security futures with regard to
its market making activity.
---------------------------------------------------------------------------
\90\ See CFTC Rule 41.42(c)(2)(v); SEC Rule 400(c)(2)(v).
---------------------------------------------------------------------------
The Commissions have also decided that it is unnecessary to restate
the applicability of existing net capital requirements under CFTC and
SEC rules, or to impose additional net capital requirements, as a
condition of the exclusion for persons acting as market makers. Firms
will continue to be subject to applicable CFTC or SEC net capital
requirements. Further, even if a member is not subject to net capital
requirements, the member's carrying firm will be subject to the
treatment provided in existing SEC or CFTC net capital rules, whichever
are applicable, with respect to the member's security futures
transactions.
As noted above, the Commissions received several comments regarding
the circumstances under which an exchange member should be considered a
market maker for purposes of the margin rules, other than in
circumstances that fall within the exception in Section 7(c)(3) of the
Exchange Act. These comments largely refer to the requirement that the
exchange member "hold itself out as being willing to buy and sell
security futures for its own account on a regular or continuous basis'
in order to qualify for the exclusion. The Commissions do not believe
that registration with the SEC or CFTC is, by itself, sufficient to
show that a market participant is holding itself out as willing to buy
and sell security futures. However, the Commissions believe that there
are a number of different ways that an exchange member could satisfy
this condition. For example, an exchange's or association's rules could
require the member to effect a certain percentage of its security
futures trades on that exchange or association with persons other than
registered market makers on that exchange or association.\91\
---------------------------------------------------------------------------
\91\ National securities exchanges registered under section 6(a)
of the Exchange Act require their options market makers to conduct
at least 50% of their total contract volume in option classes to
which they have been appointed. See Amex Rule 958; Philadelphia
Stock Exchange ("Phlx") Rule 1014. In some cases, market makers
are required to conduct at least 75 percent of their total contract
volume in option classes to which they have been appointed. See CBOE
Rule 8.7.03; International Securities Exchange Rule 805; Pacific
Exchange ("PCX") Rule 6.37.
---------------------------------------------------------------------------
Alternatively, such rules could require that a large majority of
such exchange member's revenue is derived from business activities or
occupations from trading listed financial-based derivatives (i.e.,
security futures, stock index futures, stock and index options, foreign
currency futures and options, and interest rate futures and options) on
any exchange in the capacity of a member. As another alternative, the
exchange member could be subject to rules that impose on it an
affirmative obligation to quote on a regular or continuous basis in
security futures.
C. Interpretations of, and Exemptions From, the Final Rules
The Commissions are adopting two provisions in the Final Rules to
clarify the Commissions' authority to respond to issues that arise in
connection with the implementation of the Final Rules. First, the
Commissions are adding a provision regarding the interpretation of the
security futures margin rules. The Final Rules provide that the
Commissions shall jointly interpret the margin rules, consistent with
the criteria set forth in clauses (i) through (iv) of section
7(c)(2)(B) of the Exchange Act and Regulation T.\92\
---------------------------------------------------------------------------
\92\ See CFTC Rule 41.42(b); SEC Rule 400(b).
---------------------------------------------------------------------------
Second, the Final Rules add a provision providing that each
Commission may issue an exemption from any provision of the Final
Rules.\93\ CFTC Rule 41.42(d) provides that the CFTC may grant an
exemption with respect to any provision of CFTC Rules 41.42 through
41.49, provided that the CFTC finds that the exemption is consistent
with the public interest and the protection of customers. Similarly,
SEC Rule 400(d) provides that the SEC may grant an exemption with
respect to any provision of SEC Rules 400 through 406, provided that
the exemption is necessary or appropriate in the public interest and
consistent with the protection of investors. Because financial
relations involving security futures are subject to the Final Rules as
adopted by both the CFTC and the SEC, any person seeking an exemption
under these rules must request and obtain the same exemption from both
the CFTC and SEC. The Commissions intend to work together on exemption
requests to establish uniform policies for security futures trading.
---------------------------------------------------------------------------
\93\ See CFTC Rule 41.42(d); SEC Rule 400(d). The SEC and CFTC
exemption standards contained in the Final Rules are the same as
those set forth in the recently adopted rules relating to cash
settlement and regulatory halt requirements for security futures
products. See Securities Exchange Act Release No. 45956 (May 17,
2002), 67 FR 36740 (May 24, 2002). As noted in connection with those
rules, the SEC version of the exemption provision refers to the
protection of "investors," and the CFTC version of the provision
refers to the protection of "customers." Id. at 36745, n.64. The
difference in terminology is not intended to have any substantive
significance. Rather, the terms are used for purposes of conformity
with terminology used in the Exchange Act and CEA.
---------------------------------------------------------------------------
D. Definitions
The definition section of the Proposed Rules has been expanded to
include all applicable defined terms. Under the Proposed Rules, many of
these definitions and provisions would have been incorporated through
the application of Regulation T.
The terms "contract multiplier," "daily settlement price," and
"Regulation T" are defined in the Final Rules as proposed.\94\ The
Proposed Rules defined the terms "examining authority," "initial
margin," and "maintenance margin." \95\ These terms are not,
however, included in the Final Rules because modifications made to the
Proposed Rules make them unnecessary. The Final Rules also define the
term "self-regulatory authority," \96\ instead of the term
"regulatory authority" as proposed,\97\ and its definition has been
revised to include a reference to registration under the CEA. In
addition, the Final Rules define the term "current market value" with
respect to a security other than a security future consistently with
the Regulation T definition.\98\ Some of the defined terms incorporate
by reference definitions from the CEA, the Exchange Act, or CFTC or SEC
rules.\99\
---------------------------------------------------------------------------
\94\ See CFTC Rules 41.43(a)(3), (a)(6), and (a)(24); SEC Rules
401(a)(3), (a)(6), and (a)(24).
\95\ See Proposed CFTC Rules 41.44(a)(3), (a)(4), and (a)(5);
Proposed SEC Rules 401(a)(3), (a)(4), and (a)(5).
\96\ See CFTC Rule 41.43(a)(30); SEC Rule 401(a)(30). The
terminology was modified to eliminate confusion as to a "regulatory
authority" being a governmental regulator rather than an SRO.
\97\ See Proposed CFTC Rule 41.44(a)(7); Proposed SEC Rule
401(a)(7).
\98\ See CFTC Rule 41.43(a)(4); SEC Rule 401(a)(4); see also 12
CFR 220.2.
\99\ See, e.g., definitions of "broker," CFTC Rule 41.43(a)(2)
and SEC Rule 401(a)(2); "dealer," CFTC Rule 41.43(a)(7) and SEC
Rule 401(a)(7); "exempted security," CFTC Rule 41.43(a)(10) and
SEC Rule 401(a)(10); "futures account," CFTC Rule 41.43(a)(13) and
SEC Rule 401(a)(13); "futures commission merchant," CFTC Rule
41.43(a)(14) and SEC Rule 401(a)(14); and "securities account,"
CFTC Rule 41.43(a)(28) and SEC Rule 401(a)(28).
---------------------------------------------------------------------------
[[Page 53154]]
Terms that are not otherwise defined in the definition section of
the Final Rules will have the meaning set forth in the margin rules
applicable to the account.\100\ Terms that are neither defined in the
definition section nor in the margin rules applicable to the account
will have the meaning set forth in the Exchange Act and the CEA.\101\
If the definitions of a term in the Exchange Act and the CEA are
inconsistent as applied in particular circumstances, such term shall
have the meaning set forth in rules, regulations, or interpretations
jointly promulgated by the SEC and the CFTC.
---------------------------------------------------------------------------
\100\ See CFTC Rule 41.43(b); SEC Rule 401(b). See also infra
notes 125-126 and accompanying text.
\101\ See CFTC Rule 41.43(c); SEC Rule 401(c).
---------------------------------------------------------------------------
E. Application of Regulation T to Security Futures
Section 7(c)(2)(B)(iv) of the Exchange Act requires that the 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.\102\ To carry out that statutory
mandate, the Commissions proposed that Regulation T would apply to all
transactions in security futures, to the extent consistent with the
Proposed Rules. Thus, under the Proposed Rules, Regulation T would have
applied both to securities accounts (which are already subject to
Regulation T) and to futures accounts (which are not otherwise subject
to Regulation T) that carry security futures.\103\ This approach also
would have applied existing and future Federal Reserve Board
interpretations of Regulation T to the margin requirements for security
futures and kept the margin requirements consistent with Regulation T
without the need for amendments to the Final Rules.
---------------------------------------------------------------------------
\102\ 15 U.S.C. 78g(c)(2)(B)(iv).
\103\ See Proposed CFTC Rule 41.43(b)(1); Proposed SEC Rule
400(b)(1).
---------------------------------------------------------------------------
The Commissions, however, also recognized that there could be more
than one approach to prescribing rules that are "consistent" with
Regulation T. Accordingly, the Commissions specifically requested
commenters' views on alternative approaches to establishing consistency
with Regulation T. In particular, the Commissions solicited comment on
the approach of issuing comprehensive "stand-alone" margin rules that
would parallel Regulation T requirements for securities to the extent
that such requirements are relevant to security futures. Under that
approach, the stand-alone rules would apply to security futures and any
related securities or futures contracts that are used to offset
positions in such security futures. However, the stand-alone rules
would not apply to any other securities or futures transactions.
The Commissions received a total of 12 comment letters on the
application of Regulation T to security futures transactions.\104\ One
commenter supported the Commissions' proposed approach regarding
Regulation T.\105\ Nine commenters opposed general application of
Regulation T to security futures carried in futures accounts,\106\ and
two other commenters specifically opposed applying the Regulation T
account structure to FCMs.\107\
---------------------------------------------------------------------------
\104\ See NFA Letter; SIA/FIA Letter; Nasdaq Liffe Letter; ABN
AMRO Letter; CME/CBOT Letter; OneChicago Letter; Morgan Stanley
Letter; Peregrine Letter; SunGard Letter; Options Exchanges Letter;
Managed Funds Letter; and Rolfe and Nolan Letter.
\105\ Options Exchanges Letter at 3.
\106\ NFA Letter at 2-3; SIA/FIA Letter at 2, 4-7; ABN AMRO
Letter at 1; CME/CBOT Letter at 2-3; OneChicago Letter at 3-7;
Morgan Stanley Letter at 2, 5-6; Peregrine Letter at 2; Managed
Funds Letter at 1; and Rolfe and Nolan Letter at 1-2.
\107\ Nasdaq Liffe Letter at 6-7; and SunGard Letter at 2-3.
---------------------------------------------------------------------------
The commenter that supported application of Regulation T to all
security futures transactions believed that the alternative approach of
stand-alone rules would not satisfy the statutory requirement that the
margin requirements for security futures (other than levels of margin)
be "consistent" with those imposed on securities.\108\ The commenter
expressed the view that the term "consistent" should mean that there
is no appreciable difference between rules applicable to exchange-
traded options and rules applicable to security futures. In addition,
the commenter noted that if the Commissions adopt stand-alone margin
rules there is a risk that over time such rules will vary materially
from Regulation T because of the difficulty of promptly incorporating
the Federal Reserve Board's future interpretations of Regulation T into
stand-alone rules.
---------------------------------------------------------------------------
\108\ Options Exchanges Letter at 3.
---------------------------------------------------------------------------
Commenters opposing the general application of Regulation T to
security futures did not believe that the CFMA required such
application. One commenter contended that application of Regulation T
to futures accounts "is impractical and unnecessary" and "not
required," and that the CFMA's "consistent" standard did not
necessarily require rules "identical" or "equivalent" to the rules
applicable to exchange-traded options.\109\ Rather, this commenter
argued, Regulation T permits commodity futures to be recorded in an
account other than a margin account (a "good faith" account) and, as
a result, permitting security futures to be carried in a futures
account (not a margin account) is "consistent" with Regulation
T.\110\ Another commenter observed that while "consistency requires
reasonable comparability * * * [, i]f Congress had meant `consistent'
to mean `identical,' however, it would have used that word" or would
have clearly directed that Regulation T be applied to security
futures.\111\ Similarly, another commenter pointed out that "the CFMA
did not mandate the application of Reg[ulation] T to security futures
maintained in a futures account" and that the "imposition of
Reg[ulation] T with respect to security futures is inconsistent with
Congress's goal of facilitating trading in security futures." \112\
---------------------------------------------------------------------------
\109\ OneChicago Letter at 3.
\110\ Id. at 3-4.
\111\ NFA Letter at 2.
\112\ SIA/FIA Letter at 5.
---------------------------------------------------------------------------
Commenters that disagreed with the Commissions' proposed approach
generally urged the Commissions to adopt "stand-alone" margin rules
for security futures.\113\ All of these commenters maintained that the
programming changes necessary to enable FCMs to comply with Regulation
T would be overly costly.\114\ Generally, those commenters believed
that it would be operationally difficult or impossible to carry
security futures in a standard futures account without costly and time-
consuming reprogramming.\115\ Commenters were concerned that this would
place FCMs at a considerable disadvantage in comparison to broker-
dealers and would discourage them from trading security futures. One
commenter pointed out that a broker-dealer "would need to do little,
relative to an FCM, to bring itself into compliance with the Proposed
Rules." \116\ Another commenter expressed concern that FCMs would have
to undertake a substantial development project requiring `the
[[Page 53155]]
restructuring of FCMs' accounts and related systems changes." \117\
The commenter estimated that this would result in the expenditure of
"several thousands of personnel hours," \118\ while another commenter
believed that costs would "run well into six figures." \119\
---------------------------------------------------------------------------
\113\ See NFA Letter at 2; SIA/FIA Letter at 5; Nasdaq Liffe
Letter at 7; ABN AMRO Letter at 1; CME/CBOT Letter at 10; OneChicago
Letter at 7; SunGard Letter at 3; and Peregrine Letter at 2.
\114\ See NFA Letter at 3; SIA/FIA Letter at 4; Nasdaq Liffe
Letter at 6; ABN AMRO Letter at 1; CME/CBOT Letter at 3; OneChicago
Letter at 5; SunGard Letter at 1; and Peregrine Letter at 2.
\115\ See NFA Letter at 2; SIA/FIA Letter at 4-5; Nasdaq Liffe
Letter at 6; ABN AMRO Letter at 1; CME/CBOT Letter at 3; OneChicago
Letter at 4; SunGard Letter at 1; Peregrine Letter at 2.
\116\ OneChicago Letter at 5.
\117\ SIA/FIA Letter at 4.
\118\ Id.
\119\ Rolfe and Nolan Letter at 1.
---------------------------------------------------------------------------
Eight commenters recommended the adoption of an account-specific
margin regime for purposes of account administration.\120\ The adoption
of an account-specific margin regime was effectively endorsed by two
other commenters that advocated retention of specific existing
practices \121\ and one other that believed the imposition of
Regulation T on FCMs would be highly burdensome.\122\ One commenter
argued against the adoption of an account-specific margin regime,
stating that FCMs will have to revise a number of their operating
procedures and there is no compelling reason to make an exception for
margin procedures.\123\
---------------------------------------------------------------------------
\120\ See NFA Letter at 1-2; SIA/FIA Letter at 3-4; Nasdaq Liffe
Letter at 6-7; ABN AMRO Letter at 1; OneChicago Letter at 6-7;
Peregrine Letter at 2; Morgan Stanley Letter at 1; and Managed Funds
Letter at 2.
\121\ See Rolfe and Nolan Letter at 2; and CME/CBOT Letter at
10.
\122\ SunGard Letter at 2.
\123\ Options Exchanges Letter at 3-4.
---------------------------------------------------------------------------
After considering the commenters' suggestions, the Commissions have
determined that it is not necessary to apply Regulation T in its
entirety to security futures transactions to satisfy the requirements
under section 7(c)(2) of the Exchange Act.\124\ Given the relative
infrequency of the Federal Reserve Board adopting amendments to
Regulation T and issuing formal regulatory guidance, the Commissions do
not believe that it will be unduly burdensome or impractical to amend
these rules to maintain consistency with Regulation T. Accordingly, the
Commissions have adopted stand-alone margin rules that include certain
requirements of Regulation T. The Commissions believe that the
inclusion of these requirements in the Final Rules satisfies the
statutory requirement that margin requirements for security futures be
and remain consistent with Regulation T.
---------------------------------------------------------------------------
\124\ 15. U.S.C. 78g(c)(2).
---------------------------------------------------------------------------
The Commissions believe that many of the rules governing margin for
positions carried in securities accounts are similar enough to the
rules governing margin for positions carried in futures accounts that
the differences do not, by themselves, create an incentive for
customers either to trade security futures instead of options, or to
hold security futures in a futures account rather than a securities
account. Accordingly, the Commissions are adopting an "account-
specific" approach for those aspects of account administration that
need not be conformed to satisfy the requirement that the margin rules
for security futures be consistent with Regulation T. Thus, the Final
Rules provide that security futures held in a securities account are
subject to the Final Rules, Regulation T, and to the margin
requirements of the self-regulatory authorities of which the security
futures intermediary is a member.\125\ Security futures held in a
futures account, on the other hand, will be subject to the Final Rules
and the margin requirements of the self-regulatory authorities of which
the security futures intermediary is a member.\126\
---------------------------------------------------------------------------
\125\ See CFTC Rule 41.44(a)(1); SEC Rule 402(a)(1).
\126\ See CFTC Rule 41.44(a)(2); SEC Rule 402(a)(2).
---------------------------------------------------------------------------
Notwithstanding the Commissions' determination not to apply
Regulation T in its entirety to security futures, the Final Rules
include certain uniform provisions that govern account administration,
type, form, and use of collateral, calculation of equity, withdrawals
from accounts, and treatment of undermargined accounts. The Commissions
believe 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.
F. Account Administration Rules
1. Separation and Consolidation of Accounts
Regulation T establishes specific types of accounts for recording
different types of customer transactions (e.g., a margin account, a
cash account, a good faith account).\127\ Regulation T generally
provides that a customer can have only one margin account.\128\ While a
margin account may be divided into separate parts for bookkeeping
purposes, as authorized by the customer, all parts must be considered
as one unit in determining whether or not any transaction is
permissible under Regulation T.\129\ The determination as to whether an
account satisfies the requirements of Regulation T, moreover, may not
take into consideration items in any other account; bookkeeping entries
must be made whenever cash or securities in one account are used for
purposes of meeting requirements in another account.\130\ Consistent
with Regulation T, the Final Rules provide that the margin requirements
for one account may not be met by considering items in another account,
except where excess margin is transferred using appropriate bookkeeping
entries.\131\ To facilitate the enforcement of this general
prohibition, this provision also requires that if withdrawals of cash,
securities, or other assets deposited as margin are permitted under the
Final Rules, a security futures intermediary must make and keep
accurate bookkeeping entries when those assets are used to meet
requirements in another account.\132\ This provision parallels Section
220.3(b)(1) of Regulation T, and is intended to be consistent with
existing futures account practices under Section 4d of the CEA,\133\
CFTC Rules 1.20 and 1.22, and applicable futures exchange rules.
---------------------------------------------------------------------------
\127\ See 12 CFR 220.4(a)(1).
\128\ See 12 CFR 220.4(a)(2).
\129\ Fed. Res. Reg. Serv. Sec. 5-634.11 (Staff Op. May 15,
1978).
\130\ See 12 CFR 220.3(b)(1).
\131\ See CFTC Rule 41.44(b)(1); SEC Rule 402(b)(1).
\132\ See CFTC Rule 41.44(b)(1); SEC Rule 402(b)(1); see also
section 17(a) of the Exchange Act (15 U.S.C. 78q-1(a)), and the
rules thereunder; Section 4g of the CEA (7 U.S.C. 6g), and the rules
thereunder; National Association of Securities Dealers ("NASD")
Rule 3110; and NFA Rule 2-10.
\133\ 7 U.S.C. 6d.
---------------------------------------------------------------------------
Currently, futures exchange rules or practices similarly recognize
accounts of different types for different customer transactions (e.g.,
customer segregated, customer secured, nonsegregated). Customers may
maintain multiple accounts of the same regulatory classification or
account type, although futures exchange rules provide that identically
owned accounts within the same regulatory classification or account
type should be combined for margin purposes.\134\ Moreover, an FCM may
not apply free funds in an account under identical ownership but of a
different regulatory classification or account type to an account's
margin deficiency.\135\ As is the case under Regulation T, however, the
Final Rules require the FCM to actually document through bookkeeping
entries the transfer of funds from one account to satisfy the margin
deficiency in another account. The Commissions do not believe that this
provision will create any substantial operational burdens for FCMs
carrying security futures in futures accounts.
---------------------------------------------------------------------------
\134\ See Joint Audit Committee Handbook, Chapter 9 (June 1999),
available at <http://www.nfa.futures.org/compliance/publications/
Margins/MarginsHandbook.pdf>.
\135\ See id.
---------------------------------------------------------------------------
The Final Rules provide that all futures accounts of the same
regulatory
[[Page 53156]]
type or classification that carry security futures shall be considered
a single account for purposes of the Regulation.\136\ The Final Rules
also permit a securities futures intermediary to further consolidate
all futures accounts of the same regulatory classification or account
type, regardless of whether they carry security futures, for purposes
of determining whether the required margin for all of a customer's
futures positions (including security futures) is satisfied.\137\
---------------------------------------------------------------------------
\136\ See CFTC Rule 41.44(b)(2); SEC Rule 402(b)(2).
