[Federal Register Volume 64, Number 218 (Friday, November 12, 1999)]
[Notices]
[Pages 61682-61685]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 99-29599]


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SECURITIES AND EXCHANGE COMMISSION

[Release No. 34-42093; International Series Release No. 1209; File No. 
SR-Phlx-99-30]


Self-Regulatory Organizations; Notice of Filing of the Proposed 
Rule Change and Order Granting Partial Accelerated Approval of 
Amendment No. 1 to the Proposed Rule Change by the Philadelphia Stock 
Exchange, Inc. Relating to Non-Customized Cross-Rate Foreign Currency 
Options Margin Levels

November 3, 1999.
    Pursuant to Section 19(b)(1) of the Securities Exchange Act of 1934 
(``Act''),\1\ and Rule 19b-4 thereunder,\2\ notice is hereby given that 
on August 5, 1999, the Philadelphia Stock Exchange, Inc. (``Phlx'' and 
``Exchange'') filed with the Securities and Exchange Commission 
(``SEC'' or ``Commission'') the proposed rule change as described in 
Item I, II, and III below which Items have been prepared by the 
Exchange. On October 26, 1999, the Exchange filed Amendment No. 1 to 
the proposed rule change.\3\ The Commission is publishing this notice 
to solicit comments on the proposed rule change from interested persons 
and to grant partial accelerated approval to permit the continued use 
of the existing four percent add-on margin for non-customized Cross-
Rate FCOs until February 4, 2000.
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    \1\ 15 U.S.C. 78s(b)(1).
    \2\ 17 CFR 240.19b-4.
    \3\ In Amendment No. 1, the Exchange requested accelerated 
approval from the Commission to temporarily extend the 4% add-on 
margin for all non-customized cross-rate foreign currency options 
until February 4, 2000; provided statistical data to substantiate 
the proposed rule change; and made substantive rule changes to the 
proposed rule text. See Letter from Nandita Yagnik, Counsel, Phlx, 
to Hong-anh Tran, Attorney, Division of Market Regulation 
(``Division''), Commission, dated October 25, 1999 (``Amendment No. 
1'').
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I. Self-Regulatory Organization's Statement of the Terms of 
Substance of the Proposed Rule Change

    The Exchange proposed to amend Phlx Rule 722(d) to determine the 
add-on margin levels for non-customized cross-rate foreign currency 
options (``Cross-Rate FOCs'') using the methodology outlined in 
Commentary .16 to that Rule, in lieu of the fixed four percent rate 
that the Exchange currently uses. In the interim, the Exchange requests 
that the Commission approve, on an accelerated basis, the continued use 
of the existing four percent add-on margin for non-customized Cross-
Rate FCOs until February 4, 2000.\4\
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    \4\ SeeAmendment No. 1, supra note 3. Non-customized options 
carry specific contract terms for features such as contract size, 
strike price intervals, expiration date, price quoting and premium 
settlement.
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    The text of the proposed rule change follows. Proposed new language 
is italicized; proposed deletions are in [brackets].

Margin Accounts

    Rule 722 (a)-(c)--No change.
    (d) 1-2--No change.
    3. Short Positions--Listed Options and Currency, Currency Index 
or Stock Index Warrants. Subject to the exceptions set forth below, 
the margin on any put or call option listed or traded on a 
registered national securities exchange or association and issued by 
a registered clearing corporation or any currency warrant, currency 
index warrant or stock index warrant which is issued, guaranteed or 
carried ``short'' in a customer's account shall be 100% of the 
current market value of the option or warrant plus the percentage of 
the current market value of the underlying security, foreign 
currency or index specified in column II below.
    Notwithstanding the margin required below, the minimum margin on 
any put or call or any warrant issued, guaranteed or carried 
``short'' in a customer's account may be reduced by any ``out-of-
the-money-amount'' (as defined below), but shall not be less than 
100% of the current market value of the option or warrant plus the 
percentage of the current market value of the underlying security, 
foreign currency or index specified in column III below with the 
exception that the minimum margin required on each such put option 
contract shall not be less than the current option market value plus 
the minimum percentage set forth in column III of the option's 
aggregate exercise price amount.

