[Federal Register: October 4, 2001 (Volume 66, Number 193)]
[Proposed Rules]
[Page 50719-50741]
From the Federal Register Online via GPO Access [wais.access.gpo.gov]
[DOCID:fr04oc01-21]
[[Page 50719]]
-----------------------------------------------------------------------
Part III
Commodity Futures Trading Commission
Securities and Exchange Commission
-----------------------------------------------------------------------
17 CFR Part 41
17 CFR Part 242
Customer Margin Rules Relating to Security Futures; Proposed Rules
[[Page 50720]]
COMMODITY FUTURES TRADING COMMISSION
17 CFR Part 41
RIN 3038-AB71
SECURITIES AND EXCHANGE COMMISSION
17 CFR Part 242
[Release No. 34-44853; File No. S7-16-01]
RIN 3235-A122
Customer Margin Rules Relating to Security Futures
AGENCIES: Commodity Futures Trading Commission and Securities and
Exchange Commission.
ACTION: Joint proposed rules.
-----------------------------------------------------------------------
SUMMARY: The Commodity Futures Trading Commission ("CFTC") and the
Securities and Exchange Commission ("SEC") (collectively,
"Commissions") are proposing rules that would establish margin
requirements for security futures. The proposed rules would 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.
DATES: Comments must be received on or before November 5, 2001.
ADDRESSES: Comments should be sent to both agencies at the addresses
listed below.
CFTC: Comments should be sent to the Commodity Futures Trading
Commission, Three Lafayette Centre, 1155 21st Street, NW, Washington,
DC 20581, Attention: Office of the Secretariat. Comments may be sent by
facsimile transmission to (202) 418-5521, or by e-mail to
[email protected]. Reference should be made to "Customer Margin for
Security Futures." All comment letters will be posted, as submitted,
on the CFTC's Internet web site (http://www.cftc.gov).
SEC: Persons wishing to submit written comments should send three
copies to Jonathan G. Katz, Secretary, Securities and Exchange
Commission, 450 Fifth Street, NW, Washington, DC 20549-0609. Comments
also may be submitted electronically at the following e-mail address:
[email protected]. All comment letters should refer to File No. S7-
16-01; this file number should be included on the subject line if e-
mail is used. Comment letters received will be available for public
inspection and copying in the SEC's Public Reference Room, 450 Fifth
Street, NW., Washington, DC 20549-0102. Electronically submitted
comment letters will be posted on the SEC's Internet web site (http://www.sec.gov). The SEC does not edit personal identifying information,
such as names or e-mail addresses, from electronic submissions. Submit
only the information you wish to make publicly available.
FOR FURTHER INFORMATION CONTACT:
CFTC: Phyllis P. Dietz, Special Counsel; or Michael A. Piracci,
Attorney, Division of Trading and Markets, 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: Hong-anh Tran, Special Counsel, at (202) 942-0088; Jennifer
Colihan, Special Counsel, at (202) 942-0735; Bonnie Gauch, Attorney, at
(202) 942-0765; 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 proposing Rules 41.43 through
41.48, 17 CFR 41.43 through 41.48, and the SEC is proposing Rules 400
through 404, 17 CFR 242.400 through 242.404, under authority delegated
by the Federal Reserve Board pursuant to the Exchange Act.\1\
---------------------------------------------------------------------------
\1\ All references to the Exchange Act are to 15 U.S.C. 78a et
seq.
I. Introduction
II. Description of the Proposed Rules
A. Applicability of Regulation T
B. Who is Covered by the Proposed Rules
C. Exclusions from Coverage
1. Financial Relations between a Customer and a Creditor under a
Portfolio Margining System
2. Financial Relations between a Foreign Branch of a Creditor
and a Foreign Person
3. Margin Requirements Imposed by Clearing Agencies
4. Credit Extended, Maintained or Arranged by a Creditor to or
for a Member of a National Securities Exchange or a Registered
Broker or Dealer
a. Margin Arrangements with an Exempted Borrower
b. Margin Arrangements with a Borrower Otherwise Exempt Pursuant
to Section 7 of the Exchange Act
c. Financial Relations Between a Creditor and Member of a
National Securities Exchange or Association
D. Customer Margin Levels for Security Futures
1. Definition of Current Market Value
2. Twenty Percent of the Current Market Value
3. Margin Offsets
4. Higher Margin Levels
E. Time Limits for Collection of Margin
F. Forms of Collateral
III. SEC and CFTC Rule Review Processes Relating to Margin
Requirements for Security Futures Products
A. CFTC Rule Review Process and Procedures for Notification of
Proposed Rule Changes Related to Margin
B. SEC Rule Review Process
IV. Request for Comments
V. Paperwork Reduction Act
A. CFTC
B. SEC
VI. Costs and Benefits of the Proposed Rules
A. CFTC
B. SEC
1. Costs
a. Compliance with Regulation T
b. Levels of Margin
c. Computation of Margin
d. Notification Requirements Regarding Exempted Borrowers
e. Time Limits for Collection of Margin
2. Benefits
a. Benefits to Brokers, Dealers, and Members of National
Securities Exchanges
b. Benefits to Customers
c. Regulatory Benefits
C. Request for Comments
VII. Consideration of Burden on Competition, Promotion of
Efficiency, and Capital Formation
VIII. Regulatory Flexibility Act Certifications
A. CFTC
B. SEC
IX. Statutory Basis and Text of Proposed Rules
I. Introduction
The Commodity Futures Modernization Act of 2000 ("CFMA"),\2\
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
these newly-permissible products by the CFTC and the SEC.
---------------------------------------------------------------------------
\2\ Appendix E of Pub. L. No. 106-554, 114 Stat. 2763 (2000).
---------------------------------------------------------------------------
To facilitate the issuance of rules governing customer margin for
transactions in security futures products, the CFMA added a new
subsection (2) to Section 7(c) of the Exchange Act \3\ to provide the
Federal Reserve Board with authority to prescribe regulations for
brokers, dealers, and members of national securities exchanges
extending or maintaining credit to or for, or collecting margin from,
customers for security futures products.\4\ Section 7(c)(2) of the
Exchange Act further requires the Federal Reserve Board to prescribe
rules establishing initial and
[[Page 50721]]
maintenance customer margin requirements imposed by brokers, dealers,
and members of national securities exchanges for security futures
products.\5\ Alternatively, the Exchange Act provides that the Federal
Reserve Board may delegate this rulemaking authority jointly to the
Commissions.\6\ The Federal Reserve Board so delegated its authority by
letter dated March 6, 2001.\7\ Accordingly, the Commissions are
proposing initial and maintenance customer margin requirements,
including the levels of margin, for security futures.\8\
---------------------------------------------------------------------------
\3\ 15 U.S.C. 78g(c)(2).
\4\ See 15 U.S.C. 78g(c)(2)(A).
\5\ See 15 U.S.C. 78g(c)(2)(B).
\6\ Id.
\7\ See Letter from Jennifer J. Johnson, Secretary of the Board,
Federal Reserve Board, to Mr. James E. Newsome, Acting Chairman,
CFTC, and Ms. Laura S. Unger, Acting Chairman, SEC, March 6, 2001,
reprinted as Appendix B to this proposal.
\8\ Because Section 6(h)(6) of the Exchange Act provides that
options on security futures may not be traded for at least three
years after the enactment of the CFMA, the Commissions are not
currently proposing margin requirements for options on security
futures. 15 U.S.C. 78f(h)(6).
---------------------------------------------------------------------------
The rules proposed by the Commissions under Section 7(c)(2) of the
Exchange Act must satisfy the following four statutory requirements.
First, the rules must preserve the financial integrity of markets
trading security futures products. Second, they must prevent systemic
risk. Third, the rules must 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;\9\ 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.\10\ Fourth, the rules must 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.\11\
---------------------------------------------------------------------------
\9\ 15 U.S.C. 78f(a).
\10\ The proposed rules recognize that security futures can
compete with, and be an economic substitute for, equity securities,
such as equity options. Specifically, a synthetic futures contract
may be created by two option contracts based on the same underlying
instrument. To create a synthetic long (short) futures contract, an
investor would buy (sell) a call option and sell (buy) a put option
on the same underlying security, with the same expiration date and
strike price.
\11\ 12 CFR 220 et seq. Regulation T governs the initial margin
requirements imposed by brokers, dealers, and members of national
securities exchanges for all securities, other than exempted
securities and security futures products. The rules of self-
regulatory organizations ("SROs") govern, among other things,
maintenance margin requirements. Regulation T, among other things,
establishes the securities that may be purchased on margin, sets the
time frames within which initial margin requirements must be met,
establishes and defines the types of accounts in which broker-
dealers may record securities transactions, including the Margin
Account, Cash Account, Special Memorandum Account ("SMA"), the
Good Faith Account, and the Broker-Dealer Credit Account, and
specifies the maximum loan value (i.e., the maximum amount that may
be loaned) of certain non-exempted equity securities, not including
security futures products, that may be extended by brokers, dealers
or members of national securities exchanges.
---------------------------------------------------------------------------
As jointly proposed by the Commissions, the rules would:
� Establish the minimum initial and maintenance margin
levels required for customers carrying a long or short security futures
position at 20 percent of the "current market value" of such
position.\12\
---------------------------------------------------------------------------
\12\ The Commissions propose to define "current market value"
in Proposed CFTC Rule 41.44(a)(2) and Proposed SEC Rule 401(a)(2),
discussed infra notes 62-67 and accompanying text.
---------------------------------------------------------------------------
� Permit regulatory authority \13\ rules to provide that
customers with strategy-based offset positions involving security
futures and one or more related securities or futures have minimum
initial and maintenance margin levels lower than the aggregate margins
for the components of an offset position, provided that such minimum
margin levels are consistent with the margin requirements for
comparable offset positions involving exchange-traded option contracts.
---------------------------------------------------------------------------
\13\ The term "regulatory authority" means an SRO that is
registered as a national securities exchange under Section 6 of the
Exchange Act (15 U.S.C. 78f) or as a securities association under
Section 15A of the Exchange Act (15 U.S.C. 78o-3). See Proposed CFTC
Rule 41.44(a)(7) and Proposed SEC Rule 401(a)(7).
---------------------------------------------------------------------------
� Provide that the requirements of Regulation T, other than
margin levels, apply to financial relations between a creditor \14\ and
a customer with respect to security futures.
---------------------------------------------------------------------------
\14\ The term "creditor" is used in this release and in the
proposed rules to refer to brokers, dealers, and members of a
national securities exchange that would be subject to the margin
requirements for security futures. The use of this term and other
terms, such as "borrower," is not intended to indicate that there
is an extension of credit involved in the margining of security
futures. Rather, such terms are proposed to be used as a means to
fulfill the statutory requirement that the margin requirements for
security futures are and remain consistent with Regulation T.
Regulation T uses the term "creditor" to refer to brokers, dealers
and members of a national securities exchange that are subject to
Regulation T requirements for customers' securities positions,
including options positions. Margin requirements for short options
positions represent a performance bond, as do the margin
requirements proposed today for security futures.
---------------------------------------------------------------------------
� Establish the time limits for the collection of initial
and maintenance margin from customers; and
� Set forth the acceptable collateral for margining a
security future transaction or position.
II. Description of the Proposed Rules
A. Applicability of Regulation T
Section 7(c)(2)(B)(iv) of the Exchange Act requires that the margin
requirements (other than levels of margin), including the type, form,
and use of collateral for security futures products, are and remain
consistent with the requirements established by the Federal Reserve
Board pursuant to subparagraphs (A) and (B) of Section 7(c)(1) of the
Exchange Act, i.e., Regulation T. \15\
---------------------------------------------------------------------------
\15\ See 15 U.S.C. 78g(c)(2)(B)(iv).
---------------------------------------------------------------------------
In analyzing how to implement the statutory mandate that margin
requirements for security futures products are and remain consistent
with Regulation T, the Commissions have discussed two possible
approaches. The first approach, which is reflected in the proposed
rules, would require that Regulation T apply to financial relations,
including margin arrangements, between a creditor and a customer with
respect to security futures and any related securities or futures
contracts that are used to offset positions in such security futures,
to the extent consistent with the proposed rules. \16\
---------------------------------------------------------------------------
\16\ See Proposed CFTC Rule 41.43(b)(1); Proposed SEC Rule
400(b)(1).
---------------------------------------------------------------------------
This approach would ensure that existing and future Federal Reserve
Board interpretations of Regulation T would apply. This approach is one
way to ensure that margin requirements for security futures would
remain consistent with Regulation T without further action by the
Commissions.
A second approach would be to issue comprehensive "stand-alone"
margin rules that would parallel Regulation T requirements for
securities to the extent that such requirements are relevant to
security futures. 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. The stand-alone rules would not,
however, apply to any other securities or futures transactions.
Regulation T establishes and defines the various types of accounts
where securities subject to Regulation T may be carried and held. These
accounts include the Margin Account, \17\ SMA, \18\ the Good Faith
Account, \19\ the Broker-
[[Page 50722]]
Dealer Credit Account, \20\ and the Cash Account. \21\
---------------------------------------------------------------------------
\17\ 12 CFR 220.4.
\18\ 12 CFR 220.5.
\19\ 12 CFR 220.6.
\20\ 12 CFR 220.7.
\21\ 12 CFR 220.8.
---------------------------------------------------------------------------
More specifically, Regulation T requires all transactions to be
recorded in a Margin Account, unless they are specifically authorized
for inclusion in another account. \22\ For example, margin in excess of
the required margin under Regulation T and certain other items may be
journaled as a credit to the SMA \23\ where the credit would remain
until the customer uses such credit by withdrawing it from the account
or by applying the credit in the SMA as margin on a new securities
transaction. \24\ Certain broker-dealers also may effect or finance
certain transactions for their owners, partners, or shareholders, or
for other broker-dealers in a broker-dealer credit account. \25\
Customers may also trade instruments other than securities, such as
futures contracts and foreign currencies, in a Good Faith Account. \26\
---------------------------------------------------------------------------
\22\ See 12 CFR 220.4(a)(1).
\23\ The following entries represent credits to the SMA balance:
(1) Dividend and interest payments; (2) Regulation T excess (the
amount by which a customer's equity exceeds the initial Regulation T
requirement); (3) deposits not needed to meet Regulation T margin
calls; (4) deposits of securities (other than security futures) that
carry loan value in the margin account; and (5) cash made available
when a liquidation transaction releases funds for withdrawal from
the margin account. See 12 CFR 220.5(b)(1)-(4).
\24\ 12 CFR 220.5(b).
\25\ 12 CFR 220.7.
\26\ 12 CFR 220.6(e).
---------------------------------------------------------------------------
Under the proposed rules, security futures transactions would be
recorded in a Margin Account because the proposed margin level
requirements represent a performance bond to guarantee contract
performance by both the buyer and seller of such contract. Any daily
net gain (or loss) on a security future ("settlement variation")
would be credited to (or debited from) the Margin Account. Broker-
dealers registered with the SEC under Section 15(b)(1) of the Exchange
Act \27\ may journal any margin excess in the SMA.
---------------------------------------------------------------------------
\27\ 15 U.S.C. 78o(b)(1).
---------------------------------------------------------------------------
The Commissions request comment on the extent to which Regulation T
should apply to security futures.
