[Federal Register Volume 60, Number 22 (Thursday, February 2, 1995)]
[Notices]
[Pages 6577-6579]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 95-2553]



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SECURITIES AND EXCHANGE COMMISSION
[Release No. 34-35282; File No. SR-CBOE-94-53]


Self-Regulatory Organizations; Notice of Filing of Proposed Rule 
Change by the Chicago Board Options Exchange, Inc. Relating to a 
Determination of the Exchange's Office of the Chairman Pursuant to 
Exchange Rule 4.10(b)(3) That Certain Financial Requirements be Imposed 
Upon Member Organizations That Clear Options Market Maker Transactions

January 26, 1995.
    Pursuant to Section 19(b)(1) of the Securities Exchange Act of 1934 
(``Act''),\1\ notice is hereby given that on December 22, 1994, the 
Chicago Board Options Exchange, Inc. (``CBOE'' or ``Exchange'') filed 
with the Securities and Exchange Commission (``Commission'') the 
proposed rule change as described in Items I, II, and III below, which 
Items have been prepared by the self-regulatory organization. The 
Commission is publishing this notice to solicit comments on the 
proposed rule change from interested persons.

    \1\15 U.S.C. 78s(b)(1) (1988).
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I. Self-Regulatory Organization's Statement of the Terms of Substance 
of the Proposed Rule Change

    The CBOE proposes to issue a regulatory circular (``Regulatory 
Circular'') concerning a determination by the Exchange's Office of the 
Chairman pursuant to Exchange Rule 4.10(b)(3) that certain financial 
requirements be imposed upon member organizations that clear options 
market maker transactions.\2\

    \2\The proposed Regulatory Circular is available from the 
Commission and the CBOE. See infra Part IV.
II. Self-Regulatory Organization's Statement of the Purpose of, and 
Statutory Basis for, the Proposed Rule Change

    In its filing with the Commission, the self-regulatory organization 
included statements concerning the purpose of and basis for the 
proposed rule change and discussed any comments it received on the 
proposed rule change. The text of these statements may be examined at 
the places specified in Item IV below. The self-regulatory organization 
has prepared summaries, set forth in Sections (A), (B) and (C) below, 
of the most significant aspects of such statements.

(A) Self-Regulatory Organization's Statement of the Purpose of, and 
Statutory Basis for, the Proposed Rule Change

    The purpose of the proposed Regulatory Circular is to inform the 
Exchange's membership that, acting pursuant to its authority under Rule 
4.10(b)(3), the Office of the Chairman has determined that it is 
necessary to impose certain financial requirements upon Exchange 
members that clear the transactions of options market makers. The 
Exchange believes that for such members to continue in business without 
such requirements has the potential to threaten the financial integrity 
of Exchange market maker transactions.\3\ The Office of the Chairman 
has determined that the current method of calculating options 

[[Page 6578]]
market maker haircuts under Rule 15c3-1(c)(2)(x) of the Act is less 
effective in that many hedged positions receive haircuts which are 
excessive while the haircuts for uncovered positions do not adequately 
reflect their potential risk.\4\

    \3\Exchange Rule 4.10(b)(3) provides that the Office of the 
Chairman may impose additional financial and operational 
requirements on a member that clears market maker trades when the 
Office of the Chairman determines that the member's continuance in 
business without such requirements has the potential to threaten the 
financial or operational integrity of Exchange market maker 
transactions. Rule 4.10(b)(7) provides that the Exchange shall file 
notice with the Commission in accordance with the provisions of 
Section 19(d)(1) of the Act of all final decisions to impose 
extraordinary requirements pursuant to Rule 4.10(b)(3). In addition, 
the Exchange has elected to file the Regulatory Circular as a 
proposed rule change under Section 19(b)(1) of the Act.
    \4\The Exchange believes that the Commission and the Division of 
Market Regulation (``Division'') share its concerns. In Chapter 5 of 
the staff's report concerning capital adequacy during the 1987 
Market Break, the staff stated that, ``The substantial losses of 
market makers * * * demonstrate that the present net capital 
treatment accorded to short options positions is inadequate to 
insure against the risk of major market movements.''
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    As reflected in the Regulatory Circular, the Office of the Chairman 
has determined to require all exchange members that clear options 
market maker transactions on a proprietary or market maker customer 
basis to calculate options market maker haircuts in accordance with a 
haircut methodology developed jointly by the Exchange and the Options 
Clearing Corporation (``OCC'') and based upon the theoretical options 
pricing model of Cox-Ross-Rubinstein.\5\ The haircut treatment imposed 
by the Office of the Chairman is the same as that described in a recent 
Division no-action letter.\6\ The Office of the Chairman also has 
determined to allow an alternative calculation of haircuts for stock 
index baskets in accordance with the Division's staff no-action letter 
dated February 27, 1986.\7\ Although the 1986 no-action letter requires 
an operationally more cumbersome calculation, the Exchange believes the 
resulting lower haircuts more effectively recognize the hedging 
benefits of partial stock baskets offset by options and futures.