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                                           II  Initial and/
                                            or maintenance     III  Minimum
            I  Type of option                   margin            margin        IV  Underlying  component  value
                                               required     required(percent)
                                              (percent)
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(1) Stock................................               20                10   The equivalent number of shares
                                                                                at current market prices.
(2) Industry Index Stock Group...........               20                10   The product of the current index
                                                                                group value and the applicable
                                                                                index multiplier.
(a) Super Cap Index......................               20                10   The product of the current index
                                                                                group value and the applicable
                                                                                index multiplier.
(3) Broad Index stock group..............               15                10   The product of the current index
                                                                                group value and the applicable
                                                                                index multiplier.
(4) Foreign Currencies...................                1             \3/4\   The product of Units per foreign
                                                                                currency contract and the
                                                                                closing spot price.

[[Page 61683]]

 
(5) Cross-Rate...........................           2 [4%]             \3/4\   The product of Units per cross-
                                                                                rate contract and the closing
                                                                                spot price.
(6) Tier I Customized Cross-rate currency                4             \3/4\   The product of Units per cross-
 options.                                                                       rate contract and the closing
                                                                                spot price.
(7) Tier II Customized Cross-rate                        6             \3/4\   The product of Units per cross-
 currency options.                                                              rate contract and the closing
                                                                                spot price.
(8) Tier III Customized Cross-rate                       7             \3/4\   The product of Units per cross-
 currency options.                                                              rate contract and the closing
                                                                                spot price.
(9) Tier IV Customized Cross-rate                       17             \3/4\   The product of Units per cross-
 currency options.                                                              rate contract and the closing
                                                                                spot price.
(10) Broad Stock Index Warrant...........               15                10   The stock index group value.
(11) Industry Stock Index Warrant........               20                10   The stock index group value.
(12) Currency Warrant....................  ...............  .................  The product of units of
                                                                                underlying currency per warrant
                                                                                and the closing spot price for
                                                                                each of the currencies below.
Australian dollar........................                4             \3/4\   .................................
British pound............................                4             \3/4\   .................................
Canadian dollar..........................                4             \3/4\   .................................
German mark..............................                4             \3/4\   .................................
ECU......................................                4             \3/4\   .................................
French franc.............................                4             \3/4\   .................................
Japanese yen.............................              4 3             \3/4\   .................................
Swiss franc..............................                4             \3/4\   .................................
(13) Currency Index Warrant..............               **                **   The currency index group value.
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1 The margin requirement for foreign currency options will be determined pursuant to Commentary .16 of this Rule
  722.
2 The margin requirement for non-customized cross-rate foreign currency options will be determined pursuant to
  Commentary .16 of this Rule 722.
3 Currency index warrant margin will be determined on a case-by-case basis as approved by the Securities and
  Exchange Commission.

    For purposes of this sub-section (d)(3), ``out-of-the-money 
amounts'' are determined as follows:
    Option Issue--no change.
    4.5--No change.
    (e)--(i) No change.
    Commentary .01--15 No change.
    Commentary .16:
    .16--The margin requirement for any foreign currency put or call 
option listed or traded on the Exchange and issued by a registered 
clearing corporation which is issued, guaranteed or carried 
``short'' in a customer's account, [except for cross-rate currency 
options,] shall be the amount provided in paragraph (d)(3) of this 
Rule 722 and shall be calculated as follows:
    (a) The Exchange will review five day price movements comparing 
base currency against the underlying currency over the most recent 
three year period for each foreign currency pair underlying options 
traded on the Exchange and will set a margin level which would have 
covered the price changes over the review period at least 97.5% of 
the time (``confidence level'').
    (b) Subsequent reviews of five day price changes over the most 
recent three year period will be performed quarterly on the 15th of 
January, April, July and October of each year.
    (c) If the results of subsequent reviews show that the 
confidence level for any currency has fallen below 97%, the Exchange 
will increase the margin requirement for that currency up to a 98% 
confidence level. If the results show a confidence level between 97% 
and 97.5%, the currency will be monitored monthly until the 
confidence level exceeds 97.5% for two consecutive months. If the 
results of a monthly review show that the confidence level has 
fallen below 97%, the margin requirement will be increased to a 98% 
confidence level. If the results of any review show that the 
confidence level has exceeded 98.5%, the margin level would be 
reduced to a level which would provide a 98% confidence level.
    (d) The Exchange will also review each currency pair for large 
price movements outside the margin level (``extreme outlier test''). 
If the results of any review show a price movement, either positive 
or negative, of greater than two times the current margin level, the 
margin requirement for that currency pair will be increased to a 
confidence level of 99%.
    (e) Pursuant to paragraph (i)(8) of this Rule 722, the Exchange 
may also conduct reviews of currency margin levels at any time that 
market conditions warrant.