Q 1 The Commissions request commenters' suggestions on alternative
ways to satisfy the statutory requirement 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 of Regulation T. In particular, commenters are asked to
discuss the advantages and disadvantages of issuing a rule that
incorporates Regulation T by reference, as compared to issuing a stand-
alone rule that would include requirements of Regulation T insofar as
they are relevant to security futures. With respect to the stand-alone
alternative, commenters are asked to consider any potential issues
arising from the Federal Reserve Board's on-going authority to amend or
interpret Regulation T and how such a stand-alone rule would ensure
that the margin requirements for security futures held in either a
securities account or a futures account would remain, over time,
consistent with Regulation T. Commenters are asked to explain the
meaning they ascribe to the term "consistent," when discussing means
for satisfying the statutory requirement.
Q 2 The existing customer account structure used by futures
commission merchants ("FCMs") offers one type of customer account
into which all customer property, including cash and other assets, is
deposited. FCMs are not currently subject to Regulation T and,
therefore, do not delineate accounts in accordance with Regulation T.
(a) Would the application of Regulation T account requirements to
FCMs, to the extent they hold customer positions in security futures,
necessitate the restructuring of FCM account systems?
(b) In addition to the Regulation T account structure, what other
requirements of Regulation T would necessitate operational or other
changes for FCMs that are notice-registered broker-dealers?
(c) What are the estimated costs associated with such changes?
Q 3 Can a futures account be considered a Margin Account under
Regulation T? If not, how would an FCM modify its futures accounts to
satisfy Regulation T requirements for Margin Accounts?
Q 4 In order to comply with Regulation T, would FCMs need to
establish Regulation T accounts other than margin accounts? If so, what
would be the costs and operational feasibility of establishing such
accounts?
Q 5 What benefits to FCM customers or others can be expected if an
FCM converts to the Regulation T account structure?
Q 6 What benefits to FCM customers or others can be derived from
application of other provisions of Regulation T?
Q 7 How should the SMA work in the context of security futures?
Q 8 Are there any other requirements under Regulation T that are
inappropriate for security futures?
Q 9 Without applying Regulation T account requirements, could the
existing rules applicable to futures accounts satisfy the statutory
requirement that the margin requirements (other than levels of margin)
including the type, form, use of collateral for security futures are
and remain consistent with Regulation T?
Q 10 How would broker-dealers, including FCMs that are notice-
registered broker-dealers, and members of national securities exchanges
structure customer accounts if Regulation T were not incorporated by
reference into the margin rules for security futures?
Q 11 (a) If the Commissions were to issue stand-alone rules that
were parallel to Regulation T, how would commenters recommend that the
Commissions incorporate the Federal Reserve Board's existing and future
interpretations of Regulation T into such stand-alone rules?
(b) How would stand-alone rules impact the way securities firms
calculate margin requirements for securities other than security
futures?
(c) Is there a risk of inconsistent application of the same rules?
(d) What implications would this approach have for compliance with
such rules?
Q 12 Should the proposed rules incorporate any special
requirements for specific types of transactions or trading activity
(e.g., day trading) that may be imposed under the margin rules of the
SROs?
B. Who Is Covered by the Proposed Rules
The principal purpose of the proposed rules is to regulate customer
margin collected by brokers, dealers, and members of national
securities exchanges related to customers' transactions in security
futures, including the minimum amount of initial and maintenance margin
that must be collected.\28\ The proposal would require a broker,
dealer, or member of a national securities exchange that effects
transactions for a customer involving, or carrying an account for a
customer containing, a security future to collect from such customer
sufficient collateral to satisfy the margin requirements set forth in
Proposed CFTC Rules 41.43 through 41.48, and Proposed SEC Rules 400
through 404.\29\
---------------------------------------------------------------------------
\28\ See Proposed CFTC Rule 41.43(a); Proposed SEC Rule 400(a).
\29\ See Proposed CFTC Rule 41.54(a); Proposed SEC Rule 402(a).
---------------------------------------------------------------------------
FCMs are brokers or dealers under the Exchange Act if they effect
transactions in securities, including security future
[[Page 50723]]
products, and they would therefore be subject to these proposed rules.
Accordingly, such FCMs must register as broker-dealers under Section
15(b) of the Exchange Act. \30\ The CFMA added Section 15(b)(11) to the
Exchange Act, \31\ which permits FCMs to register as broker-dealers by
filing a written notice with the SEC for the limited purpose of trading
security futures products, if certain conditions are met.\32\ In
addition, although certain natural persons that are members of
designated contract markets registered under Section 6(g) of the
Exchange Act\33\ are exempt from the broker-dealer registration
requirements, those persons are members of a national securities
exchange and, as such, would be subject to the proposed rules.\34\
---------------------------------------------------------------------------
\30\ 15 U.S.C. 78o(b).
\31\ 15 U.s.C. 78o(b)(11).
\32\ See Securities Exchange Act Release No. 44730 (August 21,
2001), 66 FR 45138 (August 27, 2001) (SEC Release adopting
amendments to its broker-dealer registration requirements for
notice-registered broker-dealers and adopting Form BD-N).
\33\ 15 U.S.C. 78f(g).
\34\ See Proposed CFTC Rule 41.45; Proposed SEC Rule 402(a).
---------------------------------------------------------------------------
The rules would explicitly exclude certain categories of financial
relations.\35\ The proposed exclusions are described below.
---------------------------------------------------------------------------
\35\ See Proposed CFTC Rule 41.43(b)(3); Proposed SEC rule
400(b)(3). The Commissions note that there may be some factual
circumstances that will satisfy the criteria of more than one
exclusion.
---------------------------------------------------------------------------
C. Exclusions From Coverage
1. Financial Relations Between a Customer and a Creditor under a
Portfolio Margining System
Section 7(c)(2)(B)(iii) of the Exchange Act \36\ provides that the
margin requirements for security futures must be consistent with the
margin requirements for comparable exchange-traded options, and the
initial and maintenance margin levels for a security future may not be
lower than the lowest level of margin, exclusive of premium, required
for any comparable exchange-traded option. Accordingly, risk-sensitive/
portfolio-based margining ("portfolio margining") for security
futures would be permissible to the extent it would be permissible for
comparable exchange-traded options.
---------------------------------------------------------------------------
\36\ 15 U.S.C. 78g(c)(2)(B)(iii).
---------------------------------------------------------------------------
Regulation T by its terms does not apply to financial relations
between a customer and a creditor to the extent that they "comply with
a portfolio margining system under rules approved or amended by the
SEC."\37\ Moreover, Regulation T provides that the required margin for
exchange-traded options shall be the amount or other position specified
by the rules of the registered national securities exchange or
registered national securities association authorized to trade the
option, that have been approved, or amended, by the SEC.\38\
Accordingly, if a portfolio margining system were developed by a
registered national securities exchange or registered securities
association, and approved by the SEC for exchange-traded options, a
comparable portfolio margining system could be developed for security
futures products.
---------------------------------------------------------------------------
\37\ 12 CFR 220.1(b)(3)(i).
\38\ 12 CFR 220.12(f)(1).
---------------------------------------------------------------------------
The proposed rules \39\ similarly do not apply to financial
relations between a customer and a creditor to the extent that they
comply with a portfolio margining system under rules that have become
effective in accordance with Section 19(b)(2) of the Exchange Act and,
as applicable, Section 5c(c) of the CEA.\40\
---------------------------------------------------------------------------
\39\ See Proposed CFTC Rule 41.43(b)(3)(i); Proposed SEC rule
400(b)(3)(i).
\40\ 15 U.S.C. 78s(b)(2); 7 U.S.C. 7a-2(c). Pursuant to Sections
19(b)(1) and 6(g)(4)(B)(ii) of the Exchange Act (15 U.S.C. 78s(b)(1)
and 15 U.S.C. 78f(g)(4)(B)(ii), respectively), rules implementing
portfolio margining for security futures must be submitted to the
SEC for approval in accordance with Section 19(b)(2) of the Exchange
Act. Designated contract markets registered under Section 5 of the
CEA and registered derivatives transaction execution facilities
("DTFs") also must seek prior approval from the CFTC or provide
notice by written certification to the CFTC, pursuant to Section
5c(c) of the CEA (7 U.S.C. 7a-2(c)). See infra notes 110-140 and
accompanying text.
---------------------------------------------------------------------------
Portfolio margining sets levels of margin by assessing the actual
net market risk of specific market positions in specific 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 contracts on the same underlying instrument).
So that adequate margin is deposited to cover extraordinary market
events, one or more additional multipliers or other adjustments may be
applied in calculating a customer's required margin. Depending upon the
risks attributable to one or more positions, the amount of required
margin may be greater than or less than the margin levels currently
required for securities positions in a fixed-percentage strategy-based
margining system.
The SEC and the CFTC have already approved exchange rules regarding
a number of different portfolio margining systems for various purposes.
The CFTC has approved portfolio margining using the Standard Portfolio
Analysis of Risk ("SPAN") system for all currently traded futures
contracts, at both the clearing level and customer level.\41\ In 1986,
the SEC first approved The Options Clearing Corporation ("The OCC")
portfolio margining system, the Theoretical Intermarket Margin System
("TIMS"), for margin collected by The OCC for the non-equity option
positions of The OCC clearing members.\42\ In 1991, the SEC approved
The OCC's use of TIMS for equity options.\43\ Moreover, the SEC and
CFTC have approved exchange rules that permit portfolio margining for
options market makers in the context of limited cross-margining
programs involving futures and options on broad-based stock
indexes.\44\
---------------------------------------------------------------------------
\41\ The CFTC also has approved SPAN margining for all options
on futures contracts. Developed in 1988, the SPAN margining system
currently is used on more than 30 exchanges and clearing
organizations worldwide, including the London International
Financial Futures Exchange, which trades single stock futures
contracts.
\42\ See Securities Exchange Act Release No. 23167 (April 22,
1986), 51 FR 16127 (April 30, 1986).
\43\ See Securities Exchange Act Release No. 28928 (March 1,
1991), 56 FR 9995 (March 8, 1991).
\44\ 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 ("BTCC") (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);
BTCC (2001); and CME (2001). For further discussion of cross-
margining programs, see "Eighth Annual Report to the Board of
Governors of the Federal Reserve System on the Review of Stock Index
Futures and Option Margining Systems by the Commodity Futures
Trading Commission" (June 2001), note 7 and accompanying text
(available from the CFTC Office of the Secretariat).
---------------------------------------------------------------------------
Currently, the Chicago Board Options Exchange ("CBOE") is working
in cooperation with The OCC, the New York Stock Exchange ("NYSE"),
the American Stock Exchange ("AMEX"), the Chicago Board of Trade
("CBOT"), and the CME to develop a pilot program that would provide
an alternative method of margining (i.e., a portfolio margining system)
for certain customers \45\ in broad-based stock index
[[Page 50724]]
options and futures positions. The staffs of the Commissions are
working with the participating regulatory authorities and their members
to identify the regulatory and operational issues that need to be
resolved to ensure successful implementation by the regulatory
authorities of a portfolio margining system for securities futures
products.\46\ Among other issues, the Commissions would have to be
satisfied that the portfolio margining system used to calculate
customer margin requirements appropriately takes into account the
trading characteristics and historical market performance of the
applicable securities products, as well as the observed correlations
among those products to the extent that offsets across various products
are permitted. The Commissions would also need to be confident that the
system provides a sufficient cushion of margin or capital against
extraordinary price movements.
---------------------------------------------------------------------------
\45\ The pilot program currently being developed by the CBOE,
The OCC, the NYSE, AMEX, CBOT and CME is contemplated to be
available for (1) any registered broker or dealer registered with
the SEC pursuant to Section 15(b)(1) of the Exchange Act; (2) any
affiliate of a self-clearing Exchange Act Section 15(b)(1)
registered broker-dealer; (3) any registered futures floor trader to
the extent that listed index options positions hedge the trader's
index futures and options positions; and (4) any person or entity
that has or, establishes and maintains equity of at least five
million dollars across all securities and futures accounts under
his/her/its common ownership.
\46\ This pilot program would likely take a two-prong approach:
(1) It would adopt a portfolio margining system that sets margin
requirements for portfolios in a securities account consisting of
positions in products based on U.S. domestic broad-based market
indexes, including securities index options, securities index
warrants, and marginable index Unit Investment Trusts ("UITs")
based on the greatest projected net loss of all positions in a
"class group" or "product group" as determined by an options
pricing model covering a specified range of market moves; and (2) it
would adopt a cross-margining system that would apply a portfolio
margining system to portfolios consisting of positions in products
based on U.S. domestic broad-based market indexes, including
securities index options and warrants, UITs, and index futures and
options on index futures. The two prongs of the pilot are severable,
and only the approval of the first prong--a portfolio margining
system--is a precondition for using portfolio margining, rather than
strategy-based margining, for security futures.
Before approving the cross-margining system, the Commissions
would need to ensure that any such accounts are adequately protected
against insolvency risks; in particular, relief from applicable
securities and commodities customer protection regimes is necessary
to facilitate cross-margining.
---------------------------------------------------------------------------
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 also 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.\47\
---------------------------------------------------------------------------
\47\ 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." It further stated that "The
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." See Appendix B.
---------------------------------------------------------------------------
Q 13 Should there be any restrictions on a firm's eligibility to
offer a portfolio margining system to its customers? If so, what types
of restrictions are appropriate?
Q 14 Should there be any restrictions on a customer's eligibility
to use portfolio margining? If so, what types of restrictions are
appropriate?
Q 15 (a) Should a firm be permitted to elect to use either SPAN or
TIMS to calculate security futures margin requirements?
(b) Would the use of SPAN and TIMS result in significantly
different margin requirements for the same account?
(c) Are there other portfolio margining systems that the
Commissions should consider?
Q 16 What costs would be incurred in order for firms to set up and
operate a portfolio margining system? How would the costs of using a
portfolio margining system differ from the costs of using the proposed
strategy-based approach?
2. Financial Relations Between a Foreign Branch of a Creditor and a
Foreign Person
Financial relations between a foreign branch of a creditor and a
foreign person involving foreign securities are excluded from the scope
of Regulation T.\48\ Similarly, Proposed CFTC Rule 41.43(b)(3)(ii) and
Proposed SEC Rule 400(b)(3)(ii) specify that the proposed rules would
not apply to financial relations between a foreign branch of a creditor
and a foreign person involving foreign security futures.\49\ This
exclusion is designed so that financial relations between a foreign
branch of a creditor and a foreign person involving foreign securities
would be treated in a manner consistent with the way Regulation T
treats such financial relations.
---------------------------------------------------------------------------
\48\ 12 CFR 220.1(b)(3)(iv).
\49\ Regulation T defines the term "foreign person" to mean a
person other than a United States person as defiend in Section 7(f)
of the Exchange Act. See 12 CFR 220.2.
---------------------------------------------------------------------------
3. Margin Requirements Imposed by Clearing Agencies
Section 7(c)(2) of the Exchange Act gives the Federal Reserve Board
the authority to prescribe regulations regarding the extension or
maintenance of credit to or for, or the collection of margin from, any
customer on any security futures product,\50\ but it does not confer
authority over margin requirements for clearing agencies. For this
reason, in its delegation letter, the Federal Reserve Board stated 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." \51\ The margin rules of clearing
agencies are approved by the SEC pursuant to Section 19(b)(2) of the
Exchange Act.\52\ The CFTC has authority to ensure compliance with core
principles for clearing organizations under Sections 5b and 5c of the
CEA.\53\
---------------------------------------------------------------------------
\50\ 15 U.S.C. 78g(c)(2).