\137\ Id.
---------------------------------------------------------------------------
2. Accounts of Partners
The Final Rules provide that if a partner of a security futures
intermediary (organized as a partnership) has an account with the
security futures intermediary in which security futures or related
positions are held, the security futures intermediary must disregard
the partner's financial relations with the firm (as shown in the
partner's capital and ordinary drawing accounts) in calculating the
margin or equity of any such account.\138\ This provision parallels
Section 220.4(b)(5) of Regulation T,\139\ and is consistent with
current futures exchange practices. The provision is intended to
reinforce the principle of "separation of accounts" with respect to
partners in a security futures intermediary organized as a partnership,
when a partner maintains a trading account with the firm.
---------------------------------------------------------------------------
\138\ See CFTC Rule 41.44(c); SEC Rule 402(c).
\139\ 12 CFR 220.4(b)(5).
---------------------------------------------------------------------------
3. Contribution to a Joint Venture
Under the Final Rules, if an account in which security futures or
related positions are held is the account of a joint venture in which
the security futures intermediary participates, any interest of the
security futures intermediary in the joint account in excess of the
interest which the security futures intermediary would have on the
basis of its right to share in the profits must be margined in
accordance with the Final Rules.\140\ This provision parallels Section
220.4(b)(6) of Regulation T,\141\ which is intended to prevent firms
from indirectly extending credit to customers in circumstances where
the customer does not deposit equity in the account corresponding to
its share of the profits in the account (e.g., if the customer is
entitled to 90% of the profits in an account, but only deposits 40% of
the equity at the outset, the broker-dealer is effectively extending
credit to the customer in the amount of 50% of the equity in the
account).
---------------------------------------------------------------------------
\140\ See CFTC Rule 41.44(d); SEC Rule 402(d).
\141\ 12 CFR 220.4(b)(6).
---------------------------------------------------------------------------
4. Extensions of Credit
The Final Rules prohibit any extension of credit with respect to
security futures, if the extension of credit is designed to evade or
circumvent the security futures margin requirements.\142\ Among other
things, this provision is intended to prevent security futures
intermediaries from extending unsecured credit to customers, or
extending credit secured by securities or other assets in excess of the
value such assets would have under the Final Rules,\143\ to satisfy or
maintain the required margin for security futures carried in the
customer's account.\144\ For example, a security futures intermediary
may not lend a customer $100 in cash secured by less than $200 in
margin equity securities to meet a margin call for a security future.
This provision does not, however, preclude a security futures
intermediary from advancing funds to a customer to meet variation
settlement calls on behalf of an undermargined customer account, in the
ordinary course of business, provided that the security futures
intermediary issues a margin call for the funds advanced.
---------------------------------------------------------------------------
\142\ See CFTC Rule 41.44(e); SEC Rule 402(e). CFTC Rule 1.30
permits FCMs to lend their own funds to customers on pledged
securities; the proceeds of such loans are treated as customer funds
for purposes of the CEA. 17 CFR 1.30. Extensions of credit by
brokers and dealers with respect to securities are governed by
Regulation T and the margin rules of the national securities
exchanges and securities associations.
\143\ See CFTC Rule 41.46(c); SEC Rule 404(c).
\144\ Futures exchange rules also impose certain restrictions on
the financing of futures positions. See, e.g., CME Rule 930.G
("Clearing members may not extend loans to account holders for
performance bond purposes unless such loans are secured as defined
in [17 CFR] 1.17(c)(3)"); New York Mercantile Exchange ("NYMEX")
Rule 4.03 ("Clearing Members shall not be permitted to make loans
to any customers for the purpose of financing margins on NYMEX
Division contracts unless such loans are secured, as such term is
defined in [17 CFR] 1.17").
---------------------------------------------------------------------------
The Final Rules permit a security futures intermediary to arrange
for an extension of credit to or for a customer by a person, provided
that the extension of credit would not constitute a violation of
Regulations T, U, or X by such person.\145\ In this connection, the
Commissions believe that credit extended for the purpose of satisfying
or maintaining the required margin for a security future is "purpose
credit" for purposes of the Federal Reserve Board's credit
regulations. For example, a security futures intermediary may not
arrange for a Regulation T creditor to extend credit to a customer
against securities or other assets in a nonpurpose or nonsecurities
credit account to enable the customer to meet a margin requirement with
respect to a security future. Likewise, a security futures intermediary
may not arrange for a bank or other Regulation U lender to extend
credit secured directly or indirectly by margin stock in excess of the
maximum loan value of the collateral (i.e., 50% of current market
value) securing the credit for the purpose of purchasing or carrying a
security future. Similarly, a security futures intermediary may not
arrange for a Regulation X borrower to obtain an extension of credit
within or from outside the United States for the purpose of effecting
or carrying a security futures transaction unless the credit conforms
to the Federal Reserve Board's margin regulations, as provided in
Regulation X.
---------------------------------------------------------------------------
\145\ See CFTC Rule 41.44(e)(2); SEC Rule 402(e)(2).
---------------------------------------------------------------------------
G. Customer Margin Levels for Security Futures
The Commissions proposed to require both the seller and the buyer
of a security future to provide and maintain, on a daily basis, cash or
other acceptable assets equal to a percentage of the "current market
value" of the security future. The Commissions are adopting those
requirements substantially as proposed.
1. Definition of Current Market Value
The Commissions proposed to define the term "current market
value" of a security future as the product of the daily settlement
price of the security future (as shown by any regularly published
reporting or quotation service) and either the applicable number of
shares per contract (when the underlying instrument is a single stock),
or the applicable contract multiplier (when the underlying instrument
is a narrow-based security index).\146\ The Commissions also proposed
to define the term "current market value" with respect to a narrow-
based security index future to mean the product of the daily settlement
price of such security future, as shown by any regularly published
reporting or quotation service, and the applicable contract
multiplier.\147\
The Commissions received one comment on these definitions, which
suggested that the pricing convention for determining current market
value need not be the same for security futures held in a security
account and for
[[Page 53157]]
security futures held in a futures account.\148\ The Commissions,
however, believe that a uniform definition of current market value is
necessary to ensure that identical contracts are not subject to
different margin requirements based on the type of account in which
they are carried.
---------------------------------------------------------------------------
\146\ See Proposed CFTC Rule 41.44(a)(2)(i); Proposed SEC Rule
401(a)(2)(i).
\147\ See Proposed CFTC Rule 41.44(a)(2)(ii); Proposed SEC Rule
401(a)(2)(ii).
\148\ SIA/FIA Letter at Appendix I, Q 18.
---------------------------------------------------------------------------
As noted above, section 7(c)(2)(B)(3)(I) of the Exchange Act \149\
requires that the margin requirements for security futures be
consistent with the margin requirements for comparable exchange-traded
options. The Commissions believe that using the daily settlement price
\150\ at the end of each trading day to calculate margin requirements
for security futures on that day is consistent with the use of the
closing price of the option and the underlying security for determining
maintenance margin for equity options.\151\ In addition, the
Commissions continue to believe that using the daily settlement price
of a security future on the day of a transaction to calculate the
initial margin (rather than the daily settlement price on the day
preceding the transaction) is consistent with using the underlying
stock's closing price on the preceding business day. The daily
settlement price of a security future on the preceding business day,
for example, may not exist if such security future were not available
for trading on the preceding business day. Accordingly, the Commissions
are adopting the definition of "current market value" as proposed.
---------------------------------------------------------------------------
\149\ 15 U.S.C. 78g(c)(2)(B)(3)(I).
\150\ Under the Final Rules, the term "daily settlement price"
means, with respect to a security future, the settlement price of
such security future determined at the close of trading each day, as
determined by the rules of the applicable exchange, clearing agency
or derivatives clearing organization. See CFTC Rule 41.43(a)(6); SEC
Rule 401(a)(6).
\151\ Currently, the computation of the margin required on the
sale of an uncovered option is based on the value of the security
underlying the option. The initial margin on the sale of an
uncovered option is based on the price at which the underlying
security closed at the end of the business day before the day on
which the option is sold. The maintenance margin on an uncovered
short option is based on the closing price of the underlying
security at the end of each business day.
---------------------------------------------------------------------------
2. Margin Levels for Unhedged Positions
The Commissions proposed that the minimum initial and maintenance
margin levels required of customers for each security future carried in
a long or short position be 20% of the current market value of such
security future.\152\ This proposed level was based on the requirement
under section 7(c)(2) of the Exchange Act that the initial and
maintenance margin levels for a security future not be lower than the
lowest level of margin, exclusive of premium, required for any
comparable option contracts traded on any exchange registered pursuant
to section 6(a) of the Exchange Act.\153\
---------------------------------------------------------------------------
\152\ See Proposed CFTC Rule 41.45(b); Proposed SEC Rule 402(b).
\153\ 15 U.S.C. 78g(c)(2)(B)(iii)(II).
---------------------------------------------------------------------------
Twelve commenters commented on this aspect of the Proposed
Rules.\154\ Six commenters found 20% to be an acceptable level.\155\
Two commenters advocated a 25% margin level,\156\ and one commenter,
joined by a second, stated that its members could not reach a consensus
as between 20% and 25%.\157\ One commenter expressed the view 20% could
be either too high or low, and suggested that for certain positions,
50% initial margin would be appropriate.\158\
---------------------------------------------------------------------------
\154\ See SIA Credit Division Letter; Morgan Stanley Letter;
Drinkard Letter; Partnoy Letter; Klein Letter; SIA/FIA Letter; One
Chicago Letter; NFA Letter; Peregrine Letter; Options Exchanges
Letter; Nasdaq Liffe Letter; and Managed Funds Letter.
\155\ See NFA Letter at 4; Nasdaq Liffe Letter at 5; Options
Exchanges Letter at 5; OneChicago Letter at 2; Peregrine Letter at
2; Managed Funds Letter at 3.
\156\ See Morgan Stanley Letter at 6; SIA Credit Division Letter
at 1.
\157\ See SIA/FIA Letter at 2-3, 10-11; ABN AMRO Letter at 1.
\158\ Partnoy Letter at 10-14.
---------------------------------------------------------------------------
One commenter considered the 20% level to be consistent with the
margin requirements for exchange-traded options, but "more than
adequate" in terms of preserving the financial integrity of the market
and preventing systemic risk.\159\ Another commenter stated that it
"does not oppose" the 20% level, but favors portfolio margining.\160\
---------------------------------------------------------------------------
\159\ NFA Letter at 4.
\160\ Nasdaq Liffe Letter at 5.
---------------------------------------------------------------------------
One commenter said that its members were split between recommending
20% and 25%.\161\ Those supporting the 20% level believed that it was
consistent with the levels applicable to exchange-traded options and
consistent with the intent of the CFMA. This margin level in
combination with a T+1 settlement period and the fact that the Proposed
Rules permit higher margin levels, made some members conclude that 20%
is a prudent minimum level.\162\ Other members thought that 20% is too
low, failing to take into account the varying volatility/share price
profiles of equity securities and the credit risk implications of those
differences. Those members favored a 25% minimum, finding this to be
"consistent" with margin levels for options.\163\ They further noted
that a comparable option position consists of a long (short) call/short
(long) put option pair struck at the forward price of the underlying
security.\164\
---------------------------------------------------------------------------
\161\ SIA/FIA Letter at 2.
\162\ Id. at 10.
\163\ Id.
\164\ Id.
---------------------------------------------------------------------------
Finally, one commenter urged the Commissions to adopt a 25% margin
level, citing historical data and stating that this level is consistent
with the minimum margin level applied under SRO rules to long equity
positions.\165\ It argued that the 20% level would create an advantage
for security futures as compared to listed option put/call pairs,
noting margin levels in excess of 30% for combinations based on
relatively high volatility stocks, and margin levels in excess of 20%
for combinations based on relatively low volatility stocks.\166\
---------------------------------------------------------------------------
\165\ Morgan Stanley Letter at 6-8.
\166\ Id. at 7.
---------------------------------------------------------------------------
After considering the commenters' views, the Commissions have
adopted the margin levels as proposed. The Commissions believe that a
security future is comparable to a short, at-the-money option, as
discussed in the release accompanying the Proposed Rules ("Proposing
Release").\167\ Currently, the margin requirement for a short, at-the-
money option, where the underlying instrument is either an equity
security (such as a stock or an instrument immediately convertible into
a stock) or an index, is 100% of the option proceeds plus 20% of the
value of the underlying security or index.\168\
---------------------------------------------------------------------------
\167\ See Securities Exchange Act Release No. 44853 (September
26, 2001), 66 FR at 50776 (October 4, 2001).
\168\ See, e.g., Amex Rule 462; CBOE Rule 12.3; NASD Rule 2520;
New York Stock Exchange ("NYSE") Rule 431; PCX Rule 2.16; and Phlx
Rule 722.
---------------------------------------------------------------------------
Unlike an options contract, however, a futures contract involves
obligations of both parties to perform in the future: The buyer (long)
to purchase the asset underlying the future, and the seller (short) to
deliver the asset. As a result, both the buyer and the seller of a
futures contract must post and maintain margin on a daily basis to
assure contract performance and the integrity of the marketplace. In
addition, all market participants pay or receive daily variation
settlement as a result of all open futures positions being marked to
current market value. Accordingly, the margin levels apply equally for
both buyers and sellers of security futures.
The Commissions have considered the comments, and have determined
that a minimum margin level of 20% satisfies the comparability standard
of section 7(c)(2) of the Exchange Act.\169\ In addition, the
Commissions note that the Final Rules permit self-regulatory
[[Page 53158]]
authorities and security futures intermediaries to establish higher
margin levels or to take appropriate action to preserve their own
financial integrity.\170\ As a result, the Commissions are adopting the
minimum initial and maintenance margin levels for unhedged positions,
as proposed.
---------------------------------------------------------------------------
\169\ See 15 U.S.C. 78g(c)(2).
\170\ See CFTC Rule 41.42(c)(1); SEC Rule 400(c)(1).
---------------------------------------------------------------------------
3. Margin Offsets
The Proposed Rules included a provision to allow national
securities exchanges and national securities associations to adopt
rules that reduce the margin levels below 20% of current market value
for customers with certain positions in securities or futures that
offset the risk of their positions in security futures.\171\ The
Proposed Rules provided further that the resulting margin levels could
not be lower than the lowest customer margin levels required for
comparable offset positions involving exchange-traded options.\172\ In
addition, the Commissions published a table that included offsets for
security futures that the Commissions had preliminarily identified as
consistent with those permitted for comparable offset positions
involving options and that would qualify for reduced margin
levels.\173\
---------------------------------------------------------------------------
\171\ See Proposed CFTC Rule 41.45(d); Proposed SEC Rule 402(d).
\172\ Id.
\173\ See Securities Exchange Act Release No. 44853 (September
26, 2001), 66 FR at 50727-29 (October 4, 2001).
---------------------------------------------------------------------------
The Commissions received three comments with respect to the
proposed offsets.\174\ One of the commenters stated that offsets
involving security futures and options should be recognized only if the
risk from the security future is completely offset by the option.\175\
Another commenter expressed concern that the offsets would produce
margin levels that did not accurately reflect the risk of the positions
and suggested that the Commissions adopt general provisions regarding
margin levels for offsetting positions instead of providing specific
examples. \176\ Finally, one commenter suggested modifying the existing
strategy-based rules to put security futures on a par with cash
equities in connection with offsetting strategies involving listed
options and to reduce the margin requirements for certain calendar and
basket spreads involving security futures.\177\ This commenter also
suggested that the Commissions address the treatment of spreads
involving non-fungible security futures.\178\
---------------------------------------------------------------------------
\174\ See Options Exchanges Letter; Partnoy Letter; SIA/FIA
Letter.
\175\ Options Exchanges Letter at 6.
\176\ Partnoy Letter at 14.
\177\ SIA/FIA Letter at Appendix I, Q 19.
\178\ Meeting between SEC and CFTC staff and representatives of
SIA/FIA (February 6, 2002).
---------------------------------------------------------------------------
After considering the commenters' views, the Commissions have
adopted, substantially as proposed, rules that permit self-regulatory
authorities to establish margin levels for offset positions involving
security futures that are lower than the required margin levels for
unhedged positions.\179\ Under the Final Rules, a self-regulatory
authority may set the required initial or maintenance margin level for
an offsetting position involving security futures and related positions
at a level lower than the level that would be required if the positions
were margined separately. Such rules must meet the criteria set forth
in section 7(c)(2)(B) of the Exchange Act \180\ and must be effective
in accordance with section 19(b)(2) of the Exchange Act \181\ and, as
applicable, Section 5c(c) of the CEA.\182\
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\179\ See CFTC Rule 41.45(b)(2); SEC Rule 403(b)(2).
\180\ 15 U.S.C. 78g(c)(2)(B).
\181\ 15 U.S.C. 78s(b)(2).
\182\ 7 U.S.C. 7a-2(c).
---------------------------------------------------------------------------
The Commissions have retained, with certain revisions, the table of
offsets that they deem to be consistent with offsets recognized for
comparable exchange-traded options. In particular, the revised table of
offsets reflects an adjustment in the level of margin required for
certain calendar and basket spreads involving security futures to more
accurately reflect the risk of such positions relative to comparable
spreads involving exchange-traded options. An offset position for
spreads involving non-fungible security futures also has been added to
the table.
When it approved strategy-based offsets for options, the SEC found
that it was appropriate for the SROs to recognize the hedged nature of
certain combined options strategies and prescribe margin requirements
that better reflect the risk of those strategies.\183\ The SEC also
found that the SROs' proposals relating to strategy-based offsets
involving options contracts were carefully crafted as they were based
on the SROs' experiences in monitoring the credit exposures of options
strategies. In particular, the SEC noted that the SROs regularly
examine the coverage of options margin as it relates to price movements
in the underlying securities and index components. Moreover, the SROs'
proposals were thoroughly reviewed by the NYSE Rule 431 Review
Committee, which is comprised of securities industry participants who
have extensive experience in margin and credit matters. As a result of
these factors, the SEC was confident that the SROs' proposed margin
requirements were consistent with investor protection and properly
reflected the risks of the underlying options positions.
---------------------------------------------------------------------------
\183\ See Securities Exchange Act Release Nos. 41658 (July 27,
1999), 64 FR 42736 (August 5, 1999) (order approving SR-CBOE-97-67
amending CBOE Rule 12.3); 42011 (October 14, 1999), 64 FR 57172
(October 22, 1999) (order approving SR-NYSE-99-03 amending NYSE Rule
431); 43582 (November 17, 2000), 65 FR 70854 (November 28, 2000)
(order approving SR-Amex-99-27 amending Amex Rule 462); and 43581
(November 17, 2000), 65 FR 71151 (November 29, 2000) (order
approving SR-NASD-00-15 amending NASD Rule 2520).
---------------------------------------------------------------------------
The table of offsets reflects a reduction in the minimum initial
and maintenance margin requirement for calendar spreads \184\ and
basket spreads,\185\ in response to the comment that the risk posed by
certain spreads involving security futures is lower than the risk posed
by comparable spreads involving exchange-traded options. \186\ In light
of the observation that security futures are not subject to early
exercise and therefore do not exhibit the same price volatility as
options, the minimum initial and maintenance margin requirement
recognized for calendar spreads and basket spreads has been reduced to
5% of the current market value of the long or short position.\187\ The
Commissions deliberated as to whether risk-based margin computations
using SPAN could be applied to these strategies, so long as the
offsetting positions were the only positions included in the margin
computation. The Commissions have decided not to permit risk-based
margin computations for these offsets at this time.
---------------------------------------------------------------------------
\184\ A calendar spread is an offset position consisting of a
long security future and short security future on the same
underlying security, each contract expiring in a different month.
See table of offsets, item 10.
\185\ A basket spread is an offset consisting of a security
future based on an index and a basket of security futures that
replicates the index, i.e., a basket that contains the same
securities, and in the same proportion, as the index. See table of
offsets, items 17 and 18.
\186\ Meeting between SEC and CFTC staff and representatives of
SIA/FIA (February 6, 2002).
\187\ By way of comparison, the minimum margin required for
offsetting long and short positions in the same security under the
rules of the national securities exchanges is 5% of the current
market value of the long position. See, e.g., NYSE Rule 431(e)(1).
---------------------------------------------------------------------------
The table of offsets, likewise, reflects a reduction in the
required margin recognized for spreads involving a long or short
security future and a short or long position in the same security
underlying the security future, given that these spreads are
economically
[[Page 53159]]
analogous to calendar spreads.\188\ The Commissions intend to review
the margin levels for the offsets discussed above after six months of
security futures trading to determine whether the margin levels have
resulted in regulatory arbitrage with comparable positions involving
exchange-traded options, and may jointly undertake appropriate action.
---------------------------------------------------------------------------
\188\ See table of offsets, items 4 and 13.
---------------------------------------------------------------------------
Based on the same commenter's suggestion, the Commissions believe
that an additional offset should be recognized for spreads involving
identical, non-fungible security futures.\189\ Because there is a
possibility that certain security futures may not be fungible across
markets, a customer may simultaneously hold a long security future and
a short security future on the same underlying security even when those
security futures have identical contract terms. As a result, the
customer will be economically neutral but will be required to hold both
positions to expiration and meet daily variation settlement calls with
respect to each contract. The commenter expressed the view that a
minimum margin level of 1% would be appropriate.\190\ The Commissions
recognize that the rules of a clearing agency or derivatives clearing
organization may effectively net the two contracts at final settlement.