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 Exchange 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 V below. The Exchange 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

1. Purpose
    In 1991, the Commission approved the Exchange's proposal to list 
and trade three non-customized Cross-Rate FCOs--German mark/Japanese 
yen, British pound/German mark and British pound/Japanese yen 
options.\5\ The Commission's 1991 order approved the proposed four 
percent add-on margin level for the Cross-Rate FCOs for a one-year 
period only, because FCOs were new products and the Commission was 
concerned that the volatility in the underlying currencies could change 
significantly. The Commission also stated that the Exchange should 
further analyze the add-on margin adequacy and, within nine months, 
submit the analysis along with a proposed rule change to retain the 
margin level or establish a new level.
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    \5\ See Securities Exchange Act Release No. 29919 (November 7, 
1991), 56 FR 58109 (November 5, 1991) (``1991 Order''). The Exchange 
received approval to list the British pound/Japanese yen Cross-rate 
FCO, but it has not listed such a contract.
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    Based on the 1991 Order, the Exchange's customer margin 
requirements for short positions for non-customized Cross-Rate FCOs 
equaled the add-on margin of four percent of the

[[Page 61684]]

current market value of the underlying FCO contract, plus 100 percent 
of the current market value of the option's premium, adjusted for 
``out-of-the-money-amounts,'' \6\ not to be less than 100 percent of 
the current options premium, plus a ``minimum add-on margin amount.'' 
\7\ The Exchange represented at the time that this add-on margin level 
was sufficient to cover each cross-rate product's historical price 
volatility over seven-day intervals (for the July 30, 1990 to July 30, 
1991 time period) with a confidence level of at least 96 percent.
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    \6\ For foreign currency put options, ``out-of-the-money-
amounts'' equal the aggregate exercise price of the option minus the 
product of units per foreign currency contract and the closing spot 
price. See Phlx Rule 722(d).
    For foreign currency call options, ``out-of-the-money-amounts'' 
equal the product of units per foreign currency contract and the 
closing spot price minus the aggregate exercise price of the option. 
See id.
    \7\ The minimum add-on margin on any call carried ``short'' in a 
customer's account is equal to \3/4\% of the current market value of 
the underlying FCO contract; the minimum add-on margin on any such 
put option contract is equal to \3/4\% of the option's aggregate 
exercise price amount. See id.
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    Due to an oversight, the Exchange did not file the required 
analysis of the adequacy of the add-on margin or the proposed rule 
change within nine months of the 1991 Order. Following this discovery, 
the Exchange filed, in 1999, a proposed rule change codifying the four 
percent add-on margin level for a three-month period while it 
considered a method of determining add-on margin, on a permanent basis, 
for all Cross-Rate FCOs.\8\ The Commission's 1999 Order permitted the 
Exchange to apply a four percent add-on margin level for all Cross-Rate 
FCOs for a six-month period until November 4, 1999.
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    \8\ See Securities Exchange Act Release No. 41365 (May 4, 1999), 
64 FR 25946 (May 13, 1999) (SR-Phlx-99-12) (``1999 Order'').
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    On August 5, 1999, the Exchange filed the current proposed rule 
change to determine the add-on margin levels for Cross-Rate FCOs using 
the methodology outlined in Commentary .16 to Phlx Rule 722, in lieu of 
the four percent rate that the Exchange currently uses. To apply the 
Commentary .16 methodology to each currency pair of a Cross-Rate FCO, 
the Exchange proposes to review five day price movements of the base 
currency relative to the underlying currency \9\ over the most recent 
three year period and would set an add-on margin level sufficient to 
cover those price changes at least 97.5 percent of the time. If 
subsequent quarterly reviews show that the existing add-on margin level 
for any cross-rate FCO currency pair provides a confidence level below 
97 percent, the Exchange would increase the add-on margin requirement 
for that currency pair to a level that would have covered those price 
movements at a 98 percent confidence level. If a subsequent quarterly 
review shows a confidence level between 97 percent and 97.5 percent, 
the add-on margin level would remain the same but would be subject to 
monthly follow-up reviews until the confidence level exceeds 97.5 
percent for two consecutive months (then the Exchange would put it back 
on the quarterly review cycle). If a monthly follow-up review showed 
that the confidence level dropped below 97 percent, the Exchange 
proposes to increase the add-on margin level to a 98 percent confidence 
level. Generally, if any review shows that the confidence level exceeds 
98.5 percent, the Exchange would reduce the add-on margin level to a 98 
percent confidence level. To account for the possibility of 
unexpectedly large price movements, if any review show that a Cross-
Rate FCO currency pair had a five-day price movement, either positive 
or negative, greater than two times the existing add-on margin level, 
the Exchange would set the add-on margin requirement for that currency 
pair to a 99 percent confidence level (``Extreme Outlier Test'').
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    \9\ The underlying currency is the currency in which a foreign 
currency option settles. The base currency is the currency in which 
premiums are quoted and paid.
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    In addition to the routine reviews described above, the Exchange 
would continue to have authority to impose a higher margin level at any 
time, if market conditions so warrant.\10\
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    \10\ See Phlx Rule 722(i)(8).
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    Following the quarterly reviews described above and at any time 
that a particular add-on margin level changes, the Exchange proposes to 
distribute memoranda to FCO participants announcing the add-on margin 
levels derived pursuant to the proposed methodology since the actual 
add-on margin requirements for all Cross-Rate FCOs would no longer be 
stated in Phlx Rule 722.
    The Exchange subsequently filed on October 26, 1999 an amendment to 
the proposed rule change requesting that the Commission approve the 
extension of the use of a four percent add-on margin for all non-
customized Cross-Rate FCOs until February 4, 2000, to provide 
additional time for the Commission to consider the proposed rule 
change.\11\ The Exchange requests that the Commission approves the 
interim extension of the existing four percent rate, on an accelerated 
basis, to ensure that trading of these products may continue following 
November 4, 1999, when the existing four percent add-on margin expires.
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    \11\ See Amendment No. 1, supra note 3.
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2. Statutory Basis
    The Exchange believes that the proposed rule change is consistent 
with Section 6 of the Act \12\ in general, and in particular, with 
Section 6(b)(5),\13\ in that it is designed to facilitate transactions 
in securities, to remove impediments to and perfect the mechanism of a 
free and open market and a national market system, as well as to 
protect investors and the public interest by providing a margin level 
which is directly related to the currency risk incurred by customers 
trading these Cross-Rate FCO products. In particular, the Exchange 
believes that the proposal is identical with the method of determining 
margin calculation for non-customized foreign currency options where 
the base currency is denominated in U.S. dollars (``non-customized 
dollar-based FCOs''). The Exchange believes that this margin 
methodology, coupled with the extreme outlier test, should ensure 
adequate margin requirements for Cross-Rate FCOs.
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    \12\ 15 U.S.C. 78f(b).
    \13\ 15 U.S.C. 78f(b)(5).
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B. Self-Regulatory Organization's Statement on Burden on Competition