\51\ See Appendix B.
\52\ 15 U.S.C. 78s(b)(2).
\53\ 7 U.S.C. 7a-1; 7 U.S.C. 7a-2.
---------------------------------------------------------------------------
Proposed CFTC Rule 41.43(b)(3)(iii) and Proposed SEC Rule
400(b)(3)(iii) would exclude from the proposed rules margin
requirements that clearing agencies registered with the SEC or the CFTC
impose on their members. The purpose of the proposed rules would be to
clarify that these margin rules would not apply to clearing agencies
registered with either the SEC or the CFTC.
4. Credit Extended, Maintained or Arranged by a Creditor to or for a
Member of a National Securities Exchange or a Registered Broker or
Dealer
a. Margin Arrangements With an Exempted Borrower
Proposed CFTC Rule 41.43(b)(3)(iv)(A) and Proposed SEC Rule
400(b)(3)(iv)(A) would exclude from the proposed rules' requirements
margin arrangements between a creditor and a borrower with respect to
the borrower's financing of proprietary positions in security futures,
based on the creditor's good faith determination that the borrower is
an "exempted borrower." Regulation T defines an "exempted borrower"
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 percent of its gross revenues on
[[Page 50725]]
an annual basis from transactions with persons other than brokers,
dealers, and persons associated with a broker or dealer.\54\
---------------------------------------------------------------------------
\54\ 12 CFR 220.2.
---------------------------------------------------------------------------
The Regulation T criteria for an "exempted borrower" establish
standards for the applicability of Section 7(c)(3)(A) of the Exchange
Act, which exempts from federal margin rules "credit extended,
maintained, or arranged by a member of a national securities exchange
or a broker or dealer to or for 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." \55\
---------------------------------------------------------------------------
\55\ See 15 U.S.C. 78g(c)(3)(A); see also 12 CFR 220.2.
---------------------------------------------------------------------------
The Commissions propose under CFTC Rule 41.45(e) and SEC Rule
402(e) that once a person ceases to qualify as an exempted borrower
under Regulation T, it would be required to notify the creditor of this
fact before establishing any new security future positions. Under such
circumstances, any new security future positions established by such
person would be subject to the provisions of this proposed regulation.
b. Margin Arrangements With a Borrower Otherwise Exempt Pursuant to
Section 7 of the Exchange Act
Under Section 7(c)(3) of the Exchange Act, the financing of the
market making or underwriting activities of a member of a national
securities exchange or a registered broker or dealer is exempted from
the scope of federal margin regulation.\56\ The Federal Reserve Board
has expressed the view that certain futures floor traders, i.e., those
trading in the current open-outcry environment, act as market makers
and therefore would be exempt under Section 7(c)(3) of the Exchange
Act.\57\ For clarity, the Commissions are proposing to specify under
Proposed CFTC Rule 41.43(b)(3)(iv)(B) and Proposed SEC Rule
400(b)(3)(iv)(B) that credit extended by a broker, dealer or member of
a national securities exchange that is exempt under Section 7(c)(3) of
the Exchange Act \58\ would also be excluded from the proposed rules.
---------------------------------------------------------------------------
\56\ See 15 U.S.C. 78g(c)(3).
\57\ In its March 6, 2001 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]." See
Appendix B.
\58\ 15 U.S.C. 78g(c)(3).
---------------------------------------------------------------------------
c. Financial Relations Between a Creditor and a Member of a National
Securities Exchange or Association
In addition, because the Commissions expect that certain members of
national securities exchanges that use a screen-based trading system
also will act as market makers, the Commissions are proposing to
exclude from the scope of the proposed rules certain floor traders,
floor brokers, and securities dealers who are exchange members and who
have market maker obligations. Accordingly, the Commissions propose
under CFTC Rule 41.43(b)(3)(iv)(C) and SEC Rule 400(b)(3)(iv)(C) to
exclude from the scope of these proposed rules credit extended by a
creditor to a member of a national securities exchange or a national
securities association registered pursuant to Section 15A(a) of the
Exchange Act \59\ that does not directly or indirectly accept or
solicit orders from any customer or provide advice to any customer in
connection with the trading of securities futures and that is
registered with such exchange or association as a security futures
dealer, pursuant to regulatory authority rules approved by the SEC
pursuant to Section 19(b)(2) of the Exchange Act.\60\ To take advantage
of this exemption these regulatory authority rules would have to
require such member: (1) To be registered as a floor trader or floor
broker with the CFTC, or as a dealer with the SEC; (2) to comply with
applicable SEC or CFTC net capital requirements; (3) to maintain
records sufficient to demonstrate compliance with this proposed
exclusion and the rules of the exchange or association; and (4) to hold
itself out as willing to buy and sell security futures for its own
account on a regular or continuous basis.\61\ Finally, the regulatory
authority's rules would have to provide for disciplinary action against
a member for its failure to comply with the Commissions' margin rules
or the rules of the exchange or association.
---------------------------------------------------------------------------
\59\ 15 U.S.C. 78o-3(a).
\60\ 15 U.S.C. 78s(b)(2).
\61\ This provision incorporates the definition of "market
maker" found in Section 3(a)(38) of the Exchange Act (15 U.S.C.
78c(a)(38)), which provides that a market maker is "any specialist
permitted to act as a dealer, any dealer acting in the capacity of
block positioner, and any dealer who, with respect to a security,
holds himself out (by entering quotations in an inter-dealer
communications system or otherwise) as being willing to buy and sell
such security for his own account on a regular or continuous
basis."
---------------------------------------------------------------------------
Q 17 (a) Do the criteria set forth in proposed CFTC Rule
41.43(b)(3)(iv)(C)(2) and proposed SEC Rule 400(b)(3)(iv)(C)(2)
encompass all of the persons that would perform a market maker function
in an electronic market?
(b) Is this provision equitable to both securities exchanges and
futures exchanges trading security futures?
D. Customer Margin Levels for Security Futures
This section describes how the Commissions propose that brokers,
dealers, and national securities exchange members calculate the
customer margin levels for security futures. Specifically, the
Commissions propose 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.
1. Definition of Current Market Value
Currently, the initial and maintenance margin requirements for the
sale of an at-the-money, uncovered put or call option are 100 percent
of the option premium,\62\ plus a fixed percentage of the value of the
underlying financial instrument. The reference price used in
determining the value of the underlying financial instrument when
calculating the initial margin required on the sale of an uncovered
option differs from the reference price used in calculating its
maintenance margin. Specifically, to determine the initial margin
required on the sale of an uncovered put or call option, the price used
to determine the value of the underlying stock is the price at which
the stock closed on the business day preceding the day on which the
option is sold.\63\ To determine the maintenance margin required at the
end of a particular trading day for an uncovered, short put or call
option, the price used is the price at which the underlying stock
closed at the end of such trading day.\64\
---------------------------------------------------------------------------
\62\ The option premium is the net sales proceeds of the option
on the day the option is sold. See Amex Rule 462; CBOE Rule 12.3;
and NYSE Rule 431.
\63\ Id.
\64\ Id.
---------------------------------------------------------------------------
The CFMA requires that the margin requirements for security futures
be consistent with the margin requirements for comparable options
contracts. For this reason, the Commissions are proposing to use a
reference price for determining security futures margin consistent with
the reference price used for determining margin on uncovered short
options positions. Specifically, the Commissions are proposing to
require that the daily settlement price of a security future be used to
calculate both the initial and maintenance margin
[[Page 50726]]
requirements for such security future.\65\ The Commissions believe
that, for purposes of calculating margin requirements for a security
future, using the daily settlement price for such future as the
reference price is consistent with the use of the closing price of the
underlying security used as the reference price for determining margin
for equity options. For these reasons, the Commissions are proposing to
use the daily settlement price of a security future as the reference
price for calculating margin for such security future.
---------------------------------------------------------------------------
\65\ Under Proposed CFTC Rule 41.44(a)(8) and Proposed SEC Rule
401(a)(8), the 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 or clearing organization. This
daily settlement price is used for calculating daily margin
requirements. For physical delivery contracts, the settlement price
on the last trading day may also be used as the invoice price for
delivery of the security. For cash settled contracts, the final
settlement price of a security future is directly based on the
market for the underlying stock or security and may differ from the
daily settlement price on the last trading day. See Securities
Exchange Act Release No. 44743 (August 24, 2001), 66 FR 45904
(August 30, 2001).
---------------------------------------------------------------------------
In addition, the Commissions believe that using the daily
settlement price of a security future on the day of a transaction--
rather than the daily settlement price on the day preceding the
transaction--to calculate the initial margin 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.
Finally, the Commissions propose to define "current market value"
of a future on a single security, on any trading day, to be 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.\66\ The Commissions propose to define
"current market value" of a narrow-based security index future to be
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.\67\ Q 18 Is the proposed method for
calculating current market value of a security future appropriate? If
not, commenters are requested to suggest alternatives.
---------------------------------------------------------------------------
\66\ See Proposed CFTC Rule 41.44(a)(2)(i); Proposed SEC Rule
401(a)(2)(i).
\67\ See Proposed CFTC Rule 41.44(a)(2)(ii); Proposed SEC Rule
401(a)(2)(ii). Under Proposed CFTC Rule 41.44(a)(1) and Proposed SEC
Rule 401(a)(1), the term 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.
---------------------------------------------------------------------------
2. Twenty Percent of the Current Market Value
The Commissions propose that the minimum initial and maintenance
margin levels required of customers for each security future carried in
a long or short position be 20 percent of the current market value of
such security future.\68\ Under Section 7(c)(2) of the Exchange Act,
the initial and maintenance margin levels for a security future must
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.\69\
---------------------------------------------------------------------------
\68\ See Proposed CFTC Rule 41.45(b); Proposed SEC Rule 402(b).
\69\ 15 U.S.C. 78g(c)(2).
---------------------------------------------------------------------------
Currently, all listed options have the same margin requirements.
For long, listed option contracts the purchaser is generally required
to pay the full amount of such contract. The required initial and
maintenance margin for short, at-the-money listed option contracts,
where the underlying instrument is either an equity security (such as a
stock or an instrument immediately convertible into a stock), or a
narrow-based index, are 100 percent of the option proceeds plus 20
percent of the underlying security or index value.\70\
---------------------------------------------------------------------------
\70\ See, e.g., Amex Rule 462; CBOE Rule 12.3; National
Association of Securities Dealers ("NASD") Rule 2520; NYSE Rule
431; PCX Rule 2.16; and Philadelphia Stock Exchange 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. Thus, both the buyer and the seller of a futures
contract must initially post and maintain, on a daily basis, margin to
assure contract performance and the integrity of the marketplace. In
addition, all market participants pay or receive daily settlement
variation payments as a result of all open futures positions being
marked to current market value by the clearing organization.
The Commissions propose that the initial and maintenance margin
levels required of customers for each security future carried in a long
or short position be 20 percent of the current market value of such
security future \71\ because 20 percent is the uniform margin level
required for short, at-the-money equity options traded on U.S. options
exchanges. Any national securities exchange or national securities
association may, of course, impose higher margin level requirements on
its members, and any broker, dealer, or member of a national securities
exchange may impose higher margin level requirements on its
customers.\72\
---------------------------------------------------------------------------
\71\ See Proposed CFTC Rule 41.45(b)(1); Proposed SEC Rule
402(b)(1).
\72\ See Proposed CFTC Rule 45.45(b)(2); Proposed SEC Rule
402(b)(2).
---------------------------------------------------------------------------
As noted elsewhere in this notice, the Federal Reserve Board has
expressed the view that "more risk-sensitive, portfolio-based
approaches to margining security futures products" should be
adopted.\73\ Pending adoption of such systems by regulatory
authorities, however, the 20 percent level is consistent with the
current requirements for comparable equity options.
---------------------------------------------------------------------------
\73\ See Appendix B.
---------------------------------------------------------------------------
3. Margin Offsets
The Commissions also propose to allow national securities exchanges
or national securities associations to have rules that reduce the
margin requirements for customers with certain security or futures
positions that offset their security futures positions, provided that
the resulting margin levels are not lower than the lowest customer
margin levels required for comparable offset positions involving option
contracts traded on any exchange registered pursuant to Section 6(a) of
the Exchange Act.\74\
---------------------------------------------------------------------------
\74\ See Proposed CFTC Rule 41.45(d); Proposed SEC Rule 402(d).
---------------------------------------------------------------------------
Currently, regulatory authority rules approved by the SEC permit
lower maintenance margin requirements for stock positions that are part
of hedging strategies with options positions.\75\ The following hedging
strategies, for example, currently have lower maintenance margin
requirements for the overall combined position than would be the case
if each component position in each of the hedging strategies described
below were margined separately:
---------------------------------------------------------------------------
\75\ 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).
---------------------------------------------------------------------------
(1) Long put option/long stock;
(2) Long call option/short stock;
(3) Long stock/long put option/short call option (where the put and
the call options have the same expiration date and exercise price);
[[Page 50727]]
(4) Short stock/short put option/long call option (where the put
and the call options have the same expiration date and exercise price);
and
(5) Long stock/long put option/short call option (where the put and
the call options have the same expiration date, but the exercise price
of the long put option is lower than the exercise price of the short
call option).\76\
---------------------------------------------------------------------------
\76\ See, e.g., NYSE Rule 431(f)(2)(G). In addition to these
hedging strategies that affect the maintenance margin requirement
for the underlying stock, there are strategies involving covered
calls (long the underlying security and a short call option
position) and covered puts (short the underlying security and a
short put option position) in which there are no initial or
maintenance margin requirements for the option component. There are
also hedging strategies involving option-to-option offsets with
lower initial and maintenance margin requirements.
---------------------------------------------------------------------------
Because, however, the initial margin for equity securities is
governed by Regulation T, the initial margin on the stock components of
hedging strategies remains the same as initial margin for stock that is
not part of a hedging strategy.\77\ Thus, to initially purchase any one
of these combined stock/option(s) positions on margin, a customer must
satisfy the margin requirements individually for each of the securities
that compose the hedging strategy. For example, when entering into a
combined long call option position and a short position in the stock
underlying the call option, a customer must pay for the call option in
full \78\ and satisfy the initial margin requirement for the short
stock position, which is the greater of: (1) The amount specified in
Regulation T; (2) the maintenance margin requirement under SRO rules
for a short stock;\79\ (3) such greater amount as the SRO may from time
to time require for specific securities; or (4) the minimum equity
required to be deposited under the SRO's rules.\80\ However, for the
customer to maintain the same long call option and short stock
position, the customer need only maintain margin in its account equal
to the lesser of: (1) 10 percent of the call option exercise price,
plus 100 percent of any amount by which the call option is out-of-the-
money; and (2) the maintenance margin requirement on the short stock
position.\81\
---------------------------------------------------------------------------
\77\ Regulation T requires that the initial margin for certain
equity securities, other than exempted securities and security
future products, be 50 percent of the current market value of the
security. See 12 CFR 220.12(a).