    \5\See letter from Mary L. Bender, First Vice President, CBOE, 
and John C. Hiatt, Executive Vice President, OCC, to Michael 
Macchiaroli, Associate Director, Division, Commission, dated May 7, 
1993.
    \6\See letter from Brandon Becker, Director, Division, 
Commission, to Mary L. Bender, First Vice President, CBOE, and 
Timothy Hinkes, Vice President, OCC, dated March 15, 1994. See also 
Securities Exchange Act Release No. 33761 (March 15, 1994), 59 FR 
13275 (Proposed Rule Amendments to Capital Requirements for Brokers 
or Dealers Under the Securities Exchange Act of 1934).
    \7\See letter from Michael A. Macchiaroli, Assistant Director, 
Division, Commission, to David Marcus, Executive Vice President, 
Regulatory Services Group, New York Stock Exchange, Inc., dated 
February 27, 1986.
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    To the extent that this Exchange imposed haircut treatment would 
result in lower charges than currently required by Rule 15c3-1 under 
the Act, the February 27, 1986 and March 15, 1994 no-action letters 
provide the basis for the lower charges. To the extent that the 
Exchange imposed haircut treatment would result in higher haircuts, 
such greater requirements are being imposed pursuant to the Exchange's 
authority under its Rule 4.10(b)(3).
    To date, all but two Exchange members which clear the transactions 
of independent options market makers are calculating haircuts pursuant 
to the methodology described in this filing. We understand that the 
remaining two Exchange members are currently taking the operational 
steps necessary to comply with these parameters, and that these firms 
will be operationally prepared to calculate haircuts under these 
parameters by no later than early January 1995.
    All Exchange market makers have been provided timely and adequate 
notice of the impending haircut changes through Exchange regulatory 
circulars and direct communication from their clearing members. The 
Exchange also provided several opportunities for special meetings with 
Exchange Financial Compliance staff to discuss the impact of the 
haircut changes. The new haircuts and implementation plan were also 
discussed at numerous meetings of the Exchange's Clearing Procedures 
Committee. The expected impact of risk-based haircuts was also 
discussed at a general meeting open to all Exchange members. It is our 
understanding that market makers on other exchanges have also been 
advised of the new charges. The implementation has proceeded 
smoothly.\8\

    \8\The new haircut methodology has been implemented at options 
market maker clearing firms on a staggered basis subsequent to 
thorough testing of each firm's capabilities by the Exchange, OCC, 
and other designated examining authorities. The first three firms 
began using the new haircuts on May 6, 1994. Other implementation 
dates were May 27, June 3, June 24, July 1, and July 22, 1994. The 
last two firms which clear independent options market makers are 
expected to have the operational capability to begin using the new 
haircut methodology sometime in the first quarter of 1995. One self-
clearing broker-dealer also is preparing to implement risk-based 
haircuts; options market making is not a material part of the firm's 
business and a date for implementation has not yet been scheduled.
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    The Exchange believes that the imposition of these financial 
requirements is within the Exchange's authority, and that these 
requirements represent a more rigorous and reasoned basis upon which to 
assess capital charges. All market maker clearing firms are expected to 
be using the revised methodology of calculating haircuts by early 
January 1995. Nevertheless, the Office of the Chairman is using its 
authority under Rule 4.10(b)(3) to make it clear that the revised 
haircut treatment will be imposed now and equally across all positions 
of all options market makers, pending the Commission's consideration of 
a proposed rule to impose a similar haircut treatment upon all broker-
dealers.\9\

    \9\See supra note 6.
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    The Exchange believes that its proposal is consistent with and 
furthers the objectives of Section 6(b)(5) of the Act in that it will 
promote maintenance of fair and orderly markets and will contribute to 
the protection of investors and the public interest.

(B) Self-Regulatory Organization's Statement on Burden on Competition

    CBOE does not believe that the proposed rule change will impose any 
burden on competition.

(C) Self-Regulatory Organization's Statement on Comments on the 
Proposed Rule Change Received From Members, Participants, or Others

    Written comments on the proposed rule change were neither solicited 
nor received.

III. Date of Effectiveness of the Proposed Rule Change and Timing 
for Commission Action

    Within 35 days of the date of publication of this notice in the 
Federal Register or within such longer period (i) as the Commission may 
designate up to 90 days of such date if it finds such longer period to 
be appropriate and publishes its reasons for so finding or (ii) as to 
which the self-regulatory organization consents, the Commission will:
    (a) By order approve such proposed rule change, or
    (b) Institute proceedings to determine whether the proposed rule 
change should be disapproved.

IV. Solicitation of Comments

    Interested persons are invited to submit written data, views and 
arguments concerning the foregoing. Persons making written submissions 
should file six copies thereof with the Secretary, Securities and 
Exchange Commission, 450 Fifth Street NW., Washington, DC 20549. Copies 
of the submission, all subsequent amendments, all written statements 
with respect to the proposed rule change that are filed with the 
Commission, and all written communications relating to the proposed 
rule change between the Commission and any person, other than those 
that may be withheld from the public in accordance with the provisions 
of 5 U.S.C. 552, will be available for inspection and copying in the 
Commission's Public Reference Section, 450 Fifth Street NW., 
Washington, DC. Copies of such filing 

[[Page 6579]]
will also be available for inspection and copying at the principal 
office of the above-mentioned self-regulatory organization. All 
submissions should refer to File No. SR-CBOE-94-53 and should be 
submitted by February 23, 1995.

    For the Commission, by the Division of Market Regulation, 
pursuant to delegated authority.\10\

    \10\17 CFR 200.30-3(a)(12) (1994).
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Margaret H. McFarland,
Deputy Secretary.
[FR Doc. 95-2553 Filed 2-1-95; 8:45 am]
BILLING CODE 8010-01-M