However, due to potential differences in daily settlement prices across
markets or other market-specific events, the Commissions have
determined that such offset positions will be subject to a minimum
margin requirement of 3%.
---------------------------------------------------------------------------
\189\ See table of offsets, item 19.
\190\ Meeting between SEC and CFTC staff and representatives of
SIA/FIA (February 6, 2002).
---------------------------------------------------------------------------
The Commissions believe that the offsets identified in the
following table are consistent with the strategy-based offsets
permitted for comparable offset positions involving exchange-traded
options. The Commissions expect that self-regulatory authorities
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 following table of
offsets.
----------------------------------------------------------------------------------------------------------------
Security underlying the Initial margin Maintenance margin
Description of offset security future requirement requirement
----------------------------------------------------------------------------------------------------------------
1. Long security future or short Individual stock or 20% of the current 20% of the current
security future. narrow-based security market value of the market value of the
index. security future. security future.
2. Long security future (or Individual stock or 20% of the current The lower of: (1) 10% of
basket of security futures narrow-based security market value of the the aggregate exercise
representing each component of a index. long security future, price \3\ of the put
narrow-based securities index plus pay for the long plus the aggregate put
\1\) and long put option \2\ on put in full. out-of-the-money \4\
the same underlying security (or amount, if any; or (2)
index). 20% of the current
market value of the
long security future.
3. Short security future (or Individual stock or 20% of the current 20% of the current
basket of security futures narrow-based security market value of the market value of the
representing each component of a index. short security future, short security future,
narrow-based securities index plus the aggregate put plus the aggregate put
\1\) and short put option on the in-the-money amount, if in-the-money amount, if
same underlying security (or any. Proceeds from the any.\5\
index). put. Proceeds from the
put sale may be applied.
4. Long security future and short Individual stock or The initial margin 5% of the current market
position in the same security narrow-based security required under value as defined in
(or securities basket \1\) index. Regulation T for the Regulation T of the
underlying the security future. short stock or stocks. stock or stocks
underlying the security
future.
5. Long security future (or Individual stock or 20% of the current 20% of the current
basket of security futures narrow-based security market value of the market value of the
representing each component of a index. long security future, long security future,
narrow-based securities index plus the aggregate call plus the aggregate call
\1\) and Short call option on in-the-money amount, if in-the-money amount, if
the same underlying security (or any. Proceeds from the any.
index). call sale may be
applied.
6. Long a basket of narrow-based Narrow-based security 20% of the current 20% of the current
security futures that together index. market value of the market value of the
tracks a broad based index \1\ long basket of narrow- long basket of narrow-
and short a broad-based security based security futures, based security futures,
index call option contract on plus the aggregate call plus the aggregate call
the same index. in-the-money amount, if in-the-money amount, if
any. Proceeds from the any.
call sale may be
applied.
7. Short a basket of narrow-based Narrow-based security 20% of the current 20% of the current
security futures that together index. market value of the market value of the
tracks a broad-based security short basket of narrow- short basket of narrow-
index \1\ and short a broad- based security futures, based security futures,
based security index put option plus the aggregate put plus the aggregate put
contract on the same index. in-the-money amount, if in-the-money amount, if
any. Proceeds from the any.
put sale may be applied.
8. Long security a basket a Narrow-based security 20% of the current The lower of: (1) 10% of
narrow-based securities futures index. market value of the the aggregate exercise
that together tracks a broad- long basket of narrow- price of the put, plus
based security index \1\ and based security futures, the aggregate put out-
long a broad-based security plus pay for the long of-the-money amount, if
index put option contract on the put in full. any; or (2) 20% of the
same index. current market value of
the long basket of
security futures.
[[Page 53160]]
9. Short a basket of narrow-based Narrow-based security 20% of the current The lower of: (1) 10% of
security futures that together index. market value of the the aggregate exercise
tracks a broad-based security short basket of narrow- price of the call, plus
index \1\ and long a broad-based based security futures, the aggregate call out-
security index call option plus pay for the long of-the-money amount, if
contract on the same index. call in full. any; or (2) 20% of the
current market value of
the short basket of
security futures
10. Long security future and Individual stock or The greater of: 5% of The greater of: 5% of
short security future on the narrow-based security the current market the current market
same underlying security (or index. value of the long value of the long
index). security future; or 2) security future; or (2)
5% of the current 5% of the current
market value of the market value of the
short security future. short security future.
11. Long security future, long Individual stock or 20% of the current 10% of the aggregate
put option and short call narrow-based security market value of the exercise price, plus
option. The long security index. long security future, the aggregate call in-
future, long put and short call plus the aggregate call the-money amount, if
must be on the same underlying in-the-money amount, if any.
security and the put and call any, plus pay for the
must have the same exercise put in full. Proceeds
price. (Conversion). from the call sale may
be applied.
12. Long security future, long Individual stock or 20% of the current The lower of: (1) 10% of
put option and short call narrow-based security market value of the the aggregate exercise
option. The long security index. long security future, price of the put plus
future, long put and short call plus the aggregate call the aggregate put out-
must be on the same underlying in-the-money amount, if of-the-money amount, if
security and the put exercise any, plus pay for the any; or (2) 20% of the
price must be below the call put in full. Proceeds aggregate exercise
exercise price. (Collar). from call sale may be price of the call, plus
applied. the aggregate call in-
the-money amount, if
any.
13. Short security future and Individual stock or The initial margin 5% of the current market
long position in the same narrow-based security required under value, as defined in
security (or securities basket index. Regulation T for the Regulation T, of the
\1\) underlying the security long stock or stocks. long stock or stocks.
future.
14. Short security future and Individual stock or The initial margin 10% of the current
long position in a security narrow-based security required under market value, as
immediately convertible into the index. Regulation T for the defined in Regulation
same security underlying the long security. T, of the long security
security future, without
restriction, including the
payment of money.
15. Short security future (or Individual stock or 20% of the current The lower of: (1) 10% of
basket of security futures narrow-based security market value of the the aggregate exercise
representing each component of a index. short security future, price of the call, plus
narrow-based securities index plus pay for the call the aggregate call out-
\1\) and long call option or in full. of-the-money amount, if
warrant on the same underlying any; or (2) 20% of the
security (or index). current market value of
the short security
future.
16. Short security future, Short Individual stock of 20% of the current 10% of the aggregate
put option and long call option. narrow-based security market value of the exercise price, plus
The short security future, short index. short security future, the aggregate put in-
put and long call must be on the plus the aggregate put the-money amount, if
same underlying security and the in-the-money amount, if any.
put and call must have the same any, plus pay for the
exercise price. (Reverse call in full. Proceeds
Conversion). from put sale may be
applied.
17. Long (short) a basket of Narrow-based security 5% of the current market 5% of the current market
security futures, each based on index. value of the long value of the long
a narrow-based security index (short) basket of (short) basket of
that together tracks the broad- security 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% The greater of: (1) 5%
security futures that together narrow-based security of the current market of the current market
tracks a narrow-based index \1\ index. value of the long value of the long
and short (long) a narrow based security future(s); or security future(s); or
index future. (2) 5% of the current (2) 5% of the current
market value of the market value of the
short security short security
future(s). future(s).
19. Long (short) a security Individual stock and The greater of: (1) 3% The greater of: (1) 3%
future and short (long) an narrow-based security of the current market of the current market
identical security future traded index. value of the long value of the long
on a different market.\6\. security future(s); or security future(s); or
(2) 3% of the current (2) 3% of the current
market value of the market value of market
short security value of the short
future(s). security future(s).
----------------------------------------------------------------------------------------------------------------
\1\ Baskets of securities or security futures contracts must replicate the securities that comprise the index,
and in the same proportion.
\2\ Generally, for the purposes of these rules, unless otherwise specified, stock index warrants shall be
treated as if they were index options.
[[Page 53161]]
\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. See, e.g., Amex Rules 900 and 900C; CBOE
Rule 12.3; and NASD Rule 2522.
\4\ "Out-of-the-money" amounts must be 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. See, e.g., NYSE Rule
431 (Exchange Act Release No. 42011 (October 14, 1999), 64 FR 57172 (October 22, 1999) (order approving SR-
NYSE-99-03)); Amex Rule 462 (Exchange Act Release No. 43582 (November 17, 2000), 65 FR 71151 (November 29,
2000) (order approving SR-Amex-99-27)); CBOE Rule 12.3 (Exchange Act Release No. 41658 (July 27, 1999), 64 FR
42736 (August 5, 1999) (order approving SR-CBOE-97-67)); or NASD Rule 2520 (Exchange Act Release No. 43581
(November 17, 2000), 65 FR 70854 (November 28, 2000) (order approving SR-NASD-00-15)).
\5\ "In the-money" amounts must be 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 will be 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.
The Commissions note that positions in a securities account may not
be cross-margined with positions in a futures account except in
accordance with the rules of a self-regulatory authority that have
become effective under section 19(b)(2) of the Exchange Act and, as
applicable, section 5c(c) of the CEA. At present, the Commissions have
not approved the use of a cross-margining methodology for customer
securities and futures accounts. Accordingly, security futures or other
positions carried in a futures account may not currently be offset
against security futures or other positions carried in a securities
account to reduce a customer's total margin requirement.
4. Higher Margin Levels
The Proposed Rules expressly provided that self-regulatory
authorities could impose on their members initial and maintenance
margin levels that are higher than the minimum levels otherwise
specified in the rules.\191\ The Proposed Rules also provided that
self-regulatory authorities could permit their members to use a method
for computing required margin that could result in margin levels that
are higher than the minimum levels specified in the rules.\192\
---------------------------------------------------------------------------
\191\ See Proposed CFTC Rule 41.45(b)(2)(i); Proposed SEC Rule
402(b)(2)(i).
\192\ See Proposed CFTC Rule 41.45(b)(2)(ii); Proposed SEC Rule
402(b)(2)(ii).
---------------------------------------------------------------------------
The Commissions have decided that it is not necessary to adopt
these provisions of the Proposed Rules because other provisions of the
Final Rules make clear the ability of a self-regulatory authority to
establish higher margin levels. The Final Rules establish minimum
levels and do not set any limitations as to maximum levels. Moreover,
the Final Rules expressly do not preclude a self-regulatory authority
or a security futures intermediary from imposing additional margin
requirements, including higher initial and maintenance margin levels,
consistent with the Final Rules.\193\
---------------------------------------------------------------------------
\193\ See CFTC Rule 41.42(c)(1); SEC Rule 400(c)(1).
---------------------------------------------------------------------------
As noted previously, a portfolio margining system such as SPAN may
be used to compute required margin based on the parameters established
in accordance with the Final Rules. Each security futures intermediary
remains responsible for collecting margin in compliance with the Final
Rules.
5. Procedures for Certain Margin Level Adjustments
The Commissions proposed to allow national securities exchanges
registered under section 6(g) of the Exchange Act \194\ and national
securities associations registered under section 15A(k) of the Exchange
Act \195\ to raise or lower margin levels in accordance with section
19(b)(7) of the Exchange Act,\196\ as long as the resulting levels
satisfy the minimum level requirements.\197\ The Commissions received
no comments on this aspect of the proposal, and are adopting it as
proposed.\198\
---------------------------------------------------------------------------
\194\ 15 U.S.C. 78f(g).
\195\ 15 U.S.C. 78o-3(k).
\196\ 15 U.S.C. 78s(b)(7).
\197\ See Proposed CFTC Rule 41.45(c); Proposed SEC Rule 402(c).
\198\ See CFTC Rule 41.45(c); SEC Rule 403(c).
---------------------------------------------------------------------------
H. Satisfaction of Required Margin
Section 7(c)(2)(B)(iv) of the Exchange Act \199\ requires that the
type, form and use of collateral for security futures products be and
remain consistent with the requirements of Regulation T. To fulfill
this statutory requirement, the Commissions proposed to permit security
futures intermediaries to accept as margin for security futures any of
the types of collateral permitted under Regulation T to satisfy a
margin deficiency in a margin account.\200\ The Commissions also
proposed to allow self-regulatory authorities to establish their own
margin collateral requirements as long as those requirements were
consistent with the requirements of Regulation T.\201\
---------------------------------------------------------------------------
\199\ 15 U.S.C. 78g(c)(2)(B)(iv).
\200\ See Proposed CFTC Rule 41.47(a)(4); Proposed SEC Rule
404(a)(4).
\201\ See Proposed CFTC Rule 41.47(b); Proposed SEC Rule 404(b).
---------------------------------------------------------------------------
The Final Rules continue to limit the type, form, and use of
collateral deposits that security futures intermediaries may accept to
satisfy the required margin for security futures to those permitted
under Regulation T.\202\ The Commissions are, however, permitting
security futures intermediaries to include the net value of certain
additional items--specifically, long options \203\ and open trade
equity \204\--in computing the equity in an account. Moreover, for
purposes of determining whether the required margin in an account is
satisfied, the final rules
[[Page 53162]]
permit security futures intermediaries to compute equity in accordance
with applicable self-regulatory authority rules, subject to certain
adjustments to ensure consistency with Regulation T.\205\
---------------------------------------------------------------------------
\202\ See CFTC Rule 41.46(a); SEC Rule 404(a).
\203\ See CFTC Rule 41.46(c)(1)(iv); SEC Rule 404(c)(1)(ii).
\204\ See CFTC Rule 41.46(c)(1)(vi) and (c)(2)(iii); SEC Rule
404(c)(1)(vi) and (c)(2)(iii).
\205\ See CFTC Rule 41.46; SEC Rule 404.
---------------------------------------------------------------------------
1. Type, Form and Use of Collateral
a. Acceptable Collateral Deposits. The Commissions proposed to
permit security futures intermediaries to accept as margin for security
futures a deposit of any combination of cash, margin securities as
defined in Regulation T,\206\ exempted securities as defined in section
3(a)(12) of the Exchange Act,\207\ and other collateral permitted under
Regulation T to satisfy a margin deficiency in the margin account.\208\
---------------------------------------------------------------------------
\206\ Under Section 202.2 of Regulation T (12 CFR 220.2), margin
securities include: (1) Any security registered or having unlisted
trading privileges on a national securities exchange; (2) any
security listed on the Nasdaq Stock Market; (3) any nonequity
security; (4) any security issued by either an open-end investment
company or unit investment trust which is registered under section 8
of the Investment Company Act of 1940 (15 U.S.C. 80a-8); (5) any
foreign margin stock; and (6) any debt security convertible into a
margin security.
\207\ 15 U.S.C. 78c(a)(12).
\208\ See Proposed CFTC Rule 41.47(a)(4); Proposed SEC Rule
404(a)(4).
---------------------------------------------------------------------------
The Commissions received four comments on this issue.\209\ One
commenter supported the Commissions' proposal with respect to
permissible collateral.\210\ The other three commenters suggested that
the Commissions should permit security futures intermediaries to accept
other forms of collateral in addition to those permitted by Regulation
T.\211\
---------------------------------------------------------------------------
\209\ See Options Exchanges Letter; NFA Letter; CME/CBOT Letter;
SIA/FIA Letter.
\210\ Options Exchanges Letter at 6-7.
\211\ See NFA Letter at 6-7; CME/CBOT Letter at 3-4; and SIA/FIA
Letter 6-8.
---------------------------------------------------------------------------
Two of these commenters suggested that the type of collateral
permitted should be determined based on the type of account. Under an
account-specific approach, for security futures held in futures
accounts, the types of permissible collateral would be determined by
SRO rules; and for security futures held in securities accounts, the
types of permissible collateral would be governed by Regulation T.\212\
The other commenter maintained that, unless the Commissions recognize
other instruments that are commonly accepted as collateral within a
futures account (e.g., letters of credit), the margin requirements
would disadvantage the futures community and would make it unlikely
that customers would carry security futures products in a futures
account.\213\
---------------------------------------------------------------------------
\212\ See NFA Letter at 7; SIA/FIA Letter at 6.
\213\ CME/CBOT Letter at 4.
---------------------------------------------------------------------------
The Commissions have considered the commenters' views, and have
adopted the provisions regarding acceptable collateral deposits
substantially as proposed. In particular, the Commissions do not
believe that it would be consistent with the requirements regarding
type, form, and use of collateral under Regulation T to permit
customers to satisfy the required margin for security futures in a
futures account using letters of credit or other types of collateral
not currently permitted under Regulation T. Any types of collateral the
Federal Reserve Board may subsequently permit in a Regulation T margin
account, however, may also be used to satisfy the required margin for
security futures under the Final Rules.\214\
---------------------------------------------------------------------------
\214\ CFTC Rule 41.46(b)(1); SEC Rule 404(b)(1).
---------------------------------------------------------------------------
b. Use of Money Market Mutual Funds. The definition of "margin
security" under Regulation T includes, among other securities, money
market mutual funds. A number of futures exchanges currently accept
money market mutual fund shares as performance bond deposits for
futures and options on futures, subject to certain conditions imposed
under CFTC Rule 1.25.\215\ Regulation T also permits creditors to
extend good faith loan value to shares in money market mutual funds and
other mutual funds carried in a securities account, although the
limitations on extensions of credit in connection with new issues of
securities under section 11(d)(1) of the Exchange Act have limited the
practicability of their use.\216\
---------------------------------------------------------------------------
\215\ See, e.g., CME Rule 930.C.
\216\ In a recent interpretive release providing guidance on the
application of certain provisions of the federal securities laws to
trading in security futures products, the SEC expressed the view
that a security future is not an extension of credit under section
11(d)(1) of the Exchange Act (15 U.S.C. 78k(d)(1)), and that margin
collected in connection with a security futures transaction
represents a good faith deposit against performance and not
"partial payment" for the security. Securities Exchange Act
Release No. 46101 (June 21, 2002), 67 FR 43234, 43245 (June 27,
2002). Accordingly, a deposit of money market mutual fund shares by
a customer to satisfy the required margin for a security future does
not, in the SEC's view, constitute a direct or indirect extension or
maintenance of credit to or for the customer on such shares for
purposes of Section 11(d)(1) (15 U.S.C. 78k(d)(1)).
---------------------------------------------------------------------------
The Final Rules permit the use of money market mutual fund shares
\217\ to satisfy the required margin for security futures and related
positions carried in a securities account or futures account, subject
to certain conditions.\218\ These conditions are intended to facilitate
a security futures intermediary's hypothecation or liquidation of money
market mutual fund shares deposited as margin for security futures, as
necessary to meet a customer's clearing obligations.
---------------------------------------------------------------------------
\217\ See CFTC Rule 41.43(a)(22); SEC Rule 401(a)(22).
\218\ See CFTC Rule 41.46(b)(2); SEC Rule 404(b)(2).
---------------------------------------------------------------------------
Specifically, a security futures intermediary may accept money
market mutual fund shares as margin if the following conditions are met
(e.g., under the rules of a self-regulatory authority or pursuant to a
three-way agreement among the security futures intermediary, the
customer, and the money market mutual fund or its transfer agent):
(1) The customer waives any right to redeem the fund shares without
the consent of the security futures intermediary and instructs the fund
or its transfer agent accordingly;
(2) The security futures intermediary (or clearing agency or
derivatives clearing organization with which the security is deposited
as margin) obtains the right to redeem the shares in cash, promptly
upon request; and
(3) The fund agrees to satisfy any conditions necessary or
appropriate to ensure that the shares may be redeemed in cash, promptly
upon request.
2. Computation of Equity
The Proposed Rules would have required security futures
intermediaries to compute the equity in an account in accordance with
Regulation T for purposes of determining whether the required margin
for security futures is satisfied.\219\ The Commissions received one
comment on this issue.\220\ The commenter expressed the opinion that
the rules governing collateral haircuts in securities and futures
accounts need not be identical, as long as the relevant standards do
not create a material incentive for customers to carry security futures
positions in a futures account rather than a securities account.\221\
---------------------------------------------------------------------------
\219\ See Proposed CFTC Rule 41.43(b); Proposed SEC Rule 400(b).
\220\ SIA/FIA Letter.
\221\ Id., at 6.
---------------------------------------------------------------------------
The Commissions have considered this commenter's views and have
determined not to require security futures intermediaries to compute
equity in accordance with Regulation T. The Final Rules provide that,
for purposes of determining whether the required margin for security
futures carried in an account is satisfied, the equity in an account
shall be computed in accordance with the margin rules
[[Page 53163]]
applicable to the account.\222\ However, so that that collateral and
other components of equity are valued consistently in securities and
futures accounts, the Final Rules require security futures
intermediaries to make certain adjustments to equity when determining
whether the required margin for security futures carried in an account
is satisfied.\223\ Each of these components of equity is discussed in
turn below.
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\222\ See CFTC Rule 41.46(c); SEC Rule 404(c). For purposes of
determining whether the required margin for security futures and
related positions is satisfied under the Final Rules, the equity in
a futures account is defined to include the account's net
liquidating equity plus the collateral value of margin securities,
exempted securities, and other acceptable margin deposits. See Joint
Audit Committee, Margins Handbook, Chapter 1 (June 1999) (definition
of "margin equity"). Securities may not be combined with security
futures carried in a futures account to create an offset position
except pursuant to a cross-margining arrangement, as described in
Section II.G.3 of this release.
\223\ See CFTC Rule 41.46(c), (d), and (e); SEC Rule 404(c),
(d), and (e).