\78\ See, e.g., NYSE Rule 431(f)(2)(C).
\79\ The maintenance margin for a short stock is calculated as
either: (1) $2.50 per share or 100% of the current market value (as
defined in Regulation T), whichever amount is greater, of each stock
short in the account selling at less than $5.00 per share; or (2)
$5.00 per share or 30% of the current market value (as defined in
Regulation T), whichever amount is greater, of each stock short in
the account selling at $5.00 per share or above. See, e.g., NYSE
Rule 431(c).
\80\ A customer is required to have equity of at least $2,000,
except that cash need not be deposited in excess of the cost of any
security purchased. See, e.g., NYSE Rule 431(b).
\81\ See, e.g., NYSE Rule 431(f)(2)(G)(v).
---------------------------------------------------------------------------
Under this joint proposal, the Commissions propose that customers
be permitted to offset positions involving security futures with
certain related securities or futures. Such offsets would be available
under regulatory authority rules approved by the SEC pursuant to
Section 19(b)(2) of the Exchange Act.\82\
---------------------------------------------------------------------------
\82\ 15 U.S.C. 78s(b)(2). Implementation of such rules by
designated contract markets registered under Section 5 of the CEA (7
U.S.C. 7) and registered DTFs also would be subject to the notice
requirements of Section 5c of the CEA (7 U.S.C. 7a-2). See infra
notes 110-121 and accompanying text.
---------------------------------------------------------------------------
When the SEC approved strategy-based offsets for options (that are
comparable to the offsets proposed to be permitted for security futures
in the chart below), 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.83-88 Furthermore, the SEC 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.
---------------------------------------------------------------------------
\83\-\88\See supra note 75.
---------------------------------------------------------------------------
The following table includes strategy-based offsets for security
futures that the Commissions have preliminarily identified as
consistent with those permitted for comparable offset positions
involving options, and that would qualify for reduced margin levels.
Although the levels are intended to be consistent with the margin
levels for comparable offsets involving options, the Commissions
recognize that the margin levels set forth in the table may not fully
reflect the reduction in risk associated with the offsets.
----------------------------------------------------------------------------------------------------------------
Security
Description of underlying the Initial margin Maintenance margin
offset security future requirement requirement
----------------------------------------------------------------------------------------------------------------
1.............................. Long security Individual stock 20% current market 20% current market
future or short or narrow-based value of the value of the
security future. security index. security future. security future.
2.............................. Long security Individual stock 20% of the current The lower of: (1)
future (or basket or narrow-based market value of 10% of the the
of security security index. the long security aggregate
futures future, plus pay exercise price
representing each for the long put \3\ of the plus
component of a in full. put plus the
narrow-based aggregate put out-
securities index of-the-money \4\
\1\) and long put amount, if any;
option \2\ on the or (2) 20% of the
same underlying current market
security (or value of the long
index). security future.
3.............................. Short security Individual stock 20% of the current 20% of the current
future (or basket or narrow-based market value of market value of
of security security index. the short the short
futures security future, security future,
representing each plus the plus the
component of a aggregate put in- aggregate put in-
narrow-based the-aggregate the-money amount,
securities index) money amount, if if any.\5\
and short put any. Proceeds
option on the from the put sale
same underlying may be applied.
security (or
index).
[[Page 50728]]
4.............................. Long security Individual stock The initial margin 10% of the current
future and short or narrow-based required under market value as
position in the security index. Regulation T for defined in
same security (or the short stock Regulation T of
securities or stocks. the stock or
basket) stocks underlying
underlying the the security
security future. future.
5.............................. Long security Individual stock 20% of the current 20% of the current
future (or basket or narrow-based market value of market value of
of security security index. the long security the long security
futures future, plus the future, plus the
representing each aggregrate call aggregate call in-
component of a in-the-money the-money amount,
narrow-based amount, if any. if any.
securities index) Proceeds from the
and Short call call sale may be
option on the applied.
same underlying
security (or
index).
6.............................. Long a basket of Narrow-based 20% of the current 20% of the current
narrow-based security index. market value of market value of
security futures the long basket the long basket
that together of narrow-based of narrow-based
tracks a broad security futures, security futures,
based index and plus the plus the
short a broad- aggregate call in- aggregate call in-
based security the-money amount, the-money amount,
index call option if any. Proceeds if any.
contract on the from the call may
same index. be applied.
7.............................. Short a basket of Narrow-based 20% of the current 20% of the current
narrow-based security index. market value of market value of
security futures the short basket the short basket
that together of narrow-based of narrow-based
tracks a broad- security futures, security futures,
based security plus the plus the
index and short a aggregate put in- aggregate put in-
broad-based the-money amount, the-money amount,
security index if any. Proceeds if any.
put option from the put sale
contract on the may be applied.
same index.
8.............................. Long a basket of Narrow-based 20% of the current The lower of: (1)
narrow-based security index. market value of of 10% of the
security futures the long basket aggregate
that together of narrow-based exercise price of
tracks a broad- security futures, the put, plus the
based security plus pay for the aggregate put out-
index and long a long put in full. of-the-money
broad-based amount, if any;
security index or (2) 20% of the
put option current market
contract on the value of the long
same index. basket of
security futures.
9.............................. Short a basket of Narrow-based 20% of the current The lower of: (1)
narrow-based security index. market value of 10% of the
security futures the short based aggregate
that together of narrow-based exercise price of
tracks a broad- security futures, the call, plus
based security plus pay for the the aggregate
index and long a long call in full. call out-of-the-
broad-based money amount, if
security index any; or (2) 20%
call option of the current
contract on the market value of
same index. the short basket
of security
futures.
10.............................. Long security Individual stock The greater of: The greater of:
future and short or narrow-based 10% of the 10% of the
security future security index. current market current market
on the same value of the long value of the long
underlying security future; security future;
security (or or (2) 10% of the or (2) 10% of the
index). current market current market
value of the value of the
short security short security
future. future.
11.............................. Long security Individual stock 20% of the current 10% of the
future, long put or narrow-based market value of aggregate
option and short security index. the long security exercise price,
call option. The future, plus the plus the
long security aggregate call in- aggregate call in-
future, long put the-money amount, the-money amount,
and short call if any, plus pay if any.
must be on the for the put in
same underlying full. Proceeds
security and the from the call
put and call must sale may be
have the same applied.
exercise price.
(Conversion).
12............ Long security Individual stock 20% of the current The lower of: (1)
future, long put or narrow-based market value of 10% of the
option and short security index. the long security aggregate
call option. The future, plus the exercise price of
long security aggregate call in- the put plus the
future, long put the-money amount, aggregate put out-
and short call if any, plus pay of-the-money
must be on the for the put in amount, any; or
same underlying full. Proceeds (2) 20% of the
security and the from call sale aggregate
put exercise may be applied. exercise price of
price must be the call, plus
below the call the aggregate
exercise price. call in-the-money
(Collar).......... amount, if any.
[[Page 50729]]
13.............................. Short security Individual stock The initial margin 10% of the current
future and long or narrow-based required under market value, as
position in the security index. Regulation T for defined in
same security (or the long stock or Regulation T, of
securities stocks. the long stock or
basket) stocks.
underlying the
security future
(or long position
in a security
immediately
convertible into
the same security
underlying the
security future,
without
restriction,
including the
payment of money).
14.............................. Short security Individual stock 20% of the current The lower of: (1)
future (or stock or narrow-based market value of 10% of the
or basket of security index. the short aggregate
security futures security future, exercise price of
representing each plus pay for the the call, plus
component of a call in full. the aggregate
narrow-based call out-of-the-
securities index) money amount, if
and long call any; or (2) 20%
option or warrant of the current
on the same market value of
underlying the short
security (or security future.
index).
15.............................. Short security Individual stock 20% of the current 10% of the
future, Short put or narrow-based market value of aggregate
option and long security index. the short exercise price,
call option. The security future, plus the
short security plus the aggregate put in-
future, short put aggregate put in- the-money amount,
and long call the-money amount, if any.
must be on the if any, plus pay
same underlying for the call in
security and the full. Proceeds
put and call must from put sale may
have the same be applied.
exercise price.
(Reverse
Conversion)
16.............................. Long (short) a Narrow-based 20% of the current 10% of the current
basket of security index. market value of market value of
security future, the long (short) the long (short)
each based on a basket of basket of
narrow-based security futures. security futures.
security index
that together
tracks the broad-
based index and
short (long) a
broad based-index
future.
17.............................. Long (short) a Individual stock The greater of: The greater of:
basket of and narrow-based (1) 20% of the (1) 10% of the
security futures security index. current market current market
that together value of the long value of the long
tracks a narrow- security security
based index and future(s); or (2) future(s); or (2)
short (long) a 20% of the 10% of the
narrow based- current market current market
index future. value of the value of the
short security short security
future(s). future(s).
----------------------------------------------------------------------------------------------------------------
\1\ Baskets of securities or security futures contracts must represent exactly the same 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.
\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.
(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.
(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.
[[Page 50730]]
Q 19 (a) Are there offset positions in addition to those
enumerated in the above chart that are consistent with margin
requirements for comparable options, which the Commissions should
consider adding to the list of permissible offsets?
(b) Are there offset positions included in the above chart, which
the Commissions should consider deleting from the list of permissible
offsets?
Q 20 Have the Commissions appropriately taken into account the
overall risk of a position for the specified offset positions?
Q 21 Are the proposed minimum margin levels prudential and
efficient in meeting the objectives of preserving the financial
integrity of security futures markets and preventing systemic risk?
Q 22 Are there other ways of meeting the comparability standard in
setting margin levels for offsetting positions? For example:
(a) Is it necessary to consider a long or short security futures
position to be comparable to a long or short position in an underlying
security for the purpose of determining margin for offset positions
that only involve security futures and options contracts? If not,
commenters are asked for specific recommendations on alternatives.
(b) Does the comparability standard necessitate that initial and
maintenance margin requirements for strategy-based offsets be set at
different levels?
4. Higher Margin Levels
Notwithstanding the proposed minimum initial and maintenance margin
levels specified above, the Commissions further propose that the
regulatory authorities may impose on their members initial and
maintenance margin levels that are higher than the minimum margin
levels specified in Proposed CFTC Rule 41.45(b)(1) and Proposed SEC
Rule 402(b)(1).\89\ This is to permit regulatory authorities to set
higher margin levels as may, from time to time, be considered prudent
by such regulatory authorities. In addition, regulatory authorities may
permit their members to use a method for calculating required initial
and maintenance margin that may result in margin levels that are higher
than the minimum margin levels specified in those proposed rules.\90\
Any such higher margin requirement would have to be filed with the SEC
under Section 19(b) of the Exchange Act.\91\ The Commissions also
propose that a national securities exchange registered with the SEC
under Section 6(g) of the Exchange Act ("Security Futures Product
Exchange") \92\ or a national securities association registered with
the SEC under Section 15A(k) of the Exchange Act ("Limited Purpose
National Securities Association") \93\ may raise or lower the required
margin level to a level not lower than that specified in Proposed CFTC
Rule 41.45 and Proposed SEC Rule 402,\94\ in accordance with Section
19(b)(7) of the Exchange Act.\95\
---------------------------------------------------------------------------
\89\ See Proposed CFTC Rule 41.45(b)(2)(i); Proposed SEC Rule
402(b)(2)(i).
\90\ See Proposed CFTC Rule 41.45(b)(2)(ii); Proposed SEC Rule
402(b)(2)(ii).
\91\ 15 U.S.C. 78s(b).
\92\ 15 U.S.C. 78f(g). New subsection 6(g) of the Exchange Act
provides an expedited process for an exchange that lists or trades
security futures products to register with the SEC as a national
securities exchange if that exchange (1) is a board of trade that
has been designated as a contract market or is registered as a DTF;
and (2) does not act as a market place for transactions in
securities other than security futures products. The SEC has adopted
rules prescribing the requirements for designated contract markets
and DTFs to register as national securities exchange pursuant to
Section 6(g) of the Exchange Act. See Securities Exchange Act
Release No. 44692 (August 13, 2001), 66 FR 43721 (August 20, 2001).
\93\ 15 U.S.C. 78o-3(k). A futures association registered under
Section 17 of the CEA (7 U.S.C. 21) will be registered as a national
securities association for the limited purpose of regulating the
activities of brokers or dealers registered pursuant to Section
15(b)(11) of the Exchange Act (15 U.S.C. 78o(b)(11)) with respect to
their activities in security futures products.
\94\ 15 U.S.C. 78s(b)(2). See Proposed CFTC Rule 41.45(c);
Proposed SEC Rule 402(c).
\95\ 15 U.S.C. 78s(b)(7). See infra note 130 and accompanying
text.
---------------------------------------------------------------------------
E. Time Limits for Collection of Margin
The Commissions also propose other margin requirements for security
futures. Specifically, the Commissions propose that the amount of
initial margin required by Proposed CFTC Rule 41.45 and Proposed SEC
Rule 402 would be obtained as promptly as possible and in any event
within three business days after the position is established, or within
such shorter time period as may be imposed by applicable regulatory
authority rules approved by the SEC in accordance with Section 19(b)(2)
of the Exchange Act.\96\
---------------------------------------------------------------------------
\96\ See Proposed CFTC Rule 41.46(a); Proposed SEC Rule 403(a).
---------------------------------------------------------------------------
Currently, Regulation T requires the collection of margin calls for
certain securities covered by Regulation T within five business days
after the position is established, and regulatory authority rules
require the collection of maintenance margin as promptly as possible
and in any event within fifteen business days.\97\ To lower
counterparty risk in transactions involving security futures, the
Commissions are proposing shorter time periods than those permitted by
Regulation T. Specifically, the Commissions are proposing a three
business day time period.\98\
---------------------------------------------------------------------------
\97\ See, e.g., CBOE Rule 12.2.
\98\ See Proposed CFTC Rule 41.46(a); Proposed SEC Rule 403(a).
---------------------------------------------------------------------------
Further, the Commissions propose that the amount of maintenance
margin required by Proposed CFTC Rule 41.45 and Proposed SEC Rule 402
would be obtained as promptly as possible and in any event within three
business days after the margin deficiency is created or increased, or
within such shorter time period as may be imposed by applicable
regulatory authority rules approved by the SEC pursuant to Section
19(b)(2) of the Exchange Act.\99\
---------------------------------------------------------------------------
\99\ 15 U.S.C. 78s(b)(2). See Proposed CFTC Rule 41.46(b);
Proposed SEC Rule 403(b).
---------------------------------------------------------------------------
Finally, the Commissions propose that the time limits for
collection of initial margin may be extended upon application by the
creditor to its examining authority \100\ to the extent permitted by
applicable regulatory authority rules approved by the SEC pursuant to
Section 19(b)(2) of the Exchange Act.\101\
---------------------------------------------------------------------------
\100\ "Examining authority" with respect to a creditor is
proposed to mean: (1) The regulatory authority of which such
creditor is a member, if such creditor is a member of only one
regulatory authority; (2) The regulatory authority designated
responsibility by the SEC pursuant to 17 CFR 240.17d-1 for examining
such creditor for compliance with applicable financial
responsibility rules, if a regulatory authority is so designated; or
(3) The regulatory authority designated in accordance with 17 CFR
1.52, if such creditor is a member of more than one regulatory
authority and the SEC, pursuant to 17 CFR 240.17d-1 has not
designated responsibility for examining such creditor for compliance
with applicable financial responsibility rules. See Proposed CFTC
Rule 41.44(a)(3) and Proposed SEC Rule 401(a)(3).
\101\ 15 U.S.C. 78s(b)(2). The Commission expect such regulatory
authority rules for security futures to be consistent with those
rules currently in place for securities. See, e.g., NYSE Rule 434;
and NASD Rule 2520.
---------------------------------------------------------------------------
Q 23 Are the proposed time limits for collection of margin
appropriate for security futures?
F. Forms of Collateral
Section 7(c)(2)(B)(iv) of the Exchange Act requires that the margin
requirements for security futures products (other than levels of
margin), including the type, form, and use of collateral for security
future products, are and remain consistent with the requirements
established by the Federal Reserve Board in Regulation T pursuant to
subparagraphs (A) and (B) of Section 7(c)(1) of the Exchange Act.\102\
Regulation T requires a customer to deposit margin with its broker or
dealer whenever securities transactions by the customer, on any given
day, create or increase a "margin deficiency" \103\ in the
[[Page 50731]]
customer's margin account.\104\ Under Regulation T, such a deposit must
be made in the form of cash, margin securities, exempted securities, or
any combination thereof, within one "payment period" \105\ after the
margin deficiency was created or increased.\106\
---------------------------------------------------------------------------
\102\ 15 U.S.C. 78g(c)(2)(B)(iv).
\103\ Regulation T defines "margin deficiency" as "the amount
by which the required margin exceeds the equity in the margin
account." 12 CFR 220.2. The "required margin" for a position in
securities (other than security futures) is based on the "current
market value" of the securities and determined in accordance with
Section 220.12 of Regulation T. 12 CFR 220.12.
\104\ 12 CFR 220.4(c).
\105\ Regulation T defines "payment period" as "the number of
business days in the standard securities settlement cycle in the
United States, as defined in paragraph (a) of Exchange Act Rule
15c6-1 (17 CFR 240.15c6-1(a)), plus two business days." 12 CFR
220.2. Currently, the standard securities settlement cycle under
Rule 15c6-1 of the Exchange Act is three business days, resulting in
a payment period under Regulation T of five business days.
\106\ 12 CFR 220.4(c).
---------------------------------------------------------------------------
For dealings in security futures, the Commissions propose that,
under Proposed CFTC Rule 41.47(a) and Proposed SEC Rule 404(a), a
broker, dealer or a member of a national securities exchange may accept
from a customer as collateral to satisfy its margin requirement, the
following: cash, margin securities as defined in Regulation T,\107\
exempted securities as defined in Section 3(a)(12) of the Exchange
Act,\108\ or other collateral permitted under Regulation T to satisfy a
margin deficiency in the margin account.
---------------------------------------------------------------------------
\107\ Under Regulation T, 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;
(5) any foreign margin stock; and (6) any debt security convertible
into a margin security. 12 CFR 220.2.
\108\ 15 U.S.C. 78c(a)(12).
---------------------------------------------------------------------------
The Commissions also propose under Proposed CFTC Rule 41.47(b) and
Proposed SEC Rule 404(b) that nothing in the proposed rules would
prevent a regulatory authority from prescribing margin collateral
requirements (other than margin levels) including the type, form, and
use of collateral for security futures, as long as those requirements
are consistent with the requirements of Regulation T, subject to
approval by the SEC in accordance with Section 19(b)(2) of the Exchange
Act.\109\
---------------------------------------------------------------------------
\109\ 15 U.S.C. 78s(b)(2).
---------------------------------------------------------------------------
Finally, the Commissions propose under Proposed CFTC Rule 41.47(c)
and Proposed SEC Rule 404(c) that, for purposes of this section,
security futures are not margin securities. This is to clarify that
transactions and positions in security futures, like short options,
would not have loan value for margin purposes. As is the case with
short options, margin deposited on a long or short security future
represents a performance bond to assure performance on such contract.
The daily gains and losses on security futures are either credited
to the party that made a gain on such contract, or debited from the
account of the party that had a loss, such that the margin in each
party's account represents only the required amount of performance bond
on such contract. Because it is not an asset, a security future cannot
be put up as collateral for another security or futures transaction.
III. SEC and CFTC Rule Review Processes Relating to Margin
Requirements for Security Futures Products
A. CFTC Rule Review Process and Procedures for Notification of Proposed
Rule Changes Related to Margin
In general, designated contract markets, including "notice-
designated" contract markets,\110\ or registered DTFs that propose to
make a rule change regarding their 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.\111\ 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.\112\ 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.
---------------------------------------------------------------------------
\110\ 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).
\111\ 15 U.S.C. 78s(b).
\112\ 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.\113\ 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.\114\ 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.\115\
---------------------------------------------------------------------------
\113\ See also 66 FR 42256 (August 10, 2001) (CFTC rules
implementing these procedures, codified in a new Part 40 of Title
17, Rules 40.5 and 40.6).
\114\ 7 U.S.C. 7a-2(c)(1).
\115\ 7 U.S.C. 7a-2(c)(2).
---------------------------------------------------------------------------
Proposed CFTC Rule 41.48(a) would require 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 \116\ to concurrently provide
to the CFTC a copy of such a proposed rule change and any accompanying
documentation filed with the SEC.\117\ It is not required to provide
any supplemental information, even if such information is subsequently
provided to the SEC in the course of the SEC's review of the proposed
rule change. The purpose of this proposed rule is to provide the CFTC,
as a joint regulator of markets offering security futures products,
with timely notification of a proposed rule change.
---------------------------------------------------------------------------
\116\ 15 U.S.C. 78s(b)(2).
\117\ The copy may be submitted to the CFTC electronically, by
facsimile, or by delivery of a hard copy.
---------------------------------------------------------------------------
Proposed CFTC Rule 41.48(b) sets forth the notification process for
contract markets designated pursuant to Section 5 of the CEA \118\ and
registered DTFs. The process by which such an entity is to notify the
CFTC of having filed a proposed rule change with the SEC will depend on
which procedure under Section 5c(c) of the CEA \119\ the entity elects
to follow.
---------------------------------------------------------------------------
\118\ 7 U.S.C. 7a-2.
\119\ 7 U.S.C. 7a-2(c).
---------------------------------------------------------------------------
Proposed CFTC Rule 41.48(b)(1) would apply 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.\120\ In such
case, the contract market or DTF would file its requests with the SEC
and CFTC concurrently.
---------------------------------------------------------------------------
\120\ 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 \121\ is
required to provide a copy of the proposed rule change and any
accompanying
[[Page 50732]]
documentation that was filed with the SEC, concurrent with the SEC
filing. Promptly after the SEC has approved the proposed rule change,
the designated contract market or registered DTF will file the written
certification with the CFTC.
---------------------------------------------------------------------------
\121\ 7 U.S.C. 7a-2(c)(1).
---------------------------------------------------------------------------
The CFTC has considered 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. This alternative could
facilitate immediate implementation of the rule change once the rule is
approved by the SEC. The CFTC notes, however, that if the proposed rule
change were to be modified during the SEC approval process such that
the rule approved by the SEC was not the same rule that had been
certified to the CFTC, a new written certification would have to be
filed before the rule, as approved, could be implemented.
Q 24 Are there preferable alternative methods for meeting the dual
filing requirements for margin rule changes? For example, should
designated contract markets and DTFs file a rule certification with the
CFTC at the same time as the proposed rule change is submitted to the
SEC, and then file a new certification only if the proposed rule change
is modified? Or, should an entity be able to choose whether to file a
certification with the CFTC after SEC approval of such proposed rule
change or at the same time as filing the proposed rule change with the
SEC? Commenters are asked to be specific with respect to the costs and
administrative convenience of the proposed procedures or any
alternative procedures they submit for the CFTC's consideration.
B. SEC Rule Review Process
National securities exchanges registered pursuant to Section 6(a)
of the Exchange Act \122\ and national securities associations
registered pursuant to Section 15A(a) of the Exchange Act \123\ must
file proposed rule changes, including those related to the trading of
securities futures products, with the SEC under Section 19(b)(1) of the
Exchange Act.\124\ Security Futures Product Exchanges \125\ and Limited
Purpose National Securities Associations \126\ must submit proposed
rule changes to the SEC in the following three circumstances.
---------------------------------------------------------------------------
\122\ 15 U.S.C. 78f(a).
\123\ 15 U.S.C. 78o-3(a).
\124\ 15 U.S.C. 78s(b)(1).
\125\ See supra note 92.
\126\ See supra note 93.
---------------------------------------------------------------------------
First, Security Futures Product Exchanges and Limited Purpose
National Securities Associations are required to submit proposed rule
changes that relate to margin for security futures products, except for
those that result in higher margin levels, under Sections 19(b)(1) and
(b)(2) of the Exchange Act.\127\ Section 19(b)(1) of the Exchange Act
states that proposed rule changes are not effective unless approved by
the SEC or otherwise permitted in accordance with the provisions of
Section 19(b).\128\ Section 19(b)(2) of the Exchange Act sets forth the
standards by which the SEC must determine whether a proposed rule
change submitted pursuant to Section 19(b)(1) of the Exchange Act must
be either approved or disapproved.\129\ Specifically, the SEC is
directed to approve a proposed rule change if it finds that such
proposed rule change is consistent with the requirements of the
Exchange Act, and the rules and regulations thereunder applicable to
such SRO, or to disapprove a proposed rule change if it cannot make
such a finding.
---------------------------------------------------------------------------
\127\ 15 U.S.C. 78s(b)(1) and (b)(2). See Sections
6(g)(4)(B)(ii) and 15A(k)(3)(B) of the Exchange Act (15 U.S.C.
78f(g)(4)(B)(ii) and 15 U.S.C. 78o-3(k)(3)(B), respectively).
Proposed rule changes filed under Sections 19(b)(1) and (b)(2) of
the Exchange Act are submitted pursuant to Rule 19b-4 and Form 19b-
4. See 17 CFR 240.19b-4; 17 CFR 249.819.
\128\ Section 19(b)(3) of the Exchange Act sets forth the
categories of proposed rule changes that may take effect upon filing
with the SEC. 15 U.S.C. 78s(b)(3).
\129\ 15 U.S.C. 78s(b)(2).
---------------------------------------------------------------------------
Second, proposed rule changes by Security Futures Product Exchanges
and Limited Purpose National Securities Associations that relate to
higher margin levels, fraud or manipulation, recordkeeping, reporting,
listing standards, or decimal pricing for security futures products,
sales practices for security futures products for persons who effect
transactions in security futures products, or rules effectuating such
SRO's obligation to enforce the securities laws, must be submitted to
the SEC pursuant to new Section 19(b)(7) of the Exchange Act.\130\ A
proposed rule change filed pursuant to this section may take effect
when: (1) A written certification has been filed with the CFTC under
Section 5c(c) of the CEA; \131\ (2) the CFTC determines that review of
the proposed rule change is not necessary; or (3) the CFTC approves the
proposed rule change.\132\ The SEC, after consultation with the CFTC,
has the authority to summarily abrogate a proposed rule change that has
taken effect pursuant to Section 19(b)(7)(B) of the Exchange Act \133\
if it appears to the SEC that such rule change unduly burdens
competition or efficiency, conflicts with the securities laws, or is
inconsistent with the public interest and the protection of
investors.\134\
---------------------------------------------------------------------------
\130\ 15 U.S.C. 78s(b)(7). See Sections 6(g)(4)(B)(i) and
15A(k)(3)(A) of the Exchange Act (15 U.S.C. 78f(g)(4)(B)(i) and 15
U.S.C. 78o-3(k)(3)(A), respectively). Section 19(b)(7) of the
Exchange Act grants to the SEC the authority to adopt rules
regarding the filing of proposed rule changes by Security Futures
Product Exchanges and Limited Purpose National Securities
Associations. 15 U.S.C. 78s(b)(7). The SEC has adopted Rule 19b-7
and Form 19b-7 to establish procedures for filing proposed rule
changes pursuant to Section 19(b)(7) of the Exchange Act. See Rule
19b-7, 17 CFR 240.19b-7, and Form 19b-7, 17 CFR 249.822; Securities
Exchange Act Release No. 44692 (August 13, 2001), 66 FR 43721
(August 20, 2001).
\131\ 7 U.S.C. 7a-2(c). Pursuant to Section 5c(c)(1) of the CEA
(7 U.S.C. 7a-2(c)(1)), a registered entity may elect to approve and
implement any new rule or rule amendment by providing the CFTC with
a written certification that the new rule or rule amendment complies
with the CEA.
\132\ Pursuant to Section 5c(c)(2) of the CEA (7 U.S.C. 7a-
2(c)(2)), a registered entity may elect to seek prior approval of
the CFTC for any new rule or rule amendment.
\133\ 15 U.S.C. 78s(b)(7)(B). Pursuant to this section, SEC
action to abrogate a rule change will not affect the validity or
force of the rule change during the period it was in effect.
\134\ See Section 19(b)(7)(C) of the Exchange Act (15 U.S.C.
78s(b)(7)(C)). The SEC notes that it currently exercises similar
authority pursuant to Section 19(b)(3)(C) of the Exchange Act (15
U.S.C. 78s(b)(3)(C)) with respect to proposed rule changes filed by
the existing SROs, which are immediately effective upon filing
pursuant to Section 19(b)(3)(A) of the Exchange Act (15 U.S.C.
78s(b)(3)(A)).
---------------------------------------------------------------------------
Finally, in the event that the SEC abrogates a proposed rule
change, Security Futures Product Exchanges and Limited Purpose National
Securities Associations would be required, pursuant to Sections
6(g)(4)(B)(iii) \135\ and 15A(k)(3)(C) \136\ of the Exchange Act,
respectively, to refile the proposed rule change pursuant to the
requirements of Section 19(b)(1) of the Exchange Act.\137\
---------------------------------------------------------------------------
\135\ 15 U.S.C. 78f(g)(4)(B)(iii).
\136\ 15 U.S.C. 78o-3(k)(3)(C).
\137\ 15 U.S.C. 78s(b)(1).
---------------------------------------------------------------------------
The SEC must (within 35 days of the date of publication of notice
of the filing of the proposed rule change, or within such longer period
as the SEC may designate up to 90 days after such date if the SEC finds
such longer period to be appropriate and publishes its reasons for so
finding, or as to which the SRO consents) either by order approve the
proposed rule change or, after consultation with the CFTC, institute
disapproval proceedings.\138\ Section 19(b)(7)(D)(ii) of the Exchange
Act \139\ states that the SEC must approve a
[[Page 50733]]
proposed rule change that has been abrogated and refiled under Section
19(b)(1) of the Exchange Act \140\ if the SEC finds that it does not
unduly burden competition or efficiency, does not conflict with the
securities laws, and is not inconsistent with the public interest or
the protection of investors.
---------------------------------------------------------------------------
\138\ 15 U.S.C. 78s(b)(7)(D)(i).
\139\ 15 U.S.C. 78s(b)(7)(D)(ii).
\140\ 15 U.S.C. 78s(b)(1).