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a. Security Futures. The Proposed Rules provided that security
futures would not be "margin securities" for purposes of the margin
requirements and therefore would not have loan value for margin
purposes.\224\ One commenter addressed this provision and supported the
view that security futures should not have loan value for margin
purposes.\225\
---------------------------------------------------------------------------
\224\ See Proposed CFTC Rule 41.47(c); Proposed SEC Rule 404(c).
\225\ Options Exchanges Letter at 6-7.
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The Commissions have considered the commenter's views and have
adopted Final Rules that provide that security futures will have no
value for purposes of determining whether the required margin in a
securities or futures account is satisfied.\226\ This is consistent
with the treatment of other futures contracts carried in futures
accounts.
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\226\ See CFTC Rule 41.46(c)(1)(i) and (c)(2)(i); SEC Rule
404(c)(1)(i) and (c)(2)(i). As discussed below, open trade equity
resulting from the daily settlement of security futures can be used
to satisfy the required margin.
---------------------------------------------------------------------------
To avoid confusion as to whether extensions of credit in connection
with security futures are considered "purpose credit" for purposes of
the Federal Reserve Board's credit regulations,\227\ however, the
Commissions have revised the Final Rules to eliminate the statement
that security futures are not margin securities.
---------------------------------------------------------------------------
\227\ See discussion of extensions of credit in Section II.F.4.
of this release.
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b. Option Value. The Proposed Rules did not address the question of
whether the net value of options in a securities or futures account
could be applied to satisfy the required margin for security
futures.\228\ The rules of the futures exchanges generally permit FCMs
to include the value of listed options on contracts for future delivery
in computing the equity in a futures account. The rules of the national
securities exchanges and the NASD, however, generally deny value to
options carried for a customer for the purpose of computing the equity
in the customer's account.\229\
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\228\ Regulation T generally delegates the authority to specify
the amount or other position to satisfy the required margin for put
or call options on a security, certificate of deposit, securities
index or foreign currency, or a warrant on a securities index or
currency carried in a securities account to the registered
securities exchange or association authorized to trade the option
(in the case of exchange-listed options) and to the creditor's
examining authority (in the case of all other options), subject in
each case to approval by the SEC. See 12 CFR 220.12(f).
\229\ The rules of the national securities exchanges and the
NASD recognize an exception for long listed or OTC options and
warrants with a remaining period to expiration exceeding 9 months.
Such contracts are valued at their current market value (as defined
in Section 220.2 of Regulation T (12 CFR 220.2)), subject to a 75%
margin requirement. See, e.g., NYSE Rule 431(f)(2)(C).
---------------------------------------------------------------------------
One commenter expressed concern that the exclusion of net option
value from the calculation of equity in a futures account would create
significant operational difficulties for security futures
intermediaries that carry security futures in futures accounts.\230\
Two other commenters noted, however, that recognition of option value
for purposes of determining whether the required margin for security
futures is satisfied in a futures account would create a significant
regulatory disparity with exchange-traded options carried in securities
accounts.\231\
---------------------------------------------------------------------------
\230\ Meeting between SEC and CFTC staff and representatives of
SIA/FIA (February 6, 2002).
\231\ Telephone conversations between SEC staff and The OCC
staff (February 20, 2002) and between SEC staff and CBOE staff
(February 5, 2002).
---------------------------------------------------------------------------
The Commissions, having considered the commenters' concerns, are
adopting Final Rules that provide that a net long or short position in
a listed put or call option carried in a futures account shall be
valued in accordance with the margin rules applicable to the account
for purposes of determining whether the required margin for a security
future in the account is satisfied.\232\ For these purposes, the term
"listed option" is defined to mean any put or call option that is (i)
issued by a clearing agency that is registered under section 17A of the
Exchange Act \233\ or cleared and guaranteed by a derivatives clearing
organization that is registered under Section 5b of the CEA; \234\ and
(ii) traded on or subject to the rules of a self-regulatory
authority.\235\
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\232\ See CFTC Rule 41.46(c)(1)(ii); SEC Rule 404(c)(1)(ii).
\233\ 15 U.S.C. 78q-1.
\234\ 7 U.S.C. 7a-1.
\235\ See CFTC Rule 41.43(a)(16); SEC Rule 401(a)(16).
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The SEC is willing to entertain proposed rule changes by the
national securities exchanges and the NASD to grant value to listed
options in a securities account under appropriate circumstances. In
addition, the Commissions intend to review their determination to grant
value to long options carried in futures accounts after six months of
security futures trading to determine whether it has created a material
disparity between the margin requirements for security futures and the
margin requirements for comparable exchange-traded options, and may
jointly undertake appropriate action.
c. Open Trade Equity. The Proposed Rules did not address in detail
how "open trade equity" (i.e., the daily marked-to-market gain or
loss in value of futures or other exchange-traded contracts) would be
included in the equity in an account for purposes of determining
whether the required margin for security futures is satisfied. However,
eight commenters raised the issue and requested clarification from the
Commissions.\236\ Those commenters generally requested that the
Commissions clarify that broker-dealers and FCMs could treat open trade
equity on security futures positions as cash for purposes of margin and
collateral.
---------------------------------------------------------------------------
\236\ See Peregrine Letter; OneChicago Letter; NFA Letter; CME
Letter; SIA/FIA Letter; Nasdaq Liffe Letter; SunGard Letter; and
Morgan Stanley Letter.
---------------------------------------------------------------------------
One of those commenters maintained that disallowing the use of open
trade equity to satisfy margin on trades and position in other markets
could dampen customers' interest in security futures.\237\ Another of
the commenters suggested that FCMs would have to make costly systems
changes if they were not allowed to recognize open trade equity for
security futures as they are permitted to do for other futures
positions.\238\
---------------------------------------------------------------------------
\237\ OneChicago Letter at 6.
\238\ SunGard Letter at 2.
---------------------------------------------------------------------------
In light of commenters' views on this issue, the Final Rules
clarify that "open trade equity" may be applied to satisfy the
required margin for security futures and related positions.
Specifically, the Final Rules define a new term, "variation
settlement," to mean 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 or any other contract that is: (i) issued by a clearing
agency that is registered under section 17A of the
[[Page 53164]]
Exchange Act \239\ or cleared and guaranteed by a derivatives clearing
organization that is registered under Section 5b of the CEA,\240\ and
(ii) traded on or subject to the rules of a self-regulatory
authority.\241\ The Final Rules provide that variation settlement
receivable (or payable) by an account at the close of trading on any
day shall be treated as a credit (or debit) to the account on that
day.\242\
---------------------------------------------------------------------------
\239\ 15 U.S.C. 78q-1.
\240\ 7 U.S.C. 7a-1.
\241\ See CFTC Rule 41.43(a)(32); SEC Rule 401(a)(32).
\242\ See CFTC Rule 41.46(c)(1)(vi) and (c)(2)(iii); SEC Rule
404(c)(1)(vi) and (c)(2)(iii).
---------------------------------------------------------------------------
d. Margin Equity Securities. The Final Rules generally limit the
value of a margin equity security deposited as margin for security
futures in a futures account to the security's "Regulation T
collateral value," i.e., the current market value of the security
(based on its most recent closing price) less the percentage of
required margin for a position in the security held in a margin account
under Regulation T.\243\ This amount, which is currently set at 50% of
current market value, represents the amount of the value of a fully-
paid margin equity security deposited into a securities margin account
that would be available to satisfy the required margin for other
positions in the account under Regulation T, e.g., stock options.
Margin equity securities deposited as collateral for security futures
in a securities account remain subject to Regulation T margin
requirements as well as the margin requirements of applicable self-
regulatory authority rules.
---------------------------------------------------------------------------
\243\ See CFTC Rule 41.43(a)(25); SEC Rule 401(a)(25). The Final
Rules define the "current market value" of a security other than a
security future to mean the most recent closing sale price of the
security, as shown by any regularly published reporting or quotation
service. CFTC Rule 41.43(a)(4); SEC Rule 401(a)(4). If there is no
recent closing sale price, the security futures intermediary may use
any reasonable estimate of the market value of the security as of
the most recent close of business. Id.
---------------------------------------------------------------------------
By requiring FCMs to value margin equity securities as collateral
for security futures at the levels established under Regulation T,\244\
the Commissions intend to provide that margin equity securities used to
satisfy margin requirements for security futures are valued in a
consistent manner, regardless of the type of account in which a
security future is carried. The Commissions recognize, however, that
the Regulation T margin requirement applies only to new transactions
that create or increase a margin deficiency in an account.\245\ As a
result, a uniform 50% haircut on margin equity securities in a futures
account may result in the collection of more margin for security
futures carried in a futures account than would be required for
comparable positions carried in a securities account.
---------------------------------------------------------------------------
\244\ See CFTC Rule 41.46(c)(1)(iii); SEC Rule 404(c)(1)(iii).
\245\ The initial margin required for the purchase of a margin
equity security in a securities account under Regulation T is 50% of
its current market value. However, the maintenance margin required
for a position in a margin equity security under the rules of the
securities self-regulatory organizations is 25% of current market
value. See, e.g., NYSE Rule 431(c)(1). Accordingly, a customer that
seeks to use a fully paid equity security to satisfy the required
margin for a new short option transaction may apply no more than 50%
of the current market value of the security for that purpose. On
subsequent days, the customer will not be required to deposit
additional margin, regardless of changes in the price of the short
option or equity security, unless the required margin for the short
option exceeds 75% of the current market value of the equity
security.
---------------------------------------------------------------------------
Accordingly, the Final Rules provide an alternative method for
valuing margin equity securities used as collateral for security
futures in a futures account based on the same initial and maintenance
computations required under Regulation T and securities SRO rules with
respect to transactions in the account.\246\ Under this alternative
method, the haircut for margin equity securities is equal to the lowest
percentage of margin required for a margin equity security under the
rules of a national securities exchange (currently, 25%). On any day
when security futures transactions or related transactions \247\ are
effected in the account, however, a customer must satisfy a special
margin requirement equal to the amount of any margin deficiency created
or increased in the account if the margin equity securities were valued
at their Regulation T collateral value (i.e., 50% of current market
value).
---------------------------------------------------------------------------
\246\ See CFTC Rule 41.46(e); SEC Rule 404(e).
\247\ A "related transaction" is defined to include any
transaction in a related position that creates, eliminates,
increases or reduces an offsetting position involving a security
future, or any deposit or withdrawal of collateral (other than the
deduction of variation settlement and other periodic deductions by a
security futures intermediary from a customer account). CFTC Rule
41.43(a)(27); SEC Rule 401(a)(27). For example, if a customer
unwinds an offsetting position in a futures account, such as by
liquidating a long broad-based index future offsetting a basket of
security futures, any margin equity securities used to satisfy the
additional margin in the account required as a result of the
transaction would have to be valued at their Regulation T value.
---------------------------------------------------------------------------
The Final Rules provide further that, if this alternative method
for valuing margin equity securities is used in an account in which
security futures or related positions are carried and such account is
transferred from one security futures intermediary to another, the
account may be treated as if it had been maintained by the transferee
security futures intermediary from the date of its origin if the
transferee accepts, in good faith, a signed statement of the transferor
security futures intermediary (or, if that is not practicable, of the
customer), that any margin call issued under the Final Rules has been
satisfied.\248\ This provision parallels Section 220.4(b)(7) of
Regulation T, and is consistent with futures industry practices under
Section 4d of the CEA.\249\ It is intended to prevent one security
futures intermediary from transferring an undermargined account to
another security futures intermediary.
---------------------------------------------------------------------------
\248\ See CFTC Rule 41.46(e)(3); SEC Rule 404(e)(3).
\249\ 12 CFR 220.4(b)(7) and 7 U.S.C. 6d. See also NASD Rule
11870(d) and NFA Rule 2-27.
---------------------------------------------------------------------------
e. Other Securities. The Final Rules impose a haircut on exempt
securities and nonequity securities deposited as margin for security
futures carried in a futures account equal to the haircut established
under the SEC's net capital rule.\250\ This provision is intended to
codify the haircut currently imposed on Treasury securities and other
debt securities deposited as collateral for futures and options on
futures under the rules of the designated contract markets. Exempt
securities and nonequity securities deposited as collateral for
security futures in a securities account will remain subject to the
higher margin requirements applicable to such securities under
Regulation T and self-regulatory authority rules.
---------------------------------------------------------------------------
\250\ See CFTC Rule 41.46(c)(1)(iv); SEC Rule 404(c)(1)(iv).
---------------------------------------------------------------------------
f. Foreign Currency. The Final Rules provide that freely
convertible foreign currency may be valued at an amount no greater than
its daily marked-to-market U.S. dollar equivalent for purposes of
determining whether the required margin for security futures carried in
a securities or futures account is satisfied.\251\ This provision
reflects the maximum value assigned to foreign currencies under
Regulation T.\252\
---------------------------------------------------------------------------
\251\ See CFTC Rule 41.46(c)(1)(v) and (c)(2)(ii); SEC Rule
404(c)(1)(v) and (c)(2)(ii).
\252\ Many foreign currencies already are subject to significant
additional haircuts or margin requirements in securities and futures
accounts under self-regulatory authority rules. As discussed above,
security futures intermediaries and their customers would also have
to observe limitations under applicable margin rules.
---------------------------------------------------------------------------
g. Other Components of Equity. The Final Rules provide that each
other acceptable margin deposit or component of equity in a securities
or futures account shall be valued at an amount no greater than its
value in a Regulation T securities margin account.\253\ This
[[Page 53165]]
provision is intended to provide that any additional forms of
collateral permitted under Regulation T in the future or other items in
an account are valued under the Final Rules in accordance with
Regulation T.
---------------------------------------------------------------------------
\253\ See CFTC Rule 41.46(c)(1)(vii); SEC Rule 404(c)(1)(vii).
---------------------------------------------------------------------------
h. Guarantees. The Final Rules provide that no guarantee of a
customer's account shall be given any effect for purposes of
determining whether the required margin in an account is satisfied,
except as permitted under the margin rules applicable to the
account.\254\ This provision is consistent with both the requirements
currently applicable to securities accounts under Regulation T \255\
and the requirements currently applicable to futures accounts under
CFTC Rule 1.10.\256\ Thus, the account-specific practices related to
guarantees that are currently followed in securities accounts and
futures accounts, respectively, would remain effective under this
provision.
---------------------------------------------------------------------------
\254\ See CFTC Rule 41.46(f); SEC Rule 404(f).
\255\ See 12 CFR 220.3(d). The Regulation T prohibition governs
initial margin. The use of guarantees for purposes of maintenance
margin is otherwise treated under applicable margin rules.
\256\ 17 CFR 1.10. CFTC Rule 1.10(d) requires that an FCM's
financial report be completed in accordance with the CFTC's Form 1-
FR-FCM Instructions for reporting an FCM's net capital position.
These instructions provide further that "an FCM may not consider a
guarantee agreement as a substitute for margin" in customers'
accounts. Thus, margin deficits are only satisfied with the actual
transfer of free funds from the guaranteeing account.
---------------------------------------------------------------------------
3. Satisfaction of the Required Margin for Positions Other than
Security Futures
Because the scope of the Final Rules is limited to security futures
and related positions, the rules require additional margin to be
deposited in an account only when the required margin for security
futures is not satisfied by the equity in the account. The required
margin for all other positions carried in an account, and acceptable
collateral for such positions, shall be determined in accordance with
the margin rules applicable to the account.
The Final Rules do not prohibit security futures intermediaries
from accepting different collateral or assigning greater collateral
value to assets deposited as collateral with respect to other positions
carried in an account, if permitted under applicable self-regulatory
authority rules. For example, security futures intermediaries may use
letters of credit to satisfy the required margin for commodity futures
and commodity options (other than security futures) in a futures
account, even if a security future is carried in the account, as long
as the collateral or other equity allocated to the security future is
sufficient to satisfy the requirement established under the Final
Rules. Likewise, security futures intermediaries may value margin
equity securities deposited to satisfy the required margin for
commodity futures or commodity options (other than security futures)
according to the rules of the applicable board of trade.
Moreover, security futures intermediaries may allocate collateral
or other components of equity among security futures and such other
positions as they consider appropriate. For example, a security futures
intermediary may elect to allocate cash, open trade equity, option
value, and nonequity securities to satisfy the required margin for
security futures and related positions in a futures account, and
allocate margin equity securities to satisfy the required margin for
commodity futures and commodity options (other than security futures).
This allocation would allow the security futures intermediary to value
the margin equity securities as permitted by the applicable margin
rules, rather than at the security's Regulation T collateral value,
provided that the security futures in the account are adequately
margined by the other collateral in the account.
To prevent assets used to satisfy the required margin for security
futures from being counted twice for margin purposes, the Final Rules
provide that transactions, positions or deposits used to satisfy the
required margin for security futures or related positions shall be
unavailable to satisfy the required margin for any other position or
transaction or any other requirement.\257\ In particular, a related
position used to reduce the required margin for a security future may
not be used in a strategy-based offset with another item in the
account. This provision is consistent with the satisfaction restriction
in Section 220.4(c)(4) of Regulation T.\258\ For example:
A deposit of $1000 in margin equity securities used to
satisfy the required margin for a $500 margin call on a security future
cannot also be used to satisfy a $350 margin call on a broad-based
index future in a futures account, even if, under the margin rules
applicable to the account, equity securities used as collateral for the
broad-based index future may be valued at 85% of current market value
(i.e. $850).
---------------------------------------------------------------------------
\257\ See CFTC Rule 41.46(d); SEC Rule 404(d).
\258\ 12 CFR 220.4(c)(4).
---------------------------------------------------------------------------
A 100-share XYZ put option contract in a securities
account may not be used to cover both a 100-share long XYZ security
future contract as well as 100 shares of XYZ common stock.
The collateral used to satisfy the margin requirement with respect
to a security future may of course be used to satisfy the margin
requirement with respect to the same position under self-regulatory
authority rules.
I. When Margin May Be Withdrawn
The Final Rules include provisions that specify when margin may be
withdrawn from an account that contains security futures. Under the
Proposed Rules, these provisions would have been incorporated into the
Commissions' margin requirements through the application of Regulation
T. Because the Final Rules do not expressly apply Regulation T, the
Commissions have identified the circumstances in which a customer or a
security futures intermediary may withdraw cash, securities or other
collateral deposited as margin for security futures and related
positions.\259\
---------------------------------------------------------------------------
\259\ See CFTC Rule 41.47; SEC Rule 405.
---------------------------------------------------------------------------
1. Withdrawal of Margin by the Customer
The Final Rules provide that a customer may withdraw cash,
securities, or other assets deposited as margin for security futures or
related positions, provided that the equity in the account after such
withdrawal is sufficient to satisfy the required margin for the
security futures and related positions in the account under the Final
Rules.\260\
---------------------------------------------------------------------------
\260\ See CFTC Rule 41.47(a); SEC Rule 405(a).
---------------------------------------------------------------------------
Customers that use the alternative collateral valuation method for
equity securities, pursuant to CFTC Rule 41.46(e) and SEC Rule 404(e),
are subject to an additional restriction on withdrawals that parallels
the withdrawal restrictions of Regulation T.\261\ Specifically, cash,
securities or other assets may not be withdrawn with respect to an
account that uses the alternative method if:
---------------------------------------------------------------------------
\261\ See 12 CFR 220.4(e).
---------------------------------------------------------------------------
(i) Additional cash, securities, or other assets are required to be
deposited as margin for a transaction in the account on the same or a
previous day pursuant to a special margin requirement; or
(ii) The withdrawal, together with other transactions, deposits,
and withdrawals on the same day, would create or increase a margin
deficiency if the margin equity securities were valued at their
Regulation T collateral value.\262\
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\262\ See CFTC Rule 41.46(e); SEC Rule 404(e).
---------------------------------------------------------------------------
This restriction is intended to prevent a customer from withdrawing
margin
[[Page 53166]]
deposited to satisfy a special margin requirement unless the customer's
equity exceeds the required margin in the account or the customer
substitutes securities of equivalent value.
2. Withdrawal of Margin by the Security Futures Intermediary
The Final Rules provide that a security futures intermediary may
deduct certain payments and charges from a customer account to meet the
customer's obligations to the security futures intermediary and third
parties.\263\ Specifically, without regard to the other provisions of
the rule, the security futures intermediary may deduct the following
items from an account:
---------------------------------------------------------------------------
\263\ See CFTC Rule 41.47(b); SEC Rule 405(b).
---------------------------------------------------------------------------
(i) Variation settlement payable, directly or indirectly,\264\ to a
clearing agency or derivatives clearing organization to settle the
customer's obligations under a security futures contract or other
contracts cleared through the clearing agency or derivatives clearing
organization;
---------------------------------------------------------------------------
\264\ The phrase "directly or indirectly" is intended to
encompass payments either directly to a clearing agency or
derivatives clearing organization, or payments made through a
clearing broker.
---------------------------------------------------------------------------
(ii) Interest charged on credit maintained in the account;
(iii) Communication or shipping charges with respect to
transactions in the account;
(iv) Payment of commissions, brokerage, taxes, storage and other
charges lawfully accruing in connection with the positions and
transactions in the account; and
(v) Any service charges that the security futures intermediary may
impose. These items reflect the permissible withdrawals from a
securities account and a futures account under Regulation T \265\ and
Section 4d of the CEA,\266\ respectively. The Final Rules also permit a
security futures intermediary to deduct any other items that may be
deducted under Regulation T (e.g., premiums on securities borrowed,
dividends, interest, or other distributions due on borrowed
securities), to the extent permitted under applicable margin rules.