---------------------------------------------------------------------------
IV. Request for Comments
The Commissions solicit comments on all aspects of Proposed CFTC
Rules 41.43 through 41.48 and Proposed SEC Rules 242.400 through
242.404. In addition, the Commissions are seeking responses to the
numbered questions posed throughout this proposal.
Commenters are welcome to offer their views on any other matters
raised by the proposed rules.
V. Paperwork Reduction Act
A. CFTC
The Paperwork Reduction Act of 1995 ("PRA") \141\ 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 proposed rules do not require a
new collection of information on the part of any entities subject to
the proposed rules. Accordingly, the requirements imposed by the PRA
are not applicable to the proposed rules.
---------------------------------------------------------------------------
\141\ 44 U.S.C. 3501 et seq.
---------------------------------------------------------------------------
B. SEC
The PRA does not apply because the proposed rules do not impose
recordkeeping or information collection requirements, or other
collections of information which require approval of the Office of
Management and Budget under 44 U.S.C. 3501, et. seq.
VI. Costs and Benefits of the Proposed Rules
A. CFTC
Section 15(a) of the CEA \142\ 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.
---------------------------------------------------------------------------
\142\ 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.
The proposed rules constitute a package of related rule provisions.
The rules establish the amount of initial and maintenance customer
margin for transactions in security futures. The CFTC believes that the
proposed 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.\143\ The CFTC is evaluating the
costs and benefits of the proposed rules in light of the specific
considerations identified in Section 15(a) of the CEA:
---------------------------------------------------------------------------
\143\ 15 U.S.C. 78f(a).
---------------------------------------------------------------------------
1. Protection of market participants and the public. In general,
the proposed rules should further the protection of market participants
and the public.
2. Efficiency and competition. As noted above, the proposed 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, and apply to all
exchanges offering security futures. Accordingly, the proposed rules
are not expected to have a negative impact on competition.
3. Financial integrity of futures markets and price discovery. The
proposed 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 proposed rules are
consistent with sound risk management practices.
5. Other public considerations. The proposed rules would preserve
the financial integrity of markets trading security futures and prevent
systemic risk, thereby benefiting the public. The CFTC believes,
however, that the rules fall short of achieving the maximum benefits at
the lowest possible cost. The CFTC believes that portfolio margining
for security futures would foster greater market efficiency and provide
greater benefits to all market participants, without compromising the
financial integrity of the markets or giving rise to systemic
risk.\144\
---------------------------------------------------------------------------
\144\ See Paul H. Kupiec and A. Patricia White, Regulatory
Competition and the Efficiency of Alternative Derivative Product
Margining Systems, 16 The Journal of Futures Markets 943 (1996).
---------------------------------------------------------------------------
After evaluating these considerations, the CFTC has determined to
propose the rules discussed above. The CFTC invites public comment on
the application of the cost-benefit provision of Section 15(a) of the
CEA in regard to the proposed rules. Commenters are also invited to
submit any data that they may have quantifying the costs and benefits
of 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 securities 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 SEC is proposing new Rules
400 through 404 under the Exchange Act to 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; \145\ 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.
---------------------------------------------------------------------------
\145\ 15 U.S.C. 78f(a).
---------------------------------------------------------------------------
The SEC requests comments on all aspects of this cost-benefit
analysis, including identification of any additional costs and/or
benefits of the proposed rules. The SEC encourages
[[Page 50734]]
commenters to identify and supply any relevant data, analysis and
estimates concerning the costs and benefits of the proposed rules.
1. Costs
There would likely be various administrative costs to brokers,
dealers, and members of national securities exchanges attributable to
Proposed SEC Rules 400 through 404. Further, brokers, dealers, and
members of national securities exchanges that choose to effect
transactions for customers involving, or carrying an account for a
customer containing, a security future are responsible for assuring
compliance with these proposed rules and thus would incur various
costs. While the SEC is unable at this time to estimate the extent of
the costs that the proposed rules engender, it has identified below
areas where the proposed rules may impose costs.
a. Compliance With Regulation T
Proposed SEC Rule 400(b)(1) would apply 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, to the extent consistent
with the proposed rules.\146\
---------------------------------------------------------------------------
\146\ For discussion on Regulation T, and the accounts
established thereunder, see supra notes 15-27 and accompanying text.
---------------------------------------------------------------------------
Under this proposed rule, security futures transactions would be
recorded in a Margin Account. The proposed margin level requirements
represent a performance bond to guarantee contract performance by both
the buyer and seller of such contract. Any settlement variation would
be credited to (or debited from) the Margin Account.\147\ The
application of Regulation T provisions by brokers, dealers, or members
of national securities exchanges to their customers' security futures
positions would require these entities to incur certain costs, such as
making systems changes, and hiring personnel, in adhering to Regulation
T provisions.
---------------------------------------------------------------------------
\147\ Broker-dealers registered with the SEC under Section
15(b)(1) of the Exchange Act may journal any margin excess to the
SMA. 15 U.S.C. 78o(b)(1).
---------------------------------------------------------------------------
The SEC requests comments, data, and estimates on all aspects of
the costs of implementing Regulation T provisions pertaining to
security futures.
b. Levels of Margin
Proposed SEC Rule 402(b)(1) sets the level of margin at 20 percent
of current market value. The 20 percent level of margin is necessary to
fulfill the statutory requirement that the margin requirements for
security futures be consistent with the margin requirements for
comparable options contracts traded on any national securities exchange
registered under Section 6(a) of the Exchange Act.\148\
---------------------------------------------------------------------------
\148\ 15 U.S.C. 78g(c)(2)(B)(iii).
---------------------------------------------------------------------------
The SEC notes that the 20 percent margin level may appear to be
high when compared to margining methodologies currently used for
futures other than security futures. A potential cost of these higher
margin requirements is that they may lead to reduced interest in
trading security futures and, therefore, foregone hedging
opportunities.
However, while margin requirements on non-security futures
contracts generally range from 2-10 percent,\149\ SEC staff, based on
its analysis, estimates that applying traditional futures risk-based
margining methods to security futures would require margin of greater
than 10 percent.\150\ Further, economic research has thus far not been
able to establish a strong relationship between futures margin levels
and interest in the product.\151\ On the other hand, SEC staff
estimates 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.\152\ Therefore, while the
margin levels proposed for security futures may impose a cost, the SEC
believes that the proposed margin levels would 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
preliminarily believes that the proposed margin levels would be
appropriate.
---------------------------------------------------------------------------
\149\ 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.
\150\ 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 this
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 preliminary 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).
\151\ 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.
\152\ See supra note 150.
---------------------------------------------------------------------------
The SEC requests comments, data, and estimates on all aspects of
the costs associated with the margin level described in Proposed SEC
Rule 402(b)(1).
c. Computation of Margin
Proposed SEC Rule 402(b)(1) would require that brokers, dealers,
and national securities exchange members compute and ensure, on a daily
basis, that the initial and maintenance margin levels for each
customer's security future carried or held by such entity are 20
percent of the current market value of such contract. This requirement
is designed to assure contract performance and the integrity of the
marketplace.\153\ In addition, all market participants pay or receive
daily settlement variation payments (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.
---------------------------------------------------------------------------
\153\ For an in depth discussion of how margin would be computed
under the proposed rules, see supra notes 62-88 and accompanying
text.Z
---------------------------------------------------------------------------
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 brokers, dealers,
or national securities exchanges members would require these entities
to program or reprogram their computer systems to implement the margin
computations and the settlement variation procedures for securities
futures. These entities may also incur additional data storage costs
and resource costs associated with these calculations. The SEC requests
comments, data, and estimates on all aspects of the costs associated
with the proposed calculations for margin on security futures,
including whether Proposed SEC Rule 402(b)(1) under the Exchange Act is
likely to require these entities mentioned above to increase the number
of staff, or result in additional resource burdens, to perform and
implement the required calculations.
[[Page 50735]]
d. Notification Requirements Regarding Exempted Borrowers
Proposed SEC Rule 400(b)(3)(iv)(A) would exclude from the proposed
margin regulation margin arrangements between a creditor and a borrower
with respect to the borrower's financing of proprietary positions in
security futures, based on the creditor's good faith determination that
the borrower is an "exempted borrower." \154\
---------------------------------------------------------------------------
\154\ For a discussion of who is considered an "exempted
borrower," see supra notes 54-55 and accompanying text.
---------------------------------------------------------------------------
Proposed SEC Rule 402(e) would provide that once a broker, dealer,
or a member of a national securities exchange ceases to qualify as an
exempted borrower, it must notify the creditor (i.e., the broker,
dealer, or a national securities exchange member holding the position)
of this fact before establishing any new security future positions
because any new security future positions would be subject to the
proposed rules.
The notification requirement under Proposed SEC Rule 402(e) is
likely to result in various minor costs, including personnel time for
preparing the notification by any means of communication, and sending
such notification by a broker, dealer, or member of a national
securities exchange that is required to send a notification to its
creditor because it has ceased be an exempted borrower. The SEC
requests comments and estimates on the costs associated with this
notification requirement.
e. Time Limits for Collection of Margin
Proposed SEC Rules 403(a) and (b) together would require that the
amount of initial and maintenance margin required by the proposed rules
be obtained as promptly as possible and, in any event, within three
business days after the position is established, or within such shorter
time period as may be imposed by applicable regulatory authority rules
approved by the SEC in accordance with Section 19(b)(2) of the Exchange
Act. The SEC believes that the brokers, dealers, or national securities
exchange members that are effecting transactions in security futures
will need to gather information to determine for each customer's
account involving security futures when margin on such position must be
obtained from its customers. The SEC requests comments, data, and cost
estimates relating to the time limits for collection of margin
requirements.
2. Benefits
The benefits of Proposed SEC Rules 400 through 404 are related to
the benefits that will accrue as a result of the enactment of the CFMA.
By repealing the ban on single stock futures 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 Brokers, Dealers, and Members of National Securities
Exchanges
Proposed SEC Rule 402(b)(1) would provide 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,
Proposed SEC Rule 404(a) would provide that a broker, dealer or member
of a national securities exchange may accept as collateral cash, margin
securities, exempted securities, or other collateral permitted under
Regulation T to satisfy a margin deficiency in the margin account.\155\
Proposed SEC Rule 404(b) further provides that a regulatory authority
may prescribe margin collateral requirements (other than margin levels)
including the type, form, and use of collateral for security futures,
that are consistent with the requirements under Regulation T.\156\
---------------------------------------------------------------------------
\155\ For discussion on forms of collateral, see supra notes
102-109 and accompanying text.
\156\ Such requirements would be proposed by regulatory
authority rules approved by the SEC pursuant to Section 19(b)(2) of
the Exchange Act, and as applicable, subject to notice to the CFTC
in accordance with Section 5c(c) of the CEA.
---------------------------------------------------------------------------
The SEC preliminarily believes that the margin levels and other
margin requirements proposed would provide sound protection from
customer default by reducing chances of depletion of margin accounts,
and therefore reduce systemic risk associated with the trading of these
new products.
b. Benefits to Customers
Additionally, Proposed SEC Rule 402(d) would provide that customers
be permitted to offset positions involving security futures with
certain related securities or futures.\157\ 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 if such offsets
were consistent with the Exchange Act, including the requirement that
margin requirements for security futures be no less restrictive than
those imposed on options. These offsets likely would provide benefits
to customers because such rules would recognize the hedged nature of
the certain specified combined strategies and would permit lower margin
requirements that better reflect the true risk of those strategies.
Because security futures are new products, however, the SEC is unable
at this time to quantify these benefits and therefore requests
comments, data, and estimates regarding these benefits.
---------------------------------------------------------------------------
\157\ For an in depth discussion on offsets, see supra notes 74-
88 and accompanying text.
---------------------------------------------------------------------------
c. Regulatory Benefits
Proposed SEC Rule 400(b)(1) would provide, to the extent consistent
with the proposed rules, that Regulation T applies to financial
relations, including margin arrangements, between a creditor and a
customer with respect to security futures and any related securities or
futures contracts that are used to offset positions in security
futures. This provision is designed to ensure that existing and future
Federal Reserve Board interpretations of Regulation T would apply and
that, therefore, margin requirements for security futures would remain
consistent without further action by the Commissions.
C. Request for Comments
To assist the SEC and the CFTC in their evaluation of the costs and
benefits that may result from the proposed rulemaking, commenters are
requested to provide analysis and data relating to the anticipated
costs and benefits associated with the proposed rules. Specifically,
the SEC and the CFTC request commenters to address whether the proposed
rules would generate the anticipated benefits or impose additional
costs on U.S. investors or others.
VII. Consideration of Burden on Competition, Promotion of
Efficiency, and Capital Formation
Section 3(f) of the Exchange Act \158\ requires the SEC, whenever
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
[[Page 50736]]
will promote efficiency, competition, and capital formation. In
addition, Section 23(a)(2) of the Exchange Act requires the SEC, in
adopting rules under the Exchange Act, to consider the impact on
competition of any rules it adopts.\159\ Section 23(a)(2) of the
Exchange Act further provides that the SEC may not adopt a rule that
would impose a burden on competition not necessary or appropriate in
furtherance of the purposes of the Exchange Act.\160\ The rules
proposed today would impose initial and maintenance margin requirements
on brokers, dealers and members of national securities exchanges that
collect customer margin for security futures. The SEC has considered
the proposed rules in light of the standards set forth in Sections 3(f)
\161\ and 23(a)(2) \162\ of the Exchange Act.
---------------------------------------------------------------------------
\158\ 15 U.S.C. 78c(f).
\159\ 15 U.S.C. 78w(a)(2).
\160\ Id.
\161\ 15 U.S.C. 78c(f).
\162\ 15 U.S.C. 78w(a)(2).
---------------------------------------------------------------------------
The SEC preliminarily believes that the proposed rules should
promote efficiency by setting forth clear guidelines for brokers,
dealers, and members of national securities exchanges when collecting
customer margin related to security futures. Further, the SEC believes
that the proposed rules will provide sound protection from customer
default by reducing chances of depletion of margin accounts, and
therefore reduce system risk associated with the trading of these new
products.
The SEC also preliminarily believes that the proposed rules would
not impose any significant burden on competition. The proposed rules
serve only to set forth margin requirements for security futures,
including establishing margin levels and margin collateral
requirements. Lastly, the SEC preliminarily believes that the proposed
rules would not have any impact on capital formation because the
proposed rules would merely establish rules governing the collection of
customer margin. The SEC notes that these proposed margin requirements
would protect brokers, dealers, and members of national securities
exchanges from customers' default, thus encouraging participation by
these market participants in the trading of futures contracts on both
single stocks and narrow-based indexes. Therefore, the SEC
preliminarily believes that there could be an increased demand for the
underlying securities, resulting in increased capital formation.
Nevertheless, the SEC believes that the benefits to the capital
formation process principally flow from the CFMA itself, which lifts
the ban on trading of single stock futures and narrow-based index stock
futures.
The SEC requests comments on the impact of the proposed rules on
competition, efficiency and capital formation.
VIII. Regulatory Flexibility Act Certifications
A. CFTC
The Regulatory Flexibility Act ("RFA") \163\ requires that
federal agencies, in promulgating rules, consider the impact of those
rules on small entities. The proposed rules would 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.\164\
---------------------------------------------------------------------------
\163\ 5 U.S.C. 601 et seq.
\164\ 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.\165\
Recently, the CFTC determined that notice-designated contract markets
are not small entities for purposes of the RFA.\166\ 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.\167\
---------------------------------------------------------------------------
\165\ Id. at 18619.
\166\ 66 FR 44960, 44964 (August 27, 2001).
\167\ 66 FR 42256, 42268 (August 10, 2001).
---------------------------------------------------------------------------
The CFTC also 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.\168\ The CFTC is proposing to
determine that notice-registered FCMs,\169\ for the reasons applicable
to FCMs registered in accordance with Section 4f(a)(1) of the CEA,\170\
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 relationship with their customers
and must meet analogous minimum financial requirements.\171\
---------------------------------------------------------------------------
\168\ 47 FR at 18619.
\169\ 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)).
\170\ 7 U.S.C. 6f(a)(1).
\171\ See Exchange Act Rule 15c3-1(a)(2), 17 CFR 240.15c-
1(a)(2).
---------------------------------------------------------------------------
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.\172\ In proposing these
rules, the Commissions have striven to fulfill this requirement in the
least burdensome way possible.
---------------------------------------------------------------------------
\172\ 15 U.S.C. 78f(a).
---------------------------------------------------------------------------
Accordingly, the Acting Chairman, on behalf of the CFTC, certifies
pursuant to 5 U.S.C. 605(b), that the proposed rules will not have a
significant economic impact on a substantial number of small entities.
The CFTC invites the public to comment on this finding and on its
proposed determination that notice-registered FCMs are not small
entities for purposes of the RFA.
B. SEC
Section 3(a) of the RFA \173\ requires the SEC to undertake an
initial regulatory flexibility analysis of the proposed rules on the
small entities unless the Chairman certifies that the rule, if adopted,
would not have a significant economic impact on small entities.\174\
Proposed Rules 400 through 404 would apply to brokers, dealers and
members of national securities exchanges.
---------------------------------------------------------------------------
\173\ 5 U.S.C. 603(a).
\174\ 5 U.S.C. 605(b).
---------------------------------------------------------------------------
Introducing brokers ("IBs") and FCM may register as broker-
dealers by filing Form BD-N. However, because IBs cannot collect
customer margin they are not subject to these rules.\175\ In addition,
the CFTC has concluded that FCMs are not considered small entities for
the purposes of the RFA.\176\ Accordingly, there are no FCMs or IBs
that are small entities that would be affected by the proposed rules.
---------------------------------------------------------------------------
\175\ See 7 U.S.C. 1(a)(23).
\176\ See 47 FR 18618-21 (April 30, 1982). See also 66 FR 14262,
14268 (March 9, 2001).
---------------------------------------------------------------------------
The proposed rules would also apply to broker-dealers and members
of national securities exchanges. With one exception, all members of
national securities exchanges registered under Section 6(a) of the
Exchange Act are registered broker-dealers. The SEC believes that some
small broker-dealers could be affected by the proposals, but that the
proposals will not have a significant impact on a substantial number of
small broker-dealers.
[[Page 50737]]
In addition, national securities exchanges registered under Section
6(g) of the Exchange Act may have members who are floor brokers or
floor traders who are not registered broker-dealers. Floor brokers and
floor traders, however, are not eligible to clear securities
transactions or collect customer margin, and thus would not be subject
to the proposed rules.\177\
---------------------------------------------------------------------------
\177\ 7 U.S.C. 1(a)(16) and (17).
---------------------------------------------------------------------------
Accordingly, the Chairman of the SEC has certified that the
proposed rules, if adopted, would not have a significant economic
impact on a substantial number of small entities. This certification is
attached as Appendix A to this notice.
The SEC invites commenters to address whether the proposed rules
would have a significant economic impact on a substantial number of
small entities, and if so, what would be the nature of any impact on
small entities. The SEC requests that commenters provide empirical data
to support the extent of such impact.
IX. Statutory Basis and Text of Proposed Rules
The SEC is proposing Rules 400 through 404 pursuant to the Exchange
Act, particularly Sections 3(b), 6, 7(c), 15A and 23(a). Further, these
rules are proposed 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). See Appendix B.
List of Subjects
17 CFR Part 41
Brokers, Margin, Reporting and recordkeeping, Security futures
products.
17 CFR Part 242
Brokers and 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 proposed to be amended as follows:
PART 41--SECURITY FUTURES
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. Part 41 is amended by adding Secs. 41.43 through 41.48 to read
as follows:
Sec. 41.43 Customer margin--authority, purpose and scope.
(a) Authority and purpose. Sections 41.43 through 41.48 are issued
by the Commodity Futures Trading Commission (CFTC), jointly with the
Securities and Exchange Commission (SEC) 17 CFR 242.400 through
242.404, 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 (the "Exchange Act") (15 U.S.C. 78g(c)(2)(A)).
Its principal purpose is to regulate margin collected by brokers,
dealers, and members of national securities exchanges relating to
customers' transactions in security futures and imposes, among other
requirements, minimum customer initial and maintenance margin levels
for such security futures positions.
(b) Scope of section. (1) Regulation T (12 CFR part 220) shall
apply to financial relations, including margin arrangements, between a
creditor and a customer with respect to security futures and any
related securities or futures contracts that are used to offset
positions in such security futures, to the extent consistent with this
part.
(2) This part does not preclude a regulatory authority or creditor
from imposing additional margin requirements on security futures,
including higher margin levels and risk-sensitive criteria, consistent
with this part, or from taking appropriate action to preserve its
financial integrity.
(3) This part does not apply to:
(i) Financial relations between a customer and a creditor to the
extent that they comply with a portfolio margining system under rules
that have become effective in accordance with Section 19(b)(2) of the
Exchange Act (15 U.S.C. 78s(b)(2)) and, as applicable, Section 5c(c) of
the Commodity Exchange Act (the "Act") (7 U.S.C. 7a-2(c));
(ii) Financial relations between a foreign branch of a creditor and
a foreign person involving foreign security futures;
(iii) Margin requirements that clearing agencies registered with
the SEC or the CFTC impose on their members; and
(iv) Credit extended, maintained, or arranged by a creditor to or
for a member of a national securities exchange or a registered broker
or dealer if:
(A) Such creditor makes a good faith determination that the
borrower is an exempted borrower;
(B) The borrower otherwise qualifies for exemption pursuant to
Section 7(c)(3) of the Exchange Act (15 U.S.C. 78g(c)(3)); or
(C) The borrower is a member of a national securities exchange or a
national securities association registered under Section 15A(a) of the
Exchange Act (15 U.S.C. 78o-3(a)) and the borrower:
(1) Does 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; and
(2) Is registered with such exchange or such association as a
security futures dealer, pursuant to regulatory authority rules that
have become effective in accordance with Section 19(b)(2) of the
Exchange Act (15 U.S.C. 78s(b)(2)) and, as applicable, Section 5c(c) of
the Act (7 U.S.C. 7a-2(c)), that:
(i) Require such member to be registered as a floor trader or a
floor broker with the CFTC under Section 4f(a)(1) of the Act (7 U.S.C.
6f(a)(1)), or as a dealer with the SEC under Section 15(b) of the
Exchange Act (15 U.S.C. 78o(b));
(ii) Require such member to comply with applicable SEC or CFTC net
capital requirements;
(iii) Require such member to maintain records sufficient to prove
compliance with this paragraph (b)(3)(iv)(C) and the rules of the
exchange or association of which the borrower is a member;
(iv) 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
(v) Provide for disciplinary action, including revocation of such
member's registration as a security futures dealer, for such member's
failure to comply with Secs. 41.43 through 41.48 or the rules of the
exchange or association.
Sec. 41.44 Customer margin--definitions.
(a) For purposes of this part only, the following terms shall have
the meanings set forth in this section.
(1) 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.
(2) On any day, current market value means with respect to a
security future:
(i) 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
(ii) If the instrument underlying such security future is a narrow-
based security index, as defined in section 3(a)(55)(B) of the Exchange
Act (15 U.S.C. 78c(a)(55)(B)), the product of the daily settlement
price of such security
[[Page 50738]]
future as shown by any regularly published reporting or quotation
service, and the applicable contract multiplier.
(3) Examining authority with respect to a creditor means:
(i) The regulatory authority of which such creditor is a member, if
such creditor is a member of only one regulatory authority;
(ii) The regulatory authority designated responsibility by the SEC
pursuant to Sec. 240.17d-1 of this title for examining such creditor
for compliance with applicable financial responsibility rules, if a
regulatory authority is so designated; or
(iii) The regulatory authority designated in accordance with
Sec. 1.52 of this chapter, if such creditor is a member of more than
one regulatory authority and the SEC, pursuant to Sec. 240.17d-1 of
this title, has not designated responsibility for examining such
creditor for compliance with applicable financial responsibility rules.
(4) Initial margin means the margin as defined in Section
3(a)(57)(A) of the Exchange Act (15 U.S.C. 78c(a)(57)(A)), that is
required when a security future position is opened.
(5) Maintenance margin means the margin, as defined in Section
3(a)(57)(A) of the Exchange Act (15 U.S.C. 78c(a)(57)(A)), that is
required to be maintained in a customer's securities account, as
defined in Sec. 1.3(ww) of this chapter, or futures account, as defined
in Sec. 1.3(vv) of this chapter, at the end of each trading day.
(6) Regulation T means Regulation T promulgated by the Board of
Governors of the Federal Reserve System ("Federal Reserve Board"), 12
CFR part 220.
(7) Regulatory authority means a self-regulatory organization that
is registered as a national securities exchange under Section 6 of the
Exchange Act (15 U.S.C. 78f) or a registered securities association
under Section 15A of the Exchange Act (15 U.S.C. 78o-3).
(8) 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
or clearing organization.
(b) Terms used in this part and not otherwise defined in this
section shall have the meaning set forth in Regulation T (12 CFR part
220).
(c) Terms used in this part and not otherwise defined in this
section or in Regulation T (12 CFR part 220) shall have the meaning set
forth in the Exchange Act.
Sec. 41.45 Customer margin--customer margin levels for security
futures.
(a) Applicability. No broker, dealer or member of a national
securities exchange may effect a transaction involving, or carry an
account containing, a security future position with or for a customer,
without obtaining proper and adequate margin as set forth in this
section.
(b) Amount of customer margin--(1) General rule. The minimum
initial and maintenance margin levels for each security future contract
shall be 20 percent of the current market value of such contract.
(2) Exceptions. Provided that such higher margin levels or
calculation methods have become effective in accordance with Section
19(b) of the Exchange Act (15 U.S.C. 78s(b)), nothing in this section
shall prevent a regulatory authority from:
(i) Requiring initial and/or maintenance margin levels that are
higher than the minimum margin levels specified in paragraph (b)(1) of
this section; or
(ii) Using a method for calculating required initial and/or
maintenance margin that may result in margin levels that are higher
than the minimum margin levels specified in paragraph (b)(1) of this
section.
(c) Procedures for certain margin level adjustments. An exchange
registered under Section 6(g) of the Exchange Act (15 U.S.C. 78f(g)),
or a national securities association registered under Section 15A(k) of
the Exchange Act (15 U.S.C. 78o-3(k)), may raise or lower the required
margin level to a level not lower than that specified in this section,
in accordance with Section 19(b)(7) of the Exchange Act (15 U.S.C.
78s(b)(7)).
(d) Offsetting positions. Notwithstanding the minimum margin levels
specified in paragraph (b)(1) of this section, customers with offset
positions involving security futures and one or more related securities
or futures contracts may, pursuant to regulatory authority rules that
have become effective in accordance with Section 19(b)(2) of the
Exchange Act (15 U.S.C. 78s(b)(2)) and, as applicable, Section 5c(c) of
the Act (7 U.S.C. 7a-2(c)), have initial or maintenance margin levels
that are lower than the levels specified in paragraph (b)(1) of this
section, provided that such margin levels are not lower than the lowest
customer margin levels required for any comparable offset positions
involving option contracts traded on any exchange registered pursuant
to Section 6(a) of the Exchange Act (15 U.S.C. 78f(a)).
(e) Change in exempted borrower status. Once a broker, dealer, or a
member of a national securities exchange ceases to qualify as an
exempted borrower, it shall notify the creditor of this fact before
establishing any new security future positions. Any new security future
positions will be subject to the provisions of this part.
Sec. 41.46 Customer margin--time limits for collection of margin.
(a) Initial margin. The amount of initial margin required or
permitted by Sec. 41.45 shall be obtained by the creditor as promptly
as possible and in any event within three business days after the
position is established, or within such shorter time period as may be
imposed by applicable regulatory authority rules that have become
effective in accordance with section 19(b)(2) of the Exchange Act (15
U.S.C. 78s(b)(2)) and, as applicable, section 5c(c) of the Act (7
U.S.C. 7a-2(c)).
(b) Maintenance margin. The amount of maintenance margin required
or permitted by Sec. 41.45 shall be obtained by the creditor as
promptly as possible and in any event within three business days after
the margin deficiency is created or increased, or within such shorter
time period as may be imposed by applicable regulatory authority rules
that have become effective in accordance with section 19(b)(2) of the
Exchange Act (15 U.S.C. 78s(b)(2)) and, as applicable, section 5c(c) of
the Act (7 U.S.C. 7a-2(c)).
(c) Extension of time limits. The time limits for collection of
initial margin may be extended upon application by the creditor to its
examining authority to the extent permitted by applicable regulatory
authority rules that have become effective in accordance with section
19(b)(2) of the Exchange Act (15 U.S.C. 78s(b)(2)) and, as applicable,
Section 5c(c) of the Act (7 U.S.C. 7a-2(c)).
Sec. 41.47 Customer margin--forms of collateral.
(a) A broker, dealer or a member of a national securities exchange
may accept as margin collateral:
(1) Cash;
(2) Margin securities;
(3) Exempted securities as defined in section 3(a)(12) of the
Exchange Act (15 U.S.C. 78c(a)(12)); or
(4) Other collateral permitted under Regulation T (12 CFR part 220)
to satisfy a margin deficiency in the margin account.
(b) Nothing in this section shall prevent a regulatory authority
from prescribing margin collateral requirements (other than margin
levels) including the type, form, and use of collateral for security
futures, that are
[[Page 50739]]
consistent with the requirements established by the Federal Reserve
Board, pursuant to section 7(c)(1)(A) and (B) of the Exchange Act (15
U.S.C. 78g(c)(1)(A) and (B)), subject to approval by the SEC in
accordance with section 19(b)(2) of the Exchange Act (15 U.S.C.
78s(b)(2)) and, as applicable, subject to notice to the CFTC in
accordance with section 5c(c) of the Act (7a U.S.C. 7a-2(c)).
(c) For the purposes of this section, security futures are not
margin securities.
Sec. 41.48 Customer margin--filing proposed margin rule changes with
the CFTC.
(a) Notification requirement for notice-registered contract
markets. Any regulatory authority that is registered with the CFTC as a
designated contract market under section 5f of the Act (7 U.S.C.7b-1)
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 (15 U.S.C. 78s(b)(2)), concurrently
provide to the CFTC a copy of such proposed rule change and any
accompanying documentation filed with the SEC.