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\265\ 12 CFR 220.4(f).
\266\ 7 U.S.C. 6d.
---------------------------------------------------------------------------
J. Consequences of Failure To Collect Required Margin
The Commissions proposed that the amount of initial or maintenance
margin required would be obtained as promptly as possible and in any
event within three business days or within such shorter time period as
may be imposed by applicable regulatory authority rules.\267\ The
Commissions also proposed that the time limits for collection of
initial margin could be extended upon application by the creditor to
its examining authority, as defined in Proposed CFTC Rule 41.44(a)(3)
and Proposed SEC Rule 401(a)(3), to the extent permitted by applicable
regulatory authority rules.\268\ Failure to collect additional margin
within the established period would have required the creditor to
liquidate the account, as required by Regulation T.\269\
---------------------------------------------------------------------------
\267\ See Proposed CFTC Rule 41.46(a) and (b); Proposed SEC Rule
403(a) and (b).
\268\ See Proposed CFTC Rule 41.46(c); Proposed SEC Rule 403(c).
\269\ 12 CFR 220.4(d).
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The Commissions received six comments on the issue of timing for
collection of margin.\270\ One commenter supported the proposed time
limit for collection of margin, stating that a time limit of three
business days or shorter, with the opportunity for extensions upon
application, would be a reasonable time frame for initial and
maintenance margin calls.\271\
---------------------------------------------------------------------------
\270\ See Peregrine Letter; SIA Credit Division Letter; SIA/FIA
Letter; Morgan Stanley Letter; CME/CBOT Letter; and NFA Letter.
\271\ Peregrine Letter at 2.
---------------------------------------------------------------------------
One commenter disagreed with the proposed time limits and
recommended that the Commissions adopt the time limits provided in
Regulation T, which requires the collection of margin within five
business days after the position is established (T+5), and the
collection of maintenance margin as promptly as possible and in any
event within fifteen business days.\272\ Another commenter supported a
T+1 margin settlement cycle and a T+5 collection period.\273\ The same
commenter observed that "[g]iven that the initial margin collection
period for securities and listed securities options is T+5, and that,
as a result of required capital charges, futures have an effective
collection period of T+5, the Associations' members feel strongly that
a T+5 collection period should also apply to security futures." \274\
---------------------------------------------------------------------------
\272\ SIA Credit Division Letter at 2.
\273\ SIA/FIA Letter at 11.
\274\ Id.
---------------------------------------------------------------------------
Two other commenters urged the Commissions to recognize the
existing time limits in both the securities and futures
industries.\275\ Specifically, these commenters believed that although
the provisions governing the time of collection in Regulation T are
different from those set forth by the CFTC and the futures exchange
rules, the outcome is substantially similar.
---------------------------------------------------------------------------
\275\ See Morgan Stanley Letter at 10; CME/CBOT Letter at 5.
---------------------------------------------------------------------------
Finally, another commenter recommended that the period for
collecting initial and maintenance margin be extended to four days
(T+4) in order to be consistent with existing requirements in the
futures and securities industries.\276\ That commenter also expressed
concern regarding the procedures that must be followed if margin is not
received in the time prescribed, noting that the Proposed Rules would
require liquidation of positions in accordance with Regulation T. The
commenter believed that requiring a firm to liquidate positions if a
margin call is not met, or providing that the time period for
collection could be extended by the firm's examining authority, could
create significant burdens for both an FCM and its examining authority
because these are not the current practices in the futures industry.
---------------------------------------------------------------------------
\276\ NFA Letter at 5.
---------------------------------------------------------------------------
The Commissions have considered the commenters views and have
decided not to adopt uniform time periods for collection of margin. The
Commissions have determined that deference to account-specific rules in
this instance will avoid operational costs that would be incurred in
modifying existing practices, and will not provide an incentive for
customers to select one type of account (securities or futures) over
another.
In addition, the Commissions have decided not to require immediate
liquidation of the positions in a customer account if the customer
fails to deposit additional required margin within a prescribed number
of days. The Commissions believe that, in general, a security futures
intermediary should be adequately protected against potential adverse
movements in customers' positions if it takes a capital charge for the
amount by which the customer's account is undermargined. Accordingly,
the Final Rules provide that if any margin call required by this
Regulation (Secs. 242.400 through 242.406) is not met in full, the
security futures intermediary shall take the deduction required under
CFTC or SEC rules,\277\ as applicable, in computing its net
capital.\278\
---------------------------------------------------------------------------
\277\ 17 CFR 1.17(c)(5)(viii) or (ix); 17 CFR 240.15c3-
1(c)(2)(xii).
\278\ CFTC Rule 41.48(a); SEC Rule 406(a).
---------------------------------------------------------------------------
The Commissions have decided, however, to require that a security
futures intermediary liquidate positions in an account if the account
would liquidate to a deficit.\279\ To provide
[[Page 53167]]
firms with the flexibility to control liquidation of positions during
adverse market conditions, the Final Rules provide that firms shall
liquidate such positions promptly and in an orderly manner. This is
consistent with futures industry practices in which FCMs, pursuant to
customer agreements, exercise discretion in making liquidation
decisions. In this regard, the Commissions believe that it is prudent
business practice for security futures intermediaries to take steps to
liquidate customer accounts well before they are in a deficit
condition. The uniform liquidation requirement adopted under the Final
Rules differs from the liquidation requirements imposed under
Regulation T and securities SRO rules with respect to undermargined
accounts.\280\ The Final Rules clarify that this Regulation T
liquidation requirement does not apply to security futures held in a
securities account.\281\
---------------------------------------------------------------------------
\279\ CFTC Rule 41.48(b); SEC Rule 406(b). This is the same
standard that applies to options specialists under the SEC's net
capital rule. Exchange Act Rule 15c3-1(c)(2)(x)(D) (17 CFR 240.15c3-
1(c)(2)(x)(D)).
\280\ Under Regulation T, if any initial margin call is not met
in full within one payment period after a margin deficiency is
created or increased, a creditor must liquidate securities
sufficient to meet the margin call or to eliminate any margin
deficiency existing on the day such liquidation is required,
whichever is less (unless the margin deficiency created or increased
is $1000 or less). 12 CFR 220.4(d). The Regulation T payment period
is currently five business days, although it may be extended for one
or more limited periods upon application by the creditor to its
examining authority. Id. at 12 CFR 220.2, 220.4(c)(3). NYSE Rule 431
requires the amount of maintenance margin or mark to market required
by any provision of the NYSE Rule 431 to be obtained within fifteen
business days from the date such deficiency occurred, unless the
Exchange has specifically granted the member organization additional
time. NYSE Rule 431(f)(6).
\281\ CFTC Rule 41.48(c); SEC Rule 406(c).
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K. CFTC Procedures for Notification of Proposed Rule Changes Related to
Margin
In general, a designated contract market, including a "notice-
designated" contract market,\282\ or registered derivatives
transaction execution facility ("DTF") that proposes to make a rule
change regarding its security futures margin requirements (other than
proposed rule changes that result in higher margin levels) must submit
the proposed rule change to the SEC for approval in accordance with
section 19(b) of the Exchange Act.\283\ In addition, contract markets
designated pursuant to Section 5 of the CEA and registered DTFs are
also required under Section 5c(c) of the CEA to make certain filings
with the CFTC regarding rule changes, including those for security
futures products.\284\ Because ATSs are not SROs under the Exchange
Act, notice-designated contract markets that are ATSs are not required
to submit proposed rule changes to the SEC for approval in accordance
with section 19(b) of the Exchange Act.
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\282\ A notice-designated contract market is a national
securities exchange registered pursuant to section 6(a) of the
Exchange Act (15 U.S.C. 78f(a)), a national securities association
registered pursuant to section 15A(a) of the Exchange Act (15 U.S.C.
78o-3(a)), or an alternative trading system ("ATS") as defined in
Section 1a(1) of the CEA (7 U.S.C. 1a(1)) that is designated as a
contract market pursuant to Section 5f of the CEA (7 U.S.C. 7b-1).
\283\ 15 U.S.C. 78s(b).
\284\ 7 U.S.C. 7a-2(c). Notice-designated contract markets are
exempt from the requirements of Section 5c of the CEA pursuant to
Section 5f(b)(1)(D) of the CEA (7 U.S.C. 7a-2(b)(1)(D)).
---------------------------------------------------------------------------
Section 5c(c) of the CEA provides for two alternative procedures by
which such a designated contract market or registered DTF may implement
a proposed rule change.\285\ First, in accordance with Section 5c(c)(1)
of the CEA, a proposed rule change may be implemented by providing the
CFTC with a written certification that the proposed rule change
complies with the CEA.\286\ Second, Section 5c(c)(2) of the CEA
provides that, before the implementation of a proposed rule change, an
entity may request that the CFTC grant prior approval of the rule
change.\287\
---------------------------------------------------------------------------
\285\ See also 66 FR 42256 (August 10, 2001) (CFTC rules
implementing these procedures, codified in a new Part 40 of Title
17, CFTC Rules 40.5 and 40.6).
\286\ 7 U.S.C. 7a-2(c)(1).
\287\ 7 U.S.C. 7a-2(c)(2).
---------------------------------------------------------------------------
Proposed CFTC Rule 41.48(a) required any notice-designated contract
market that files a proposed rule change regarding customer margin for
security futures with the SEC for approval in accordance with section
19(b)(2) of the Exchange Act \288\ to concurrently provide to the CFTC
a copy of such a proposed rule change and any accompanying
documentation filed with the SEC.\289\ Such notice-designated contract
market was not required to provide any supplemental information, even
if such information were subsequently provided to the SEC in the course
of the SEC's review of the proposed rule change. The purpose of this
Proposed Rule was to provide the CFTC, as a joint regulator of markets
offering security futures products, with timely notification of a
proposed rule change.
---------------------------------------------------------------------------
\288\ 15 U.S.C. 78s(b)(2).
\289\ The copy may be submitted to the CFTC electronically, by
facsimile, or by delivery of a hard copy.
---------------------------------------------------------------------------
Proposed CFTC Rule 41.48(b) established the notification process
for contract markets designated pursuant to Section 5 of the CEA \290\
and registered DTFs. The process by which such an entity would notify
the CFTC of having filed a proposed rule change with the SEC would
depend on which procedure under Section 5c(c) of the CEA \291\ the
entity elected to follow.
---------------------------------------------------------------------------
\290\ 7 U.S.C. 7a-2.
\291\ 7 U.S.C. 7a-2(c).
---------------------------------------------------------------------------
Proposed CFTC Rule 41.48(b)(1) applied to any designated contract
market registered under section 5 of the CEA or registered DTF that
elects to seek the prior approval of the CFTC for a proposed rule
change, in accordance with Section 5c(c)(2) of the CEA.\292\ In such
case, the contract market or DTF would file its requests with the SEC
and CFTC concurrently.
---------------------------------------------------------------------------
\292\ 7 U.S.C. 7a-2(c)(2).
---------------------------------------------------------------------------
Under Proposed CFTC Rule 41.48(b)(2), an entity that elects to
implement a proposed rule change by filing a written certification with
the CFTC in accordance with Section 5c(c)(1) of the CEA \293\ would be
required to provide a copy of the proposed rule change and any
accompanying documentation that was filed with the SEC, concurrent with
the SEC filing. Promptly after the SEC approves the proposed rule
change, the designated contract market or registered DTF would file the
written certification with the CFTC.
---------------------------------------------------------------------------
\293\ 7 U.S.C. 7a-2(c)(1).
---------------------------------------------------------------------------
The CFTC requested comments on an alternative procedure under which
an entity would file its written certification with the CFTC at the
same time as it files the proposed rule change with the SEC, rather
than after the SEC approves the proposed rule change.
The CFTC did not receive any comments relating to this issue, and
it is therefore adopting the notification provisions as proposed, in
all material respects.
III. Paperwork Reduction Act
A. CFTC
The Paperwork Reduction Act of 1995 ("PRA") \294\ 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 Rules that have been
adopted 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.
---------------------------------------------------------------------------
\294\ 44 U.S.C. 3501 et seq.
---------------------------------------------------------------------------
B. SEC
The Paperwork Reduction Act does not apply because the rules do not
impose recordkeeping or information collection requirements, or other
collections of information that require
[[Page 53168]]
the approval of the Office of Management and Budget under 44 U.S.C.
3501, et. seq.
IV. Costs and Benefits of the Final Rules
A. CFTC
Section 15(a) of the CEA \295\ requires that the CFTC, before
promulgating a regulation under the CEA or issuing an order, consider
the costs and benefits of its action. By its terms, Section 15(a) does
not require the CFTC to quantify the costs and benefits of a new rule
or determine whether the benefits of the rule outweigh its costs.
Rather, Section 15(a) simply requires the CFTC to "consider the costs
and benefits" of its action.
---------------------------------------------------------------------------
\295\ 7 U.S.C. 19(a).
---------------------------------------------------------------------------
Section 15(a) further specifies that costs and benefits shall be
evaluated in light of the following considerations: (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. Accordingly, the CFTC could, in its discretion, give
greater weight to any one of the five considerations and could, in its
discretion, determine that, notwithstanding its costs, a particular
rule was necessary or appropriate to protect the public interest or to
effectuate any of the provisions or to accomplish any of the purposes
of the CEA.
This rulemaking constitutes a package of related rule provisions.
The Final Rules establish the amount of initial and maintenance
customer margin for transactions in security futures. The CFTC believes
that the customer margin requirements for security futures are, in
accordance with the CFMA, consistent with the margin requirements for
comparable option contracts traded on any exchange registered pursuant
to section 6(a) of the Exchange Act.\296\ The CFTC has evaluated the
costs and benefits of these rules in light of the specific
considerations identified in Section 15(a) of the CEA:
---------------------------------------------------------------------------
\296\ 15 U.S.C. 78f(a).
---------------------------------------------------------------------------
1. Protection of market participants and the public. In general,
the Final Rules should further the protection of market participants
and the public.
2. Efficiency and competition. As noted above, the margin
requirements are consistent with the margin requirements for comparable
option contracts traded on any exchange registered pursuant to section
6(a) of the Exchange Act, as required under the CFMA. To the extent
that the Final Rules permit FCMs and futures exchanges to maintain
existing operational and business practices, the Final Rules enable
market participants to minimize operational costs associated with the
introduction of security futures, and preserve meaningful customer
choice as to the type of account (securities or futures) in which the
customer may elect to carry security futures. In certain respects, the
Final Rules promote a level playing field between options exchanges and
security futures exchanges, and between broker-dealers/securities
accounts and FCMs/futures accounts. Accordingly, the Final Rules are
not expected to have a negative impact on competition.
3. Financial integrity of futures markets and price discovery. The
Final Rules should have a positive effect on the financial integrity of
security futures markets by protecting against systemic risk.
4. Sound risk management practices. The Final Rules are consistent
with sound risk management practices.
5. Other public considerations. The Final Rules are expected to
preserve the financial integrity of markets trading security futures
and prevent systemic risk, thereby benefiting the public. The CFTC
believes that the Final Rules give rise to an acceptable level of cost
in light of the expected benefits of the rules.
After evaluating these considerations, the CFTC has determined to
adopt the Final Rules discussed above. The CFTC invited public comment
on its cost-benefit analysis, but did not receive any comments in
response to this invitation. Moreover, insofar as the comments received
raise any matters that might be deemed to relate to the cost-benefit
analysis, the CFTC has addressed such comments in the foregoing
discussion and through modifications to the Proposed Rules.
B. SEC
Section 7 of the Exchange Act, which governs the amount of credit
that may be initially extended and subsequently maintained on any
security (other than an exempted security), was amended by the CFMA to
add provisions related to margin for security futures. On March 6,
2001, the Federal Reserve Board delegated its authority under section
7(c)(2) of the Exchange Act to establish margin requirements for
security futures to the SEC and CFTC. The Final Rules establish such
margin requirements.
Specifically, the CFMA amended section 7(c) of the Exchange Act to
require that the rules preserve the financial integrity of markets
trading security futures products, prevent systemic risk, and to
require that: (1) The margin requirements for a security future be
consistent with the margin requirements for comparable option contracts
traded on any exchange registered pursuant to section 6(a) of the
Exchange Act; \297\ and (2) the initial and maintenance margin levels
for a security future 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, other than an option on a security future, and to ensure
that the margin requirements (other than levels of margin), including
the type, form, and use of collateral for security futures, are and
remain consistent with the requirements established by the Federal
Reserve Board under Regulation T.
---------------------------------------------------------------------------
\297\ 15 U.S.C. 78f(a).
---------------------------------------------------------------------------
The SEC provided an estimate of the costs and benefits of the
Proposed Rules, and requested comments on all aspects of its estimate,
including identification of any additional costs or benefits of the
proposed rules. The SEC encouraged commenters to identify and supply
any relevant data, analysis and estimates concerning the costs and
benefits of the proposed rules. Several commenters expressed the view
that certain aspects of the Proposed Rules would impose costs. However,
none of the commenters provided specific data regarding the overall
costs and benefits of the Proposed Rules.
The SEC has considered the costs and benefits of the Final Rules.
We are sensitive to the costs and benefits that might arise from
compliance with our rules and amendments. In response to commenters'
concerns about the potential costs related to the application of
Regulation T to all transactions in security futures, the Commissions
are adopting stand alone margin rules for security futures that apply
only certain requirements of Regulation T that are necessary to satisfy
the statutory requirement that the margin requirements for security
futures be and remain consistent with Regulation T. The SEC understands
that some aspects of the Final Rules may impose costs on some persons
or entities. However, the Final Rules are being adopted pursuant to
statutory directive and are necessary to permit trading in security
futures. In addition, the SEC notes that the Final Rules will apply
only to those broker-dealers and FCMs that choose to do a business in
security futures.
[[Page 53169]]
1. Costs
The Final Rules will impose administrative costs on security
futures intermediaries. Further, security futures intermediaries are
responsible for complying with the Final Rules and thus will incur
various costs. The SEC has identified below areas where the Final Rules
may impose costs.
a. Compliance with Regulation T. The Proposed Rules would have
applied Regulation T to financial relations between brokers, dealers,
and members of national securities exchanges and their customers with
respect to transactions in security futures and any related securities
or futures contracts that are used to offset positions in such security
futures. Accordingly, under the Proposed Rules, Regulation T would have
applied to all transactions in security futures, whether they were
effected in a securities account or a futures account. Several
commenters expressed concern that applying Regulation T to security
futures in futures accounts would result in substantial costs to FCMs
resulting from the need to reprogram their margin systems to comply
with Regulation T.
As noted above, the Final Rules do not apply Regulation T to all
security futures transactions. Instead, as noted above, the Final Rules
incorporate certain requirements of Regulation T as necessary to
satisfy the requirement under section 7(c)(2) of the Exchange Act that
the Final Rules be and remain consistent with Regulation T. The SEC
believes that this aspect of the Final Rules should only impose minimal
administrative costs on security futures intermediaries. For broker-
dealers and members of national securities exchanges that trade
security futures, there should be little or no cost imposed by this
aspect of the Final Rules because they already are subject to
Regulation T for other securities transactions. For FCMs, there will be
some administrative costs associated with this aspect of the final
rules to program their systems to comply with the specific provisions
of Regulation T that are included in the Final Rules.
b. Levels of Margin. SEC Rule 403(b)(1) sets the level of margin at
20 percent of current market value, which is the same level that would
have been set under the Proposed Rules. The 20 percent level is
necessary to fulfill the requirement under Section 7(c)(2)(B)(iii) that
the margin requirements for security futures be consistent with the
margin requirements for comparable exchange-traded options.\298\
---------------------------------------------------------------------------
\298\ 15 U.S.C. 78g(c)(2)(B)(iii).
---------------------------------------------------------------------------
When the Proposed Rules were issued for comment, the SEC noted that
the 20 percent margin level could appear to be high when compared to
margining methodologies currently used for futures other than security
futures. As a result, a potential cost of the margin levels is that
they may lead to reduced interest in trading security futures and,
therefore, foregone hedging opportunities.
However, while margin requirements on futures other than security
futures generally range from 2-10 percent,\299\ SEC staff estimated
that applying traditional futures risk-based margining methods to
security futures would require margin of greater than 10 percent.\300\
In addition, however, SEC staff estimated that the proposed margin
levels would reduce the chances that a margin account would not contain
sufficient funds to cover a given day's price movement from
approximately 5 percent using traditional risk-based futures margining
to 0.3 percent. Further, economic research has thus far not been able
to establish a strong relationship between futures margin levels and
interest in the product.\301\ Therefore, while the margin levels under
the Final Rules may impose a cost, the SEC believes that the margin
levels should lower chances of customer default and therefore lower
systemic risk to the markets. For these reasons, and the statutory
mandate that requires comparability between security futures margin and
options margin, the SEC believes that the margin levels adopted in the
Final Rules are appropriate.
---------------------------------------------------------------------------
\299\ Catrath, A., Adrangi, B and Alleder, M. (2001), The Impact
of Margins in Futures Markets: Evidence from the Gold and Silver
Markets, The Quarterly Review of Economics and Finance, 279.
\300\ The SEC staff examined all securities with average daily
trading volume greater than 50,000, using data from 2000 from the
Center for Research in Security Prices ("CRSP"). Based on these
data, the SEC staff calculated the daily price returns and the 30-
day historical price volatility for each of the securities examined.