(b) Filing requirements under the Act. Any regulatory authority
that is registered with the CFTC as a designated contract market or
derivatives transaction execution facility under section 5 of the Act
(7 U.S.C. 7) 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 (15 U.S.C.
78s(b)(2)), notify the CFTC as follows:
(1) If the regulatory authority elects to request CFTC prior
approval for the proposed rule change pursuant to section 5c(c)(2) of
the Act (7 U.S.C. 7a-2(c)(2)), it shall concurrently file the proposed
rule change with the CFTC in accordance with Sec. 40.5 of this chapter.
(2) If the regulatory authority elects to implement a proposed rule
change by written certification pursuant to section 5c(c)(1) of the Act
(7 U.S.C. 7a-2(c)(1)), it shall concurrently provide to the CFTC 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 regulatory authority shall file its written
certification with the CFTC in accordance with Sec. 40.6 of this
chapter.
Dated: September 26, 2001.
By the Commodity Futures Trading Commission.
Jean A. Webb,
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 proposed to be 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. Sections 242.400 through 242.404 are added to read as follows:
Sec. 242.400 Customer margin requirements for security futures--
Authority, purpose and scope.
(a) Authority and purpose. Sections 242.400 through 242.404 are
issued by the Securities and Exchange Commission (SEC), jointly with
the Commodity Futures Trading Commission (CFTC) 17 CFR 41.43 through
41.48, 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)). Its principal
purpose is to regulate margin collected by brokers, dealers, and
members of national securities exchanges relating to customers'
transactions in security futures and imposes, among other requirements,
minimum customer initial and maintenance margin levels for such
security futures positions.
(b) Scope of section. (1) Regulation T (12 CFR part 220) shall
apply to financial relations, including margin arrangements, between a
creditor and a customer with respect to security futures and any
related securities or futures contracts that are used to offset
positions in such security futures, to the extent consistent with this
part.
(2) This part does not preclude a regulatory authority or creditor
from imposing additional margin requirements on security futures,
including higher margin levels and risk-sensitive criteria, consistent
with this part, or from taking appropriate action to preserve its
financial integrity.
(3) This part does not apply to:
(i) Financial relations between a customer and a creditor to the
extent that they comply with a portfolio margining system under rules
that have become 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
Commodity Exchange Act ("CEA") (7 U.S.C. 7a-2(c));
(ii) Financial relations between a foreign branch of a creditor and
a foreign person involving foreign security futures;
(iii) Margin requirements that clearing agencies registered with
the SEC or the CFTC impose on their members; and
(iv) Credit extended, maintained, or arranged by a creditor to or
for a member of a national securities exchange or a registered broker
or dealer if:
(A) Such creditor makes a good faith determination that the
borrower is an exempted borrower;
(B) The borrower otherwise qualifies for exemption pursuant to
section 7(c)(3) of the Act (15 U.S.C. 78g(c)(3)); or
(C) The borrower 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 the borrower:
(1) Does 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; and
(2) Is registered with such exchange or such association as a
security futures dealer, pursuant to regulatory authority rules,
approved by the SEC in accordance with section 19(b)(2) of the Act (15
U.S.C. 78s(b)(2)), that:
(i) 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 SEC under section 15(b) of the Act
(15 U.S.C. 78o(b));
(ii) Require such member to comply with applicable SEC or CFTC net
capital requirements;
(iii) Require such member to maintain records sufficient to prove
compliance with this paragraph (b)(3)(iv)(C) and the rules of the
exchange or association of which the borrower is a member;
(iv) 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
(v) Provide for disciplinary action, including revocation of such
member's registration as a security futures dealer, for such member's
failure to comply with Secs. 242.400 through 242.404 or the rules of
the exchange or association.
Sec. 242.401 Definitions.
(a) For purposes of this part only, the following terms shall have
the meanings set forth in this section.
[[Page 50740]]
(1) 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.
(2) On any day, current market value means with respect to a
security future:
(i) 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;
(ii) 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.
(3) Examining authority with respect to a creditor means:
(i) The regulatory authority of which such creditor is a member, if
such creditor is a member of only one regulatory authority;
(ii) The regulatory authority designated responsibility by the SEC
pursuant to Sec. 240.17d-1 of this chapter for examining such creditor
for compliance with applicable financial responsibility rules, if a
regulatory authority is so designated; or
(iii) The regulatory authority designated in accordance with
Sec. 1.52 of this title, if such creditor is a member of more than one
regulatory authority and the SEC, pursuant to Sec. 240.17d-1 of this
chapter, has not designated responsibility for examining such creditor
for compliance with applicable financial responsibility rules.
(4) Initial margin means the margin as defined in section
3(a)(57)(A) of the Act (15 U.S.C. 78c(a)(57)(A)), that is required when
a security future position is opened.
(5) Maintenance margin means the margin, as defined in section
3(a)(57)(A) of the Act (15 U.S.C. 78c(a)(57)(A)), that is required to
be maintained in a customer's securities account or commodity interest
account at the end of each trading day.
(6) Regulation T means Regulation T promulgated by the Board of
Governors of the Federal Reserve System ("Federal Reserve Board"), 12
CFR part 220.
(7) Regulatory authority means a self-regulatory organization that
is registered as a national securities exchange under section 6 of the
Act (15 U.S.C. 78f) or a registered securities association under
section 15A of the Act (15 U.S.C. 78o-3).
(8) 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
or clearing organization.
(b) Terms used in this part and not otherwise defined in this
section shall have the meaning set forth in Regulation T (12 CFR part
220).
(c) Terms used in this part and not otherwise defined in this
section or in Regulation T (12 CFR part 220) shall have the meaning set
forth in the Act.
Sec. 242.402 Customer margin for security futures.
(a) Applicability. No broker, dealer or member of a national
securities exchange may effect a transaction involving, or carry an
account containing, a security future position with or for a customer,
without obtaining proper and adequate margin as set forth in this
section.
(b) Amount of customer margin--(1) General rule. The minimum
initial and maintenance margin levels for each security future contract
shall be twenty (20) percent of the current market value of such
contract.
(2) Exceptions. Provided that such higher margin levels or
calculation methods have become effective in accordance with Section
19(b) of the Act (15 U.S.C. 78s(b)), nothing in this section shall
prevent a regulatory authority from:
(i) Requiring initial and/or maintenance margin levels that are
higher than the minimum margin levels specified in paragraph (b)(1) of
this section; or
(ii) Using a method for calculating required initial and/or
maintenance margin that may result in margin levels that are higher
than the minimum margin levels specified in paragraph (b)(1) of this
section.
(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
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)).
(d) Offsetting positions. Notwithstanding the minimum margin levels
specified in paragraph (b)(1) of this section, customers with offset
positions involving security futures and one or more related securities
or futures contracts may, pursuant to regulatory authority rules
approved by the Commission in accordance with section 19(b)(2) of the
Act (15 U.S.C. 78s(b)(2)), have initial or maintenance margin levels
that are lower than the levels specified in paragraph (b)(1) of this
section, provided that such margin levels are not lower than the lowest
customer margin levels required for any comparable offset positions
involving option contracts traded on any exchange registered pursuant
to section 6(a) of the Act (15 U.S.C. 78f(a)).
(e) Change in exempted borrower status. Once a broker, dealer, or a
member of a national securities exchange ceases to qualify as an
exempted borrower, it shall notify the creditor of this fact before
establishing any new security future positions. Any new security future
positions will be subject to the provisions of this part.
Sec. 242.403 Time limits for collection of margin.
(a) Initial margin. The amount of initial margin required or
permitted by Sec. 242.402 shall be obtained by the creditor as promptly
as possible and in any event within three (3) business days after the
position is established, or within such shorter time period as may be
imposed by applicable regulatory authority rules approved by the
Commission in accordance with section 19(b)(2) of the Act (15 U.S.C.
78s(b)(2)).
(b) Maintenance margin. The amount of maintenance margin required
or permitted by Sec. 242.402 shall be obtained by the creditor as
promptly as possible and in any event within three (3) business days
after the margin deficiency is created or increased, or within such
shorter time period as may be imposed by applicable regulatory
authority rules approved by the SEC in accordance with section 19(b)(2)
of the Act (15 U.S.C. 78s(b)(2)).
(c) Extension of time limits. The time limits for collection of
initial margin may be extended upon application by the creditor to its
examining authority to the extent permitted by applicable regulatory
authority rules approved by the Commission in accordance with section
19(b)(2) of the Act (15 U.S.C. 78s(b)(2)).
Sec. 242.404 Forms of collateral.
(a) A broker, dealer or a member of a national securities exchange
may accept as margin collateral:
(1) Cash;
(2) Margin securities;
(3) Exempted securities as defined in section 3(a)(12) of the Act
(15 U.S.C. 78c(a)(12)); or
(4) Other collateral permitted under Regulation T (12 CFR part 220)
to satisfy a margin deficiency in the margin account.
[[Page 50741]]
(b) Nothing in this section shall prevent a regulatory authority
from prescribing margin collateral requirements (other than margin
levels) including the type, form, and use of collateral for security
futures, that are consistent with the requirements established by the
Federal Reserve Board, pursuant to Section 7 (c)(1)(A) and (B) of the
Act (15 U.S.C. 78g(c)(1)(A) and (B)), subject to approval by the
Commission in accordance with section 19(b)(2) of the Act (15 U.S.C.
78s(b)(2)) and, as applicable, subject to notice to the CFTC in
accordance with section 5c(c) of the CEA (7 U.S.C. 7a-2(c)).
(c) For the purposes of this section, security futures are not
margin securities.
Dated: September 26, 2001.
By the Securities and Exchange Commission.
Margaret H. McFarland,
Deputy Secretary.
Note: Appendix A and B to the preamble will not appear in the
Code of Federal Regulations.
Appendix A--Regulatory Flexibility Act Certification
I, Harvey L. Pitt, Chairman of the Securities and Exchange
Commission (the "Commission"), hereby certify, pursuant to 5
U.S.C. Sec. 605(b), that the rules proposed in Section 242.400, et
seq., under the Securities Exchange Act of 1934 ("Exchange Act"),
which would regulate margin collected by brokers, dealers, and
members of national securities exchanges relating to customers'
transactions in security futures and impose, among other
requirements, minimum customer initial and maintenance margin levels
for such security futures positions, would not, if adopted, have a
significant economic impact on a substantial number of small
entities.
The proposed rules would affect brokers, dealers, and members of
national securities exchanges. Futures commission merchants
("FCMs") and introducing brokers ("IBs") may register as broker-
dealers by filing Form BD-N. The Commodities Futures Trading
Commission has concluded that FCMs are not considered small entities
for the purposes of RFA.\178\ In addition, because IBs cannot
collect customer margin they are not subject to these rules.
Accordingly, there are no FCMs or IBs that are small entities that
would be affected by the proposed rules.
---------------------------------------------------------------------------
\178\ See 47 FR 18618, 18618-21 (April 30, 1982). See also 66 FR
14262, 14268 (March 9, 2001).
---------------------------------------------------------------------------
The proposed rules would also apply to broker-dealers and
members of national securities exchanges. With one exception, all
members of national securities exchanges registered under Section
6(a) of the Exchange Act are registered broker-dealers. The
Commission believes that some small broker-dealers could be affected
by the proposals, but that the proposals would not have a
significant impact on a substantial number of small broker-dealers.
In addition, national securities exchanges registered under
Section 6(g) of the Exchange Act may have members who are floor
brokers or floor traders who are not registered broker-dealers.
Floor brokers and floor traders, however, are not eligible to clear
securities transactions or collect customer margin, and thus would
not be subject to the proposed rules.
Accordingly, the proposed rules, if adopted, would not have a
significant economic impact on a substantial number of small
entities.
Dated: September 25, 2001.
Harvey L. Pitt,
Chairman.
Appendix B
March 6, 2001.
Mr. James E. Newsome,
Acting Chairman, Commodity Futures Trading Commission, Three
Lafayette Centre, 21st Street, NW., Washington, DC 20581
Ms. Laura S. Unger
Acting Chairman, Securities and Exchange Commission, 450 Fifth
Street, NW., Washington, DC 20549.
Dear Acting Chairman Newsome and Acting Chairman Unger: Section
206(b) of the Commodity Futures Modernization Act of 2000 (CFMA)
amends the Securities Exchange Act of 1934 (SEA), in part by adding
a new section 7(c)(2) to provide the Board of Governors of the
Federal Reserve System with authority to prescribe margin
regulations for brokers, dealers, and members of national securities
exchanges extending credit to or collecting margin from customers on
security futures products. The Board must prescribe regulations
establishing initial and maintenance margin levels for these
contracts or delegate the authority jointly to the Commodity Futures
Trading Commission and the Securities Exchange Commission (the
Commissions).
The Board has long taken the position that the regulatory
authorities most familiar with the operation of the financial
markets should play a key role in federal oversight of margin policy
for these markets. In addition, the Board believes that the most
important function of customer margin requirements should be
prudential, that is, protection of lenders from credit losses. The
Commissions have responsibility for regulating the securities and
futures markets and will jointly oversee the exchanges trading
security futures products. Furthermore, the Commissions are
responsible for all other prudential supervision of the broker-
dealers and exchange members covered by the new margin authority.
These factors lead the Board to conclude that the Securities
Exchange Commission and the Commodity Futures Trading Commission,
jointly, are the most appropriate entities to exercise the functions
assigned to the Board under section 7(c)(2) of the SEA.
Accordingly, the Board hereby delegates its authority under
section 7(c)(2) of the SEA to the Commodity Futures Trading
Commission and the Securities Exchange Commission, jointly, until
further notice from the Board. The authority delegated by the Board
is limited to customer margin requirements imposed by brokers,
dealers, and members of national securities exchanges. It does not
cover requirements imposed by clearing agencies on their members.
Furthermore, the Board notes that section 7(c)(3) exempts the
financing of proprietary positions of certain broker-dealers and
members of securities exchanges as well as the financing of their
market making and underwriting activities from the scope of federal
margin regulation. Under the CFMA, futures commission merchants
(FCMs), floor brokers, and floor traders who trade security futures
products must become broker-dealers or members of a national
securities exchange, and therefore, may be exempt under section
7(c)(3) from regulation pursuant to the delegated authority when
they obtain credit. The exempt status of FCMs and floor brokers will
depend upon whether a substantial portion of their business consists
of transactions with persons other than broker-dealers. In the
current open-outcry environment, the Board believes that floor
traders act as market makers and therefore would be exempt. The
Board expects to have further discussions with the Commissions to
identify the conditions under which floor traders would act as
market makers in an electronic trading environment.
The Board requests that the Commodity Futures Trading Commission
and the Securities Exchange Commission, either jointly or severally,
report to the Board annually on their experience exercising the
delegated authority. In particular, the Board requests that the
Commissions provide an assessment of progress toward adopting more
risk-sensitive, portfolio-based approaches to margining security
futures products. The Board has encouraged the development of such
approaches by, for example, amending its Regulation T so that
portfolio margining systems approved by the Securities Exchange
Commission 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.
Very truly yours,
Jennifer J. Johnson,
Secretary of the Board.
[FR Doc. 01-24574 Filed 10-3-01; 8:45 am]
BILLING CODES 6351-01-P; 8010-01-P