Based on the assumption that cash and futures prices typically
move together, the SEC staff conducted a simulation, using actual
security price movements as estimates for would be futures price
movements. Based upon these security futures' price estimates, the
staff determined the margin requirements for each of these security
futures under both the 20 percent strategy-based approach and the
traditional risk-based futures approach. The staff examined how
often the funds attributable to margin requirements are insufficient
to cover the daily price movements of these security futures. This
is relevant to the examination of systemic risk because a necessary
condition for customer default to occur is the depletion of the
funds attributable to margin requirements (assuming no market risk
to close out such position).
\301\ For further details on these issues, see Fishe, R. P. H.,
Goldberg, L.G., (1986), The Effects of Margins on Trading in Futures
Markets, Journal of Futures Markets, 261; Fishe, P.H., Goldberg,
L.A., Gosnell, T.F. and Sinha, S. (1990), Margin Requirement in
Futures Markets: Their Relationship to Price Volatility, The Journal
of Futures Markets, 541.
---------------------------------------------------------------------------
c. Computation of Margin. The Final Rules require security futures
intermediaries to compute and collect, on a daily basis, required
margin for each customer's security future carried or held by such
entity. This requirement is designed to assure contract performance and
the integrity of the marketplace. In addition, all security futures
intermediaries will pay or receive daily variation settlement (i.e.,
the daily net gain or loss on a security future) as a result of all
open futures positions being marked to current market value by the
clearing organization.
The SEC believes that the daily required computation of the initial
and maintenance margin requirements and the collection and disbursement
of daily settlement variation for security futures by security futures
intermediaries will require these entities to program or reprogram
their computer systems to implement the margin computations and the
settlement variation procedures for security futures. These entities
may also incur additional data storage costs and resource costs
associated with these calculations.
d. Undermargined Accounts. SEC Rule 406(a) requires a security
futures intermediary to take a deduction in computing its net capital
to the extent that any margin call required by the Final Rules is not
met in full. In addition, SEC Rule 406(b) requires that a security
futures intermediary liquidate positions in a prompt and orderly manner
in any account in which security futures are held at any time there is
a liquidating deficit in the account. The SEC believes that these
aspects of the Final Rules may impose costs on security futures
intermediaries by requiring them to evaluate information to determine
for each customer's account involving security futures when margin
calls required under the Final Rules have not been met. Security
futures intermediaries may also incur costs in the form of capital
charges with respect to customers that do not meet margin calls. In
addition, security futures intermediaries that have customer accounts
that fall into a liquidating deficit may incur costs in complying with
the mandatory liquidation provisions of the Final Rules.
2. Benefits
The benefits of the Final Rules are related to the benefits that
will accrue as a result of the enactment of the CFMA. By repealing the
ban on futures
[[Page 53170]]
on single securities and futures on narrow-based security indexes, the
CFMA will enable a greater variety of financial products to be traded
that potentially could facilitate price discovery and the ability to
hedge. Investors will benefit by having a wider choice of financial
products to buy and sell, and markets and market participants will
benefit by having the ability to trade these products. These rules are
a prerequisite to the commencement of trading in the new products, and
therefore they are also a prerequisite to any benefits that may derive
from the availability of these products.
a. Benefits to Security Futures Intermediaries. SEC Rule 403(b)(1)
provides that the minimum initial and maintenance margin levels for
each security future would be 20 percent of the current market value of
such contract. Moreover, SEC Rule 404(b) provides that a security
futures intermediary may accept as collateral cash, margin securities,
exempted securities, or other collateral permitted under Regulation T,
as well as shares in money market mutual funds, to satisfy a margin
deficiency. The SEC believes that these aspects of the Final Rules will
provide sound protection from customer default by reducing chances of
depletion of margin accounts. Accordingly, the Final Rules should
reduce systemic risk associated with the trading of these new products.
b. Benefits to Customers. SEC Rule 403(b)(2) provides that
customers be permitted to offset positions involving security futures
with certain related securities or futures. Such offsets would be
proposed by regulatory authority rules that would be approved by the
SEC pursuant to section 19(b)(2) of the Exchange Act and, as
applicable, by the CFTC pursuant to Section 5c(c) of the CEA if such
offsets were consistent with the requirements of section 7(c)(2)(B) of
the Exchange Act, including the requirement that margin requirements
for security futures be no less restrictive than those imposed on
options. These offsets will provide benefits to customers because they
will recognize the hedged nature of certain specified combined
strategies and will permit lower margin requirements that better
reflect the true risk of those strategies.
V. Consideration of Burden on Competition, Promotion of Efficiency and
Capital Formation
Section 3(f) of the Exchange requires the SEC, when it is engaged
in rulemaking and is required to consider or determine whether an
action is necessary or appropriate in the public interest, to consider
whether the action would promote efficiency, competition, and capital
formation.\302\ Section 23(a)(2) requires the SEC, in adopting rules
under the Exchange Act, to consider the impact any rule would have on
competition.\303\ Section 23(a)(2) further provides that the SEC may
not adopt a rule not necessary or appropriate in furtherance of the
purposes of the Exchange Act. In the proposing release, the SEC
requested comments on these statutory considerations. The SEC received
no comments on the issue of competition, efficiency, or capital
formation.
---------------------------------------------------------------------------
\302\ 15 U.S.C. 78c(f).
\303\ 15 U.S.C. 78w(a)(2).
---------------------------------------------------------------------------
The SEC believes that the rules should promote efficiency by
setting forth clear guidelines for security futures intermediaries when
collecting customer margin related to security futures. Further, the
SEC believes that the rules will provide sound protection from customer
default by reducing the chances of depletion of margin accounts,
thereby reducing systemic risk associated with the trading of these new
products.
The SEC also believes that the rules would not impose any
significant burden on competition. The Final Rules provide that
security futures generally will be governed by the existing margin
rules applicable to securities accounts and to futures accounts, which
are not identical in all cases. However, the Final Rules also include
uniform provisions, applicable to security futures regardless of the
type of account in which they are held, which are designed to prevent
competitive advantages from arising simply because security futures are
held in one type of account rather than the other. The rules serve only
to set forth margin requirements for security futures. In addition, the
Final Rules satisfy section 7(c)(2)(B)(iii) of the Exchange Act, which,
among other things, requires that the margin rules for security futures
be consistent with those for comparable exchange-traded options.
Accordingly, the Final Rules are designed to prevent competitive
advantages from arising solely out of differences between the margin
requirements for security futures and those for exchange-traded
options. Lastly, the SEC believes that the rules will not have any
impact on capital formation because the rules, as adopted, merely
establish requirements governing the collection of customer margin. The
SEC reiterates that the margin requirements would protect security
futures intermediaries from customers' default, thus encouraging
participation by these market participants in the trading of futures on
both single securities and narrow-based security indexes. Therefore,
the SEC believes that there could be an increased demand for the
underlying securities, resulting in increased capital formation.
VI. Regulatory Flexibility Act
A. CFTC
The Regulatory Flexibility Act ("RFA") \304\ requires that
federal agencies, in promulgating rules, consider the impact of those
rules on small entities. The Final Rules will affect designated
contract markets, registered DTFs, and FCMs. 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.\305\
---------------------------------------------------------------------------
\304\ 5 U.S.C. 601 et seq.
\305\ 47 FR 18618-21 (April 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.\306\
Recently, the CFTC determined that notice-designated contract markets
are not small entities for purposes of the RFA.\307\ In addition, the
CFTC has determined that other trading facilities subject to its
jurisdiction, including registered DTFs, are not small entities for
purposes of the RFA.\308\
---------------------------------------------------------------------------
\306\ Id. at 18619.
\307\ 66 FR 44960, 44964 (August 27, 2001).
\308\ 66 FR 42256, 42268 (August 10, 2001).
---------------------------------------------------------------------------
In the Proposing Release, it was observed that 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.\309\ The CFTC proposed to determine that notice-
registered FCMs,\310\ for the reasons applicable to FCMs registered in
accordance with Section 4f(a)(1) of the CEA,\311\ are not small
entities for purposes of the RFA. Brokers or dealers that carry
customer accounts and receive or hold funds for those customers, and
are notice-registered as FCMs for the purpose of trading security
futures, similarly have a fiduciary
[[Page 53171]]
relationship with their customers and must meet analogous minimum
financial requirements.\312\
---------------------------------------------------------------------------
\309\ 47 FR at 18619.
\310\ 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)).
\311\ 7 U.S.C. 6f(a)(1).
\312\ See Exchange Act Rule 15c3-1(a)(2), 17 CFR 240.15c3-
1(a)(2).
---------------------------------------------------------------------------
The CFTC invited the public to comment on its proposed
determination that notice-registered FCMs would not be small entities
for purposes of the RFA. The CFTC also invited comments on its finding
that there would not be a significant economic impact on a substantial
number of small entities. The CFTC notes that no comments were received
regarding either of these issues. Additionally, the CFTC notes that
Congress mandated that customer margin for security futures be
consistent with the margin requirements for comparable option contracts
traded on any exchange registered pursuant to section 6(a) of the
Exchange Act.\313\ In adopting the Final Rules, the Commissions have
striven to fulfill this requirement in the least burdensome way
possible. The CFTC hereby determines that notice-registered FCMs are
not small entities for purposes of the RFA. Further, the CFTC believes
that the Final Rules will not have a significant economic impact on a
substantial number of small entities.
---------------------------------------------------------------------------
\313\ 15 U.S.C. 78f(a).
---------------------------------------------------------------------------
B. SEC
Pursuant to section 605(b) of the Regulatory Flexibility Act
("RFA"),\314\ the SEC certified that the adopted rule would not have
a significant economic impact on a substantial number of small
entities. This certification was attached to the Proposing Release No.
34-50720 (October 4, 2001) as Appendix A.\315\ The SEC solicited
comments concerning the impact on small entities and the RFA
certification, but received no comments.
---------------------------------------------------------------------------
\314\ 5 U.S.C. 601 et seq.
\315\ See Proposing Release, supra note 6.
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VII. Statutory Basis
The SEC is adopting Rules 400 through 406 pursuant to the Exchange
Act, particularly Sections, 3(b), 6, 7(c), 15A, and 23(a). Further,
these rules are adopted pursuant to the authority delegated jointly to
the SEC, together with the CFTC, by the Federal Reserve Board in
accordance with Exchange Act Section 7(c)(2)(A).
Text of Rules
List of Subjects
17 CFR Part 41
Brokers, Margin, Reporting and recordkeeping requirements, Security
futures products.
17 CFR Part 242
Brokers, Securities.
Commodity Futures Trading Commission
17 CFR Chapter I
In accordance with the foregoing, Title 17, chapter I of the Code
of Federal Regulations is amended as follows:
PART 41--SECURITY FUTURES PRODUCTS
1. The authority citation for Part 41 is revised 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).
2. The part heading for Part 41 is revised to read as set forth
above.
Sec. 41.41 [Redesignated]
3. In Part 41, Sec. 41.41 is redesignated as Sec. 41.3.
4. Part 41 is amended by adding Subpart E (Secs. 41.42 through
41.49) to read as follows:
Subpart E--Customer Accounts and Margin Requirements
Sec.
41.42 Customer margin requirements for security futures--authority,
purpose, interpretation, and scope.
41.43 Definitions.
41.44 General provisions.
41.45 Required margin.
41.46 Type, form and use of margin.
41.47 Withdrawal of margin.
41.48 Undermargined accounts.
41.49 Filing proposed margin rule changes with the Commission.
Subpart E--Customer Accounts and Margin Requirements
Sec. 41.42 Customer margin requirements for security futures--
authority, purpose, interpretation, and scope.
(a) Authority and purpose. Subpart E, Secs. 41.42 through 41.49,
and 17 CFR 242.400 through 242.406 ("this Regulation") are issued by
the Commodity Futures Trading Commission ("Commission") jointly with
the Securities and Exchange Commission ("SEC"), pursuant to authority
delegated by the Board of Governors of the Federal Reserve System under
section 7(c)(2)(A) of the Securities Exchange Act of 1934 ("Exchange
Act"). The principal purpose of this Regulation (Subpart E,
Secs. 41.42 through 41.49) is to regulate customer margin collected by
brokers, dealers, and members of national securities exchanges,
including futures commission merchants required to register as brokers
or dealers under section 15(b)(11) of the Exchange Act, relating to
security futures.
(b) Interpretation. This Regulation (Subpart E, Secs. 41.42 through
41.49) shall be jointly interpreted by the SEC and the Commission,
consistent with the criteria set forth in clauses (i) through (iv) of
section 7(c)(2)(B) of the Exchange Act and the provisions of Regulation
T (12 CFR part 220).
(c) Scope.
(1) This Regulation (Subpart E, Secs. 41.42 through 41.49) does not
preclude a self-regulatory authority, under rules that are effective in
accordance with section 19(b)(2) of the Exchange Act or section
19(b)(7) of the Exchange Act and, as applicable, section 5c(c) of the
Commodity Exchange Act ("Act"), or a security futures intermediary
from imposing additional margin requirements on security futures,
including higher initial or maintenance margin levels, consistent with
this Regulation (Subpart E, Secs. 41.42 through 41.49), or from taking
appropriate action to preserve its financial integrity.
(2) This Regulation (Subpart E, Secs. 41.42 through 41.49) does not
apply to:
(i) 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 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 Act;
(ii) Financial relations between a security futures intermediary
and a foreign person involving security futures traded on or subject to
the rules of a foreign board of trade;
(iii) Margin requirements that clearing agencies registered under
section 17A of the Exchange Act or derivatives clearing organizations
registered under section 5b of the Act impose on their members;
(iv) Financial relations between a security futures intermediary
and a person based on a good faith determination by the security
futures intermediary that such person is an exempted person; and
(v) Financial relations between a security futures intermediary
and, or arranged by a security futures intermediary for, a person
relating to trading in security futures by such person for its own
account, if such person:
(A) Is a member of a national securities exchange or national
securities association registered pursuant to section 15A(a) of the
Exchange Act; and
[[Page 53172]]
(B) Is registered with such exchange or such association as a
security futures dealer pursuant to rules that are effective in
accordance with section 19(b)(2) of the Exchange Act and, as
applicable, section 5c(c) of the Act, that:
(1) Require such member to be registered as a floor trader or a
floor broker with the Commission under section 4f(a)(1) of the Act, or
as a dealer with the SEC under section 15(b) of the Exchange Act;
(2) Require such member to maintain records sufficient to prove
compliance with this paragraph (c)(2)(v) and the rules of the exchange
or association of which it is a member;
(3) Require such member to hold itself out as being willing to buy
and sell security futures for its own account on a regular or
continuous basis; and
(4) Provide for disciplinary action, including revocation of such
member's registration as a security futures dealer, for such member's
failure to comply with this Regulation (Subpart E, Secs. 41.42 through
41.49) or the rules of the exchange or association.
(d) Exemption. The Commission may exempt, either unconditionally or
on specified terms and conditions, financial relations involving any
security futures intermediary, customer, position, or transaction, or
any class of security futures intermediaries, customers, positions, or
transactions, from one or more requirements of this Regulation (Subpart
E, Secs. 41.42 through 41.49), if the Commission determines that such
exemption is necessary or appropriate in the public interest and
consistent with the protection of customers. An exemption granted
pursuant to this paragraph shall not operate as an exemption from any
SEC rules. Any exemption that may be required from such rules must be
obtained separately from the SEC.
Sec. 41.43 Definitions.
(a) For purposes of this Regulation (Subpart E, Secs. 41.42 through
41.49) only, the following terms shall have the meanings set forth in
this section.
(1) Applicable margin rules and margin rules applicable to an
account mean the rules and regulations applicable to financial
relations between a security futures intermediary and a customer with
respect to security futures and related positions carried in a
securities account or futures account as provided in Sec. 41.44(a) of
this subpart.
(2) Broker shall have the meaning provided in section 3(a)(4) of
the Exchange Act.
(3) Contract multiplier means the number of units of a narrow-based
security index expressed as a dollar amount, in accordance with the
terms of the security future contract.
(4) Current market value means, on any day:
(i) With respect to a security future:
(A) If the instrument underlying such security future is a stock,
the product of the daily settlement price of such security future as
shown by any regularly published reporting or quotation service, and
the applicable number of shares per contract; or
(B) If the instrument underlying such security future is a narrow-
based security index, as defined in section 1a(25)(A) of the Act, the
product of the daily settlement price of such security future as shown
by any regularly published reporting or quotation service, and the
applicable contract multiplier.
(ii) With respect to a security other than a security future, the
most recent closing sale price of the security, as shown by any
regularly published reporting or quotation service. If there is no
recent closing sale price, the security futures intermediary may use
any reasonable estimate of the market value of the security as of the
most recent close of business.
(5) Customer excludes an exempted person and includes:
(i) Any person or persons acting jointly:
(A) On whose behalf a security futures intermediary effects a
security futures transaction or carries a security futures position; or
(B) Who would be considered a customer of the security futures
intermediary according to the ordinary usage of the trade;
(ii) Any partner in a security futures intermediary that is
organized as a partnership who would be considered a customer of the
security futures intermediary absent the partnership relationship; and
(iii) Any joint venture in which a security futures intermediary
participates and which would be considered a customer of the security
futures intermediary if the security futures intermediary were not a
participant.
(6) Daily settlement price means, with respect to a security
future, the settlement price of such security future determined at the
close of trading each day, under the rules of the applicable exchange,
clearing agency, or derivatives clearing organization.
(7) Dealer shall have the meaning provided in section 3(a)(5) of
the Exchange Act.
(8) Equity means the equity or margin equity in a securities or
futures account, as computed in accordance with the margin rules
applicable to the account and subject to adjustment under
Sec. 41.46(c), (d) and (e) of this subpart.
(9) Exempted person means:
(i) A member of a national securities exchange, a registered broker
or dealer, or a registered futures commission merchant, a substantial
portion of whose business consists of transactions in securities,
commodity futures, or commodity options with persons other than
brokers, dealers, futures commission merchants, floor brokers, or floor
traders, and includes a person who:
(A) Maintains at least 1000 active accounts on an annual basis for
persons other than brokers, dealers, persons associated with a broker
or dealer, futures commission merchants, floor brokers, floor traders,
and persons affiliated with a futures commission merchant, floor
broker, or floor trader that are effecting transactions in securities,
commodity futures, or commodity options;
(B) Earns at least $10 million in gross revenues on an annual basis
from transactions in securities, commodity futures, or commodity
options with persons other than brokers, dealers, persons associated
with a broker or dealer, futures commission merchants, floor brokers,
floor traders, and persons affiliated with a futures commission
merchant, floor broker, or floor trader; or
(C) Earns at least 10 percent of its gross revenues on an annual
basis from transactions in securities, commodity futures, or commodity
options with persons other than brokers, dealers, persons associated
with a broker or dealer, futures commission merchants, floor brokers,
floor traders, and persons affiliated with a futures commission
merchant, floor broker, or floor trader.
(ii) For purposes of paragraph (a)(9)(i) of this section only,
persons affiliated with a futures commission merchant, floor broker, or
floor trader means any partner, officer, director, or branch manager of
such futures commission merchant, floor broker, or floor trader (or any
person occupying a similar status or performing similar functions), any
person directly or indirectly controlling, controlled by, or under
common control with such futures commission merchant, floor broker, or
floor trader, or any employee of such a futures commission merchant,
floor broker, or floor trader.
(iii) A member of a national securities exchange, a registered
broker or dealer, or a registered futures commission merchant that has
been in existence for less than one year may meet the
[[Page 53173]]
definition of exempted person based on a six-month period.
(10) Exempted security shall have the meaning provided in section
3(a)(12) of the Exchange Act.
(11) Floor broker shall have the meaning provided in section 1a(16)
of the Act.
(12) Floor trader shall have the meaning provided in section 1a(17)
of the Act.
(13) Futures account shall have the meaning provided in
Sec. 1.3(vv) of this chapter.
(14) Futures commission merchant shall have the meaning provided in
section 1a(20) of the Act.
(15) Good faith, with respect to making a determination or
accepting a statement concerning financial relations with a person,
means that the security futures intermediary is alert to the
circumstances surrounding such financial relations, and if in
possession of information that would cause a prudent person not to make
the determination or accept the notice or certification without
inquiry, investigates and is satisfied that it is correct.
(16) Listed option means a put or call option that is:
(i) Issued by a clearing agency that is registered under section
17A of the Exchange Act or cleared and guaranteed by a derivatives
clearing organization that is registered under section 5b of the Act;
and
(ii) Traded on or subject to the rules of a self-regulatory
authority.
(17) Margin call means a demand by a security futures intermediary
to a customer for a deposit of cash, securities or other assets to
satisfy the required margin for security futures or related positions
or a special margin requirement.
(18) Margin deficiency means the amount by which the required
margin in an account is not satisfied by the equity in the account, as
computed in accordance with Sec. 41.46 of this subpart.
(19) Margin equity security shall have the meaning provided in
Regulation T.
(20) Margin security shall have the meaning provided in Regulation
T.
(21) Member shall have the meaning provided in section 3(a)(3) of
the Exchange Act, and shall include persons registered under section
15(b)(11) of the Exchange Act that are permitted to effect transactions
on a national securities exchange without the services of another
person acting as executing broker.
(22) Money market mutual fund means any security issued by an
investment company registered under section 8 of the Investment Company
Act of 1940 that is considered a money market fund under Sec. 270.2a-7
of this title.
(23) Persons associated with a broker or dealer shall have the
meaning provided in section 3(a)(18) of the Exchange Act.
(24) Regulation T means Regulation T promulgated by the Board of
Governors of the Federal Reserve System, 12 CFR part 220, as amended
from time to time.
(25) Regulation T collateral value, with respect to a security,
means the current market value of the security reduced by the
percentage of required margin for a position in the security held in a
margin account under Regulation T.
(26) Related position, with respect to a security future, means any
position in an account that is combined with the security future to
create an offsetting position as provided in Sec. 41.45(b)(2) of this
subpart.
(27) Related transaction, with respect to a position or transaction
in a security future, means:
(i) Any transaction that creates, eliminates, increases or reduces
an offsetting position involving a security future and a related
position, as provided in Sec. 41.45(b)(2) of this subpart; or
(ii) Any deposit or withdrawal of margin for the security future or
a related position, except as provided in Sec. 41.47(b) of this
subpart.
(28) Securities account shall have the meaning provided in
Sec. 1.3(ww) of this chapter.
(29) Security futures intermediary means any creditor as defined in
Regulation T with respect to its financial relations with any person
involving security futures, including:
(i) Any futures commission merchant;
(ii) Any partner, officer, director, or branch manager (or person
occupying a similar status or performing similar functions) of a
futures commission merchant;
(iii) Any person directly or indirectly controlling, controlled by,
or under common control with (except for business entities controlling
or under common control with) a futures commission merchant; and
(iv) Any employee of a futures commission merchant (except an
employee whose functions are solely clerical or ministerial).
(30) Self-regulatory authority means 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 Act or section 5f of
the Act, or a derivatives transaction execution facility registered
under section 5a of the Act.
(31) Special margin requirement shall have the meaning provided in
Sec. 41.46(e)(1)(ii) of this subpart.
(32) Variation settlement means 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 or any other contract that is:
(i) Issued by a clearing agency that is registered under section
17A of the Exchange Act or cleared and guaranteed by a derivatives
clearing organization that is registered under section 5b of the Act;
and
(ii) Traded on or subject to the rules of a self-regulatory
authority.
(b) Terms used in this Regulation (Subpart E, Secs. 41.42 through
41.49) and not otherwise defined in this section shall have the meaning
set forth in the margin rules applicable to the account.
(c) Terms used in this Regulation (Subpart E, Secs. 41.42 through
41.49) and not otherwise defined in this section or in the margin rules
applicable to the account shall have the meaning set forth in the
Exchange Act and the Act; if the definitions of a term in the Exchange
Act and the Act are inconsistent as applied in particular
circumstances, such term shall have the meaning set forth in rules,
regulations, or interpretations jointly promulgated by the SEC and the
Commission.
Sec. 41.44 General provisions.
(a) Applicable margin rules. Except to the extent inconsistent with
this Regulation (Subpart E, Secs. 41.42 through 41.49):
(1) A security futures intermediary that carries a security future
on behalf of a customer in a securities account shall record and
conduct all financial relations with respect to such security future
and related positions in accordance with Regulation T and the margin
rules of the self-regulatory authorities of which the security futures
intermediary is a member.
(2) A security futures intermediary that carries a security future
on behalf of a customer in a futures account shall record and conduct
all financial relations with respect to such security future and
related positions in accordance with the margin rules of the self-
regulatory authorities of which the security futures intermediary is a
member.
(b) Separation and consolidation of accounts.
(1) The requirements for security futures and related positions in
one account may not be met by considering items in any other account,
except as
[[Page 53174]]
permitted or required under paragraph (b)(2) of this section or
applicable margin rules. If withdrawals of cash, securities or other
assets deposited as margin are permitted under this Regulation (Subpart
E, Secs. 41.42 through 41.49), bookkeeping entries shall be made when
such cash, securities, or assets are used for purposes of meeting
requirements in another account.
(2) Notwithstanding paragraph (b)(1) of this section, the security
futures intermediary shall consider all futures accounts in which
security futures and related positions are held that are within the
same regulatory classification or account type and are owned by the
same customer to be a single account for purposes of this Regulation
(Subpart E, Secs. 41.42 through 41.49). The security futures
intermediary may combine such accounts with other futures accounts that
are within the same regulatory classification or account type and are
owned by the same customer for purposes of computing a customer's
overall margin requirement, as permitted or required by applicable
margin rules.
(c) Accounts of partners. If a partner of the security futures
intermediary has an account with the security futures intermediary in
which security futures or related positions are held, the security
futures intermediary shall disregard the partner's financial relations
with the firm (as shown in the partner's capital and ordinary drawing
accounts) in calculating the margin or equity of any such account.
(d) Contribution to joint venture. If an account in which security
futures or related positions are held is the account of a joint venture
in which the security futures intermediary participates, any interest
of the security futures intermediary in the joint account in excess of
the interest which the security futures intermediary would have on the
basis of its right to share in the profits shall be margined in
accordance with this Regulation (Subpart E, Secs. 41.42 through 41.49).
(e) Extensions of credit. (1) No security futures intermediary may
extend or maintain credit to or for any customer for the purpose of
evading or circumventing any requirement under this Regulation (Subpart
E, Secs. 41.42 through 41.49).
(2) A security futures intermediary may arrange for the extension
or maintenance of credit to or for any customer by any person, provided
that the security futures intermediary does not willfully arrange
credit that would constitute a violation of Regulation T, U or X of the
Board of Governors of the Federal Reserve System (12 CFR parts 220,
221, and 224) by such person.
(f) Change in exempted person status. Once a person ceases to
qualify as an exempted person, it shall notify the security futures
intermediary of this fact before entering into any new security futures
transaction or related transaction that would require additional margin
to be deposited under this Regulation (Subpart E, Secs. 41.42 through
41.49). Financial relations with respect to any such transactions shall
be subject to the provisions of this Regulation (Subpart E, Secs. 41.42
through 41.49).
Sec. 41.45 Required margin.
(a) Applicability. Each security futures intermediary shall
determine the required margin for the security futures and related
positions held on behalf of a customer in a securities account or
futures account as set forth in this section.
(b) Required margin.--(1) General rule. 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.
(2) Offsetting positions. Notwithstanding the margin levels
specified in paragraph (b)(1) of this section, a self-regulatory
authority may set the required initial or maintenance margin level for
an offsetting position involving security futures and related positions
at a level lower than the level that would be required under paragraph
(b)(1) of this section if such positions were margined separately,
pursuant to rules that meet the criteria set forth in section
7(c)(2)(B) of the Exchange Act and are effective in accordance with
section 19(b)(2) of the Exchange Act and, as applicable, section 5c(c)
of the Act.
(c) Procedures for certain margin level adjustments. An exchange
registered under section 6(g) of the Exchange Act, or a national
securities association registered under section 15A(k) of the Exchange
Act, may raise or lower the required margin level for a security future
to a level not lower than that specified in this section, in accordance
with section 19(b)(7) of the Exchange Act.
Sec. 41.46 Type, form and use of margin.
(a) When margin is required. Margin is required to be deposited
whenever the required margin for security futures and related positions
in an account is not satisfied by the equity in the account, subject to
adjustment under paragraph (c) of this section.
(b) Acceptable margin deposits. (1) The required margin may be
satisfied by a deposit of cash, margin securities (subject to paragraph
(b)(2) of this section), exempted securities, any other asset permitted
under Regulation T to satisfy a margin deficiency in a securities
margin account, or any combination thereof, each as valued in
accordance with paragraph (c) of this section.
(2) Shares of a money market mutual fund may be accepted as a
margin deposit for purposes of this Regulation (Subpart E, Secs. 41.42
through 41.49), Provided that:
(i) The customer waives any right to redeem the shares without the
consent of the security futures intermediary and instructs the fund or
its transfer agent accordingly;
(ii) The security futures intermediary (or clearing agency or
derivatives clearing organization with which the shares are deposited
as margin) obtains the right to redeem the shares in cash, promptly
upon request; and
(iii) The fund agrees to satisfy any conditions necessary or
appropriate to ensure that the shares may be redeemed in cash, promptly
upon request.
(c) Adjustments.-- (1) Futures accounts. For purposes of this
section, the equity in a futures account shall be computed in
accordance with the margin rules applicable to the account, subject to
the following:
(i) A security future shall have no value;
(ii) Each net long or short position in a listed option on a
contract for future delivery shall be valued in accordance with the
margin rules applicable to the account;
(iii) Except as permitted in paragraph (e) of this section, each
margin equity security shall be valued at an amount no greater than its
Regulation T collateral value;
(iv) Each other security shall be valued at an amount no greater
than its current market value reduced by the percentage specified for
such security in Sec. 240.15c3-1(c)(2)(vi) of this title;
(v) Freely convertible foreign currency may be valued at an amount
no greater than its daily marked-to-market U.S. dollar equivalent;
(vi) Variation settlement receivable (or payable) by an account at
the close of trading on any day shall be treated as a credit (or debit)
to the account on that day; and
(vii) Each other acceptable margin deposit or component of equity
shall be valued at an amount no greater than its value under Regulation
T.
(2) Securities accounts. For purposes of this section, the equity
in a securities account shall be computed in accordance with the margin
rules
[[Page 53175]]
applicable to the account, subject to the following:
(i) A security future shall have no value;
(ii) Freely convertible foreign currency may be valued at an amount
no greater than its daily mark-to-market U.S. dollar equivalent; and
(iii) Variation settlement receivable (or payable) by an account at
the close of trading on any day shall be treated as a credit (or debit)
to the account on that day.
(d) Satisfaction restriction. Any transaction, position or deposit
that is used to satisfy the required margin for security futures or
related positions under this Regulation (Subpart E, Secs. 41.42 through
41.49), including a related position, shall be unavailable to satisfy
the required margin for any other position or transaction or any other
requirement.
(e) Alternative collateral valuation for margin equity securities
in a futures account.
(1) Notwithstanding paragraph (c)(1)(iii) of this section, a
security futures intermediary need not value a margin equity security
at its Regulation T collateral value when determining whether the
required margin for the security futures and related positions in a
futures account is satisfied, provided that:
(i) The margin equity security is valued at an amount no greater
than the current market value of the security reduced by the lowest
percentage level of margin required for a long position in the security
held in a margin account under the rules of a national securities
exchange registered pursuant to section 6(a) of the Exchange Act;
(ii) Additional margin is required to be deposited on any day when
the day's security futures transactions and related transactions would
create or increase a margin deficiency in the account if the margin
equity securities were valued at their Regulation T collateral value,
and shall be for the amount of the margin deficiency so created or
increased (a "special margin requirement"); and
(iii) Cash, securities, or other assets deposited as margin for the
positions in an account are not permitted to be withdrawn from the
account at any time that:
(A) Additional cash, securities, or other assets are required to be
deposited as margin under this section for a transaction in the account
on the same or a previous day; or
(B) The withdrawal, together with other transactions, deposits, and
withdrawals on the same day, would create or increase a margin
deficiency if the margin equity securities were valued at their
Regulation T collateral value.
(2) All security futures transactions and related transactions on
any day shall be combined to determine the amount of a special margin
requirement. Additional margin deposited to satisfy a special margin
requirement shall be valued at an amount no greater than its Regulation
T collateral value.
(3) If the alternative collateral valuation method set forth in
paragraph (e) of this section is used with respect to an account in
which security futures or related positions are carried:
(i) An account that is transferred from one security futures
intermediary to another may be treated as if it had been maintained by
the transferee from the date of its origin, if the transferee accepts,
in good faith, a signed statement of the transferor (or, if that is not
practicable, of the customer), that any margin call issued under this
Regulation (Subpart E, Secs. 41.42 through 41.49) has been satisfied;
and
(ii) An account that is transferred from one customer to another as
part of a transaction, not undertaken to avoid the requirements of this
Regulation (Subpart E, Secs. 41.42 through 41.49), may be treated as if
it had been maintained for the transferee from the date of its origin,
if the security futures intermediary accepts in good faith and keeps
with the transferee account a signed statement of the transferor
describing the circumstances for the transfer.
(f) Guarantee of accounts. No guarantee of a customer's account
shall be given any effect for purposes of determining whether the
required margin in an account is satisfied, except as permitted under
applicable margin rules.
Sec. 41.47 Withdrawal of margin.
(a) By the customer. Except as otherwise provided in
Sec. 41.46(e)(1)(ii) of this subpart, cash, securities, or other assets
deposited as margin for positions in an account may be withdrawn,
provided that the equity in the account after such withdrawal is
sufficient to satisfy the required margin for the security futures and
related positions in the account under this Regulation (Subpart E,
Secs. 41.42 through 41.49).
(b) By the security futures intermediary. Notwithstanding paragraph
(a) of this section, the security futures intermediary, in its usual
practice, may deduct the following items from an account in which
security futures or related positions are held if they are considered
in computing the balance of such account:
(1) Variation settlement payable, directly or indirectly, to a
clearing agency that is registered under section 17A of the Exchange
Act or a derivatives clearing organization that is registered under
section 5b of the Act;
(2) Interest charged on credit maintained in the account;
(3) Communication or shipping charges with respect to transactions
in the account;
(4) Payment of commissions, brokerage, taxes, storage and other
charges lawfully accruing in connection with the positions and
transactions in the account;
(5) Any service charges that the security futures intermediary may
impose; or
(6) Any other withdrawals that are permitted from a securities
margin account under Regulation T, to the extent permitted under
applicable margin rules.
Sec. 41.48 Undermargined accounts.
(a) Failure to satisfy margin call. If any margin call required by
this Regulation (Subpart E, Secs. 41.42 through 41.49) is not met in
full, the security futures intermediary shall take the deduction
required with respect to an undermargined account in computing its net
capital under SEC or Commission rules.
(b) Accounts that liquidate to a deficit. If at any time there is a
liquidating deficit in an account in which security futures are held,
the security futures intermediary shall take steps to liquidate
positions in the account promptly and in an orderly manner.
(c) Liquidation of undermargined accounts not required.
Notwithstanding Sec. 41.44(a)(1) of this subpart, Sec. 220.4(d) of
Regulation T (12 CFR 220.4(d)) respecting liquidation of positions in
lieu of deposit shall not apply with respect to security futures
carried in a securities account.
Sec. 41.49 Filing proposed margin rule changes with the Commission.
(a) Notification requirement for notice-designated contract
markets. Any self-regulatory authority that is registered with the
Commission as a designated contract market under section 5f of the Act
shall, when filing a proposed rule change regarding customer margin for
security futures with the SEC for approval in accordance with section
19(b)(2) of the Exchange Act, concurrently provide to the Commission a
copy of such proposed rule change and any accompanying documentation
filed with the SEC.
(b) Filing requirements under the Act. Any self-regulatory
authority that is
[[Page 53176]]
registered with the Commission as a designated contract market under
section 5 of the Act or a derivatives transaction execution facility
under section 5a of the Act shall, when filing a proposed rule change
regarding customer margin for security futures with the SEC for
approval in accordance with section 19(b)(2) of the Exchange Act,
submit such proposed rule change to the Commission as follows:
(1) If the self-regulatory authority elects to request the
Commission's prior approval for the proposed rule change pursuant to
section 5c(c)(2) of the Act, it shall concurrently file the proposed
rule change with the Commission in accordance with Sec. 40.5 of this
chapter.
(2) If the self-regulatory authority elects to implement a proposed
rule change by written certification pursuant to section 5c(c)(1) of
the Act, it shall concurrently provide to the Commission a copy of the
proposed rule change and any accompanying documentation filed with the
SEC. Promptly after obtaining SEC approval for the proposed rule
change, such self-regulatory authority shall file its written
certification with the Commission in accordance with Sec. 40.6 of this
chapter.
Dated: July 31, 2002.
By the Commodity Futures Trading Commission.
Catherine D. Dixon,
Assistant Secretary.
Securities and Exchange Commission
17 CFR Chapter II
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 AND ATS
1. The authority citation for part 242 is revised 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, 78mm, 78n, 78o(b), 78o(c), 78o(g),
78q(a), 78q(b), 78q(h), 78w(a), 78dd-1, 80a-23, 80a-29, and 80a-37.
2. Part 242 is amended by adding the undesignated center heading
"Regulation M" before Sec. 242.100.
3. An undesignated center heading and Secs. 242.400 through 242.406
are added to read as follows:
Customer Margin Requirements for Security Futures
Sec.
242.400 Customer margin requirements for security futures--
authority, purpose, interpretation, and scope.
242.401 Definitions.
242.402 General provisions.
242.403 Required margin.
242.404 Type, form and use of margin.
242.405 Withdrawal of margin.
242.406 Undermargined accounts.
Customer Margin Requirements for Security Futures
Sec. 242.400 Customer margin requirements for security futures--
authority, purpose, interpretation, and scope.
(a) Authority and purpose. Sections 242.400 through 242.406 and 17
CFR 41.42 through 41.49 ("this Regulation, Secs. 242.400 through
242.406") are issued by the Securities and Exchange Commission
("Commission") jointly with the Commodity Futures Trading Commission
("CFTC"), pursuant to authority delegated by the Board of Governors
of the Federal Reserve System under section 7(c)(2)(A) of the
Securities Exchange Act of 1934 ("Act") (15 U.S.C. 78g(c)(2)(A)). The
principal purpose of this Regulation (Secs. 242.400 through 242.406) is
to regulate customer margin collected by brokers, dealers, and members
of national securities exchanges, including futures commission
merchants required to register as brokers or dealers under section
15(b)(11) of the Act (15 U.S.C. 78o(b)(11)), relating to security
futures.
(b) Interpretation. This Regulation (Secs. 242.400 through 242.406)
shall be jointly interpreted by the Commission and the CFTC, consistent
with the criteria set forth in clauses (i) through (iv) of section
7(c)(2)(B) of the Act (15 U.S.C. 78g(c)(2)(B)) and the provisions of
Regulation T (12 CFR part 220).
(c) Scope. (1) This Regulation (Secs. 242.400 through 242.406) does
not preclude a self-regulatory authority, under rules that are
effective in accordance with section 19(b)(2) of the Act (15 U.S.C.
78s(b)(2)) or section 19(b)(7) of the Act (15 U.S.C. 78s(b)(7)) and, as
applicable, section 5c(c) of the Commodity Exchange Act ("CEA") (7
U.S.C. 7a-2(c)), or a security futures intermediary from imposing
additional margin requirements on security futures, including higher
initial or maintenance margin levels, consistent with this Regulation
(Secs. 242.400 through 242.406), or from taking appropriate action to
preserve its financial integrity.
(2) This Regulation (Secs. 242.400 through 242.406) does not apply
to:
(i) 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 criteria set forth in section
7(c)(2)(B) of the Act (15 U.S.C. 78g(c)(2)(B)) and that are effective
in accordance with section 19(b)(2) of the Act (15 U.S.C. 78s(b)(2))
and, as applicable, section 5c(c) of the CEA (7 U.S.C. 7a-2(c));
(ii) Financial relations between a security futures intermediary
and a foreign person involving security futures traded on or subject to
the rules of a foreign board of trade;
(iii) Margin requirements that clearing agencies registered under
section 17A of the Exchange Act (15 U.S.C. 78q-1) or derivatives
clearing organizations registered under section 5b of the CEA (7 U.S.C.
7a-1) impose on their members;
(iv) Financial relations between a security futures intermediary
and a person based on a good faith determination by the security
futures intermediary that such person is an exempted person; and
(v) Financial relations between a security futures intermediary
and, or arranged by a security futures intermediary for, a person
relating to trading in security futures by such person for its own
account, if such person:
(A) Is a member of a national securities exchange or national
securities association registered pursuant to section 15A(a) of the Act
(15 U.S.C. 78o-3(a)); and
(B) Is registered with such exchange or such association as a
security futures dealer pursuant to rules that are effective in
accordance with section 19(b)(2) of the Act (15 U.S.C. 78s(b)(2)) and,
as applicable, section 5c(c) of the CEA (7 U.S.C. 7a-2(c)), that:
(1) Require such member to be registered as a floor trader or a
floor broker with the CFTC under Section 4f(a)(1) of the CEA (7 U.S.C.
6f(a)(1)), or as a dealer with the Commission under section 15(b) of
the Act (15 U.S.C. 78o(b));
(2) Require such member to maintain records sufficient to prove
compliance with this paragraph (c)(2)(v) and the rules of the exchange
or association of which it is a member;
(3) Require such member to hold itself out as being willing to buy
and sell security futures for its own account on a regular or
continuous basis; and
(4) Provide for disciplinary action, including revocation of such
member's registration as a security futures dealer, for such member's
failure to comply with this Regulation (Secs. 242.400 through 242.406)
or the rules of the exchange or association.
(d) Exemption. The Commission may exempt, either unconditionally or
on specified terms and conditions, financial relations involving any
security futures intermediary, customer, position, or transaction, or
any class of
[[Page 53177]]
security futures intermediaries, customers, positions, or transactions,
from one or more requirements of this Regulation (Secs. 242.400 through
242.406), if the Commission determines that such exemption is necessary
or appropriate in the public interest and consistent with the
protection of investors. An exemption granted pursuant to this
paragraph shall not operate as an exemption from any CFTC rules. Any
exemption that may be required from such rules must be obtained
separately from the CFTC.
Sec. 242.401 Definitions.
(a) For purposes of this Regulation (Secs. 242.400 through 242.406)
only, the following terms shall have the meanings set forth in this
section.
(1) Applicable margin rules and margin rules applicable to an
account mean the rules and regulations applicable to financial
relations between a security futures intermediary and a customer with
respect to security futures and related positions carried in a
securities account or futures account as provided in Sec. 242.402(a) of
this Regulation (Secs. 242.400 through 242.406).
(2) Broker shall have the meaning provided in section 3(a)(4) of
the Act (15 U.S.C. 78c(a)(4)).
(3) Contract multiplier means the number of units of a narrow-based
security index expressed as a dollar amount, in accordance with the
terms of the security future contract.
(4) Current market value means, on any day:
(i) With respect to a security future:
(A) If the instrument underlying such security future is a stock,
theproduct of the daily settlement price of such security future as
shown by any regularly published reporting or quotation service, and
the applicable number of shares per contract; or
(B) If the instrument underlying such security future is a narrow-
based security index, as defined in section 3(a)(55)(B) of the Act (15
U.S.C. 78c(a)(55)(B)), the product of the daily settlement price of
such security future as shown by any regularly published reporting or
quotation service, and the applicable contract multiplier.
(ii) With respect to a security other than a security future, the
most recent closing sale price of the security, as shown by any
regularly published reporting or quotation service. If there is no
recent closing sale price, the security futures intermediary may use
any reasonable estimate of the market value of the security as of the
most recent close of business.
(5) Customer excludes an exempted person and includes:
(i) Any person or persons acting jointly:
(A) On whose behalf a security futures intermediary effects a
security futures transaction or carries a security futures position; or
(B) Who would be considered a customer of the security futures
intermediary according to the ordinary usage of the trade;
(ii) Any partner in a security futures intermediary that is
organized as a partnership who would be considered a customer of the
security futures intermediary absent the partnership relationship; and
(iii) Any joint venture in which a security futures intermediary
participates and which would be considered a customer of the security
futures intermediary if the security futures intermediary were not a
participant.
(6) Daily settlement price means, with respect to a security
future, the settlement price of such security future determined at the
close of trading each day, under the rules of the applicable exchange,
clearing agency, or derivatives clearing organization.
(7) Dealer shall have the meaning provided in section 3(a)(5) of
the Act (15 U.S.C. 78c(a)(5)).
(8) Equity means the equity or margin equity in a securities or
futures account, as computed in accordance with the margin rules
applicable to the account and subject to adjustment under
Sec. 242.404(c), (d) and (e) of this Regulation (Secs. 242.400 through
242.406).
(9) Exempted person means:
(i) A member of a national securities exchange, a registered broker
or dealer, or a registered futures commission merchant, a substantial
portion of whose business consists of transactions in securities,
commodity futures, or commodity options with persons other than
brokers, dealers, futures commission merchants, floor brokers, or floor
traders, and includes a person who:
(A) Maintains at least 1000 active accounts on an annual basis for
persons other than brokers, dealers, persons associated with a broker
or dealer, futures commission merchants, floor brokers, floor traders,
and persons affiliated with a futures commission merchant, floor
broker, or floor trader that are effecting transactions in securities,
commodity futures, or commodity options;
(B) Earns at least $10 million in gross revenues on an annual basis
from transactions in securities, commodity futures, or commodity
options with persons other than brokers, dealers, persons associated
with a broker or dealer, futures commission merchants, floor brokers,
floor traders, and persons affiliated with a futures commission
merchant, floor broker, or floor trader; or
(C) Earns at least 10 percent of its gross revenues on an annual
basis from transactions in securities, commodity futures, or commodity
options with persons other than brokers, dealers, persons associated
with a broker or dealer, futures commission merchants, floor brokers,
floor traders, and persons affiliated with a futures commission
merchant, floor broker, or floor trader.
(ii) For purposes of paragraph (a)(9)(i) of this section only,
persons affiliated with a futures commission merchant, floor broker, or
floor trader means any partner, officer, director, or branch manager of
such futures commission merchant, floor broker, or floor trader (or any
person occupying a similar status or performing similar functions), any
person directly or indirectly controlling, controlled by, or under
common control with such futures commission merchant, floor broker, or
floor trader, or any employee of such a futures commission merchant,
floor broker, or floor trader.
(iii) A member of a national securities exchange, a registered
broker or dealer, or a registered futures commission merchant that has
been in existence for less than one year may meet the definition of
exempted person based on a six-month period.
(10) Exempted security shall have the meaning provided in section
3(a)(12) of the Act (15 U.S.C. 78c(a)(12)).
(11) Floor broker shall have the meaning provided in Section 1a(16)
of the CEA (7 U.S.C. 1a(16)).
(12) Floor trader shall have the meaning provided in Section 1a(17)
of the CEA (7 U.S.C. 1a(17)).
(13) Futures account shall have the meaning provided in
Sec. 240.15c3-3(a) of this chapter.
(14) Futures commission merchant shall have the meaning provided in
Section 1a of the CEA (7 U.S.C. 1a).
(15) Good faith, with respect to making a determination or
accepting a statement concerning financial relations with a person,
means that the security futures intermediary is alert to the
circumstances surrounding such financial relations, and if in
possession of information that would cause a prudent person not to make
the determination or accept the notice or certification without
inquiry, investigates and is satisfied that it is correct.
[[Page 53178]]
(16) Listed option means a put or call option that is:
(i) Issued by a clearing agency that is registered under section
17A of the Act (15 U.S.C. 17q-1) or cleared and guaranteed by a
derivatives clearing organization that is registered under Section 5b
of the CEA (7 U.S.C. 7a-1); and
(ii) Traded on or subject to the rules of a self-regulatory
authority.
(17) Margin call means a demand by a security futures intermediary
to a customer for a deposit of cash, securities or other assets to
satisfy the required margin for security futures or related positions
or a special margin requirement.
(18) Margin deficiency means the amount by which the required
margin in an account is not satisfied by the equity in the account, as
computed in accordance with Sec. 242.404 of this Regulation
(Secs. 242.400 through 242.406).
(19) Margin equity security shall have the meaning provided in
Regulation T.
(20) Margin security shall have the meaning provided in Regulation
T.
(21) Member shall have the meaning provided in section 3(a)(3) of
the Act (15 U.S.C. 78c(a)(3)), and shall include persons registered
under section 15(b)(11) of the Act (15 U.S.C. 78o(b)(11)) that are
permitted to effect transactions on a national securities exchange
without the services of another person acting as executing broker.
(22) Money market mutual fund means any security issued by an
investment company registered under section 8 of the Investment Company
Act of 1940 (15 U.S.C. 80a-8) that is considered a money market fund
under Sec. 270.2a-7 of this chapter.
(23) Persons associated with a broker or dealer shall have the
meaning provided in section 3(a)(18) of the Act (15 U.S.C. 78c(a)(18)).
(24) Regulation T means Regulation T promulgated by the Board of
Governors of the Federal Reserve System, 12 CFR part 220, as amended
from time to time.
(25) Regulation T collateral value, with respect to a security,
means the current market value of the security reduced by the
percentage of required margin for a position in the security held in a
margin account under Regulation T.
(26) Related position, with respect to a security future, means any
position in an account that is combined with the security future to
create an offsetting position as provided in Sec. 242.403(b)(2) of this
Regulation (Secs. 242.400 through 242.406).
(27) Related transaction, with respect to a position or transaction
in a security future, means:
(i) Any transaction that creates, eliminates, increases or reduces
an offsetting position involving a security future and a related
position, as provided in Sec. 242.403(b)(2) of this Regulation
(Secs. 242.400 through 242.406); or
(ii) Any deposit or withdrawal of margin for the security future or
a related position, except as provided in Sec. 242.405(b) of this
Regulation (Secs. 242.400 through 242.406).
(28) Securities account shall have the meaning provided in
Sec. 240.15c3-3(a) of this chapter.
(29) Security futures intermediary means any creditor as defined in
Regulation T with respect to its financial relations with any person
involving security futures.
(30) Self-regulatory authority means a national securities exchange
registered under section 6 of the Act (15 U.S.C. 78f), a national
securities association registered under section 15A of the Act (15
U.S.C. 78o-3), a contract market registered under Section 5 of the CEA
(7 U.S.C. 7) or Section 5f of the CEA (7 U.S.C. 7b-1), or a derivatives
transaction execution facility registered under Section 5a of the CEA
(7 U.S.C. 7a).
(31) Special margin requirement shall have the meaning provided in
Sec. 242.404(e)(1)(ii) of this Regulation (Secs. 242.400 through
242.406).
(32) Variation settlement means 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 or any other contract that is:
(i) Issued by a clearing agency that is registered under section
17A of the Act (15 U.S.C. 78q-1) or cleared and guaranteed by a
derivatives clearing organization that is registered under Section 5b
of the CEA (7 U.S.C. 7a-1); and
(ii) Traded on or subject to the rules of a self-regulatory
authority.
(b) Terms used in this Regulation (Secs. 242.400 through 242.406)
and not otherwise defined in this section shall have the meaning set
forth in the margin rules applicable to the account.
(c) Terms used in this Regulation (Secs. 242.400 through 242.406)
and not otherwise defined in this section or in the margin rules
applicable to the account shall have the meaning set forth in the Act
and the CEA; if the definitions of a term in the Act and the CEA are
inconsistent as applied in particular circumstances, such term shall
have the meaning set forth in rules, regulations, or interpretations
jointly promulgated by the Commission and the CFTC.
Sec. 242.402 General provisions.
(a) Applicable margin rules. Except to the extent inconsistent with
this Regulation (Secs. 242.400 through 242.406):
(1) A security futures intermediary that carries a security future
on behalf of a customer in a securities account shall record and
conduct all financial relations with respect to such security future
and related positions in accordance with Regulation T and the margin
rules of the self-regulatory authorities of which the security futures
intermediary is a member.
(2) A security futures intermediary that carries a security future
on behalf of a customer in a futures account shall record and conduct
all financial relations with respect to such security future and
related positions in accordance with the margin rules of the self-
regulatory authorities of which the security futures intermediary is a
member.
(b) Separation and consolidation of accounts.
(1) The requirements for security futures and related positions in
one account may not be met by considering items in any other account,
except as permitted or required under paragraph (b)(2) of this section
or applicable margin rules. If withdrawals of cash, securities or other
assets deposited as margin are permitted under this Regulation
(Secs. 242.400 through 242.406), bookkeeping entries shall be made when
such cash, securities, or assets are used for purposes of meeting
requirements in another account.
(2) Notwithstanding paragraph (b)(1) of this section, the security
futures intermediary shall consider all futures accounts in which
security futures and related positions are held that are within the
same regulatory classification or account type and are owned by the
same customer to be a single account for purposes of this Regulation
(Secs. 242.400 through 242.406). The security futures intermediary may
combine such accounts with other futures accounts that are within the
same regulatory classification or account type and are owned by the
same customer for purposes of computing a customer's overall margin
requirement, as permitted or required by applicable margin rules.
(c) Accounts of partners. If a partner of the security futures
intermediary has an account with the security futures intermediary in
which security futures or related positions are held, the
[[Page 53179]]
security futures intermediary shall disregard the partner's financial
relations with the firm (as shown in the partner's capital and ordinary
drawing accounts) in calculating the margin or equity of any such
account.
(d) Contribution to joint venture. If an account in which security
futures or related positions are held is the account of a joint venture
in which the security futures intermediary participates, any interest
of the security futures intermediary in the joint account in excess of
the interest which the security futures intermediary would have on the
basis of its right to share in the profits shall be margined in
accordance with this Regulation (Secs. 242.400 through 242.406).
(e) Extensions of credit. (1) No security futures intermediary may
extend or maintain credit to or for any customer for the purpose of
evading or circumventing any requirement under this Regulation
(Secs. 242.400 through 242.406).
(2) A security futures intermediary may arrange for the extension
or maintenance of credit to or for any customer by any person, provided
that the security futures intermediary does not willfully arrange
credit that would constitute a violation of Regulation T, U or X of the
Board of Governors of the Federal Reserve System (12 CFR parts 220,
221, and 224) by such person.
(f) Change in exempted person status. Once a person ceases to
qualify as an exempted person, it shall notify the security futures
intermediary of this fact before entering into any new security futures
transaction or related transaction that would require additional margin
to be deposited under this Regulation (Secs. 242.400 through 242.406).
Financial relations with respect to any such transactions shall be
subject to the provisions of this Regulation (Secs. 242.400 through
242.406).
Sec. 242.403 Required margin.
(a) Applicability. Each security futures intermediary shall
determine the required margin for the security futures and related
positions held on behalf of a customer in a securities account or
futures account as set forth in this section.
(b) Required margin.--(1) General rule. The required margin for
each long or short position n a security future shall be twenty (20)
percent of the current market value of such security future.
(2) Offsetting positions. Notwithstanding the margin levels
specified in paragraph (b)(1) of this section, a self-regulatory
authority may set the required initial or maintenance margin level for
an offsetting position involving security futures and related positions
at a level lower than the level that would be required under paragraph
(b)(1) of this section if such positions were margined separately,
pursuant to rules that meet the criteria set forth in section
7(c)(2)(B) of the Act (15 U.S.C. 78g(c)(2)(B)) and are effective in
accordance with section 19(b)(2) of the Act (15 U.S.C. 78s(b)(2)) and,
as applicable, Section 5c(c) of the CEA (7 U.S.C. 7a-2(c)).
(c) Procedures for certain margin level adjustments. An exchange
registered under section 6(g) of the Act (15 U.S.C. 78f(g)), or a
national securities association registered under section 15A(k) of the
Act (15 U.S.C. 78o-3(k)), may raise or lower the required margin level
for a security future to a level not lower than that specified in this
section, in accordance with section 19(b)(7) of the Act (15 U.S.C.
78s(b)(7)).
Sec. 242.404 Type, form and use of margin.
(a) When margin is required. Margin is required to be deposited
whenever the required margin for security futures and related positions
in an account is not satisfied by the equity in the account, subject to
adjustment under paragraph (c) of this section.
(b) Acceptable margin deposits. (1) The required margin may be
satisfied by a deposit of cash, margin securities (subject to paragraph
(b)(2) of this section), exempted securities, any other asset permitted
under Regulation T to satisfy a margin deficiency in a securities
margin account, or any combination thereof, each as valued in
accordance with paragraph (c) of this section.
(2) Shares of a money market mutual fund may be accepted as a
margin deposit for purposes of this Regulation (Secs. 242.400 through
242.406), provided that:
(i) The customer waives any right to redeem the shares without the
consent of the security futures intermediary and instructs the fund or
its transfer agent accordingly;
(ii) The security futures intermediary (or clearing agency or
derivatives clearing organization with which the shares are deposited
as margin) obtains the right to redeem the shares in cash, promptly
upon request; and
(iii) The fund agrees to satisfy any conditions necessary or
appropriate to ensure that the shares may be redeemed in cash, promptly
upon request.
(c) Adjustments.
(1) Futures accounts. For purposes of this section, the equity in a
futures account shall be computed in accordance with the margin rules
applicable to the account, subject to the following:
(i) A security future shall have no value;
(ii) Each net long or short position in a listed option on a
contract for future delivery shall be valued in accordance with the
margin rules applicable to the account;
(iii) Except as permitted in paragraph (e) of this section, each
margin equity security shall be valued at an amount no greater than its
Regulation T collateral value;
(iv) Each other security shall be valued at an amount no greater
than its current market value reduced by the percentage specified for
such security in Sec. 240.15c3-1(c)(2)(vi) of this chapter;
(v) Freely convertible foreign currency may be valued at an amount
no greater than its daily marked-to-market U.S. dollar equivalent;
(vi) Variation settlement receivable (or payable) by an account at
the close of trading on any day shall be treated as a credit (or debit)
to the account on that day; and
(vii) Each other acceptable margin deposit or component of equity
shall be valued at an amount no greater than its value under Regulation
T.
(2) Securities accounts. For purposes of this section, the equity
in a securities account shall be computed in accordance with the margin
rules applicable to the account, subject to the following:
(i) A security future shall have no value;
(ii) Freely convertible foreign currency may be valued at an amount
no greater than its daily mark-to-market U.S. dollar equivalent; and
(iii) Variation settlement receivable (or payable) to an account at
the close of trading on any day shall be treated as a credit (or debit)
by the account on that day.
(d) Satisfaction restriction. Any transaction, position or deposit
that is used to satisfy the required margin for security futures or
related positions under this Regulation (Secs. 242.400 through
242.406), including a related position, shall be unavailable to satisfy
the required margin for any other position or transaction or any other
requirement.
(e) Alternative collateral valuation for margin equity securities
in a futures account.
(1) Notwithstanding paragraph (c)(1)(iii) of this section, a
security futures intermediary need not value a margin equity security
at its Regulation T collateral value when determining whether the
required margin for the security futures and related positions in
[[Page 53180]]
a futures account is satisfied, provided that:
(i) The margin equity security is valued at an amount no greater
than the current market value of the security reduced by the lowest
percentage level of margin required for a long position in the security
held in a margin account under the rules of a national securities
exchange registered pursuant to section 6(a) of the Act (15 U.S.C.
78f(a));
(ii) Additional margin is required to be deposited on any day when
the day's security futures transactions and related transactions would
create or increase a margin deficiency in the account if the margin
equity securities were valued at their Regulation T collateral value,
and shall be for the amount of the margin deficiency so created or
increased (a "special margin requirement"); and
(iii) Cash, securities, or other assets deposited as margin for the
positions in an account are not permitted to be withdrawn from the
account at any time that:
(A) Additional cash, securities, or other assets are required to be
deposited as margin under this section for a transaction in the account
on the same or a previous day; or
(B) The withdrawal, together with other transactions, deposits, and
withdrawals on the same day, would create or increase a margin
deficiency if the margin equity securities were valued at their
Regulation T collateral value.
(2) All security futures transactions and related transactions on
any day shall be combined to determine the amount of a special margin
requirement. Additional margin deposited to satisfy a special margin
requirement shall be valued at an amount no greater than its Regulation
T collateral value.
(3) If the alternative collateral valuation method set forth in
paragraph (e) of this section is used with respect to an account in
which security futures or related positions are carried:
(i) An account that is transferred from one security futures
intermediary to another may be treated as if it had been maintained by
the transferee from the date of its origin, if the transferee accepts,
in good faith, a signed statement of the transferor (or, if that is not
practicable, of the customer), that any margin call issued under this
Regulation (Secs. 242.400 through 242.406) has been satisfied; and
(ii) An account that is transferred from one customer to another as
part of a transaction, not undertaken to avoid the requirements of this
Regulation (Secs. 242.400 through 242.406), may be treated as if it had
been maintained for the transferee from the date of its origin, if the
security futures intermediary accepts in good faith and keeps with the
transferee account a signed statement of the transferor describing the
circumstances for the transfer.
(f) Guarantee of accounts. No guarantee of a customer's account
shall be given any effect for purposes of determining whether the
required margin in an account is satisfied, except as permitted under
applicable margin rules.
Sec. 242.405 Withdrawal of margin.
(a) By the customer. Except as otherwise provided in
Sec. 242.404(e)(1)(ii) of this Regulation (Secs. 242.400 through
242.406), cash, securities, or other assets deposited as margin for
positions in an account may be withdrawn, provided that the equity in
the account after such withdrawal is sufficient to satisfy the required
margin for the security futures and related positions in the account
under this Regulation (Secs. 242.400 through 242.406).
(b) By the security futures intermediary. Notwithstanding paragraph
(a) of this section, the security futures intermediary, in its usual
practice, may deduct the following items from an account in which
security futures or related positions are held if they are considered
in computing the balance of such account:
(1) Variation settlement payable, directly or indirectly, to a
clearing agency that is registered under section 17A of the Act (15
U.S.C. 78q-1) or a derivatives clearing organization that is registered
under section 5b of the CEA (7 U.S.C. 7a-1);
(2) Interest charged on credit maintained in the account;
(3) Communication or shipping charges with respect to transactions
in the account;
(4) Payment of commissions, brokerage, taxes, storage and other
charges lawfully accruing in connection with the positions and
transactions in the account;
(5) Any service charges that the security futures intermediary may
impose; or
(6) Any other withdrawals that are permitted from a securities
margin account under Regulation T, to the extent permitted under
applicable margin rules.
Sec. 242.406 Undermargined accounts.
(a) Failure to satisfy margin call. If any margin call required by
this Regulation (Secs. 242.400 through 242.406) is not met in full, the
security futures intermediary shall take the deduction required with
respect to an undermargined account in computing its net capital under
Commission or CFTC rules.
(b) Accounts that liquidate to a deficit. If at any time there is a
liquidating deficit in an account in which security futures are held,
the security futures intermediary shall take steps to liquidate
positions in the account promptly and in an orderly manner.
(c) Liquidation of undermargined accounts not required.
Notwithstanding Section 402(a) of this Regulation (Secs. 242.400
through 242.406), section 220.4(d) of Regulation T (12 CFR 220.4(d))
respecting liquidation of positions in lieu of deposit shall not apply
with respect to security futures carried in a securities account.
Dated: August 1, 2002.
By the Securities and Exchange Commission.
Margaret H. McFarland,
Deputy Secretary.
[FR Doc. 02-19892 Filed 8-13-02; 8:45 am]
BILLING CODE 6351-01-P; 8010-01-P