    The Exchange believes that the proposed rule change does not impose 
any burden on competition that is not necessary or appropriate in 
furtherance of the purposes of the Act.

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

    No written comments were either solicited or 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 Exchange 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.

[[Page 61685]]

IV. Commission Findings and Order Granting Accelerated Approval of 
the Temporary Extension of the Add-On Margin

    The Exchange requested that the Commission approve the extension of 
the four percent add-on margin for non-customized Cross-Rate FCOs until 
February 4, 2000, prior to the thirtieth day after the publication of 
the notice of this proposal in the Federal Register. The Exchange 
requested this extension to ensure that trading of these products may 
continue following November 4, 1999, when the existing four percent 
add-on margin expires. The Commission finds that the Exchange's request 
to extend the use of the four percent add-on margin for all non-
customized Cross-Rate FCOs until February 4, 2000 is consistent with 
the requirements of Section 6 of the Act and the rules and regulations 
thereunder applicable to a national securities exchange.\14\ 
Specifically, the Commission finds that the proposal to temporarily 
continue to use the four percent add-on margin for all non-customized 
Cross-Rate FCOs is consistent with Section 6(b)(5) of the Act \15\ 
because it will facilitate transactions in securities, promote just and 
equitable principles of trade, and protect investors and the public 
interest. The Exchange has used the existing four percent add-on rate 
since 1991 to trade Cross-Rate FCOs. The Exchange has recently provided 
the commission statistical data that indicates that the existing four 
percent margin has been adequate to cover five-day fluctuations for 
both currently listed Cross-Rate FCO currency pairs over 97 percent of 
the time over the past three years. This extension will also provide 
the Commission with additional time to consider the proposed rule 
change, while permitting the Exchange to trade these cross-rate FCOs 
products following November 4, 1999. For these reasons, the Commission 
finds good cause for approving the request for interim extension of the 
existing four percent add-on margin prior to the thirtieth day after 
the publication of notice thereof in the Federal Register.
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    \14\ In approving the temporary extension of the add-on-margin, 
the Commission has considered the rule's impact on efficiency, 
competition and capita formation. 15 U.S.C. 78c(f).
    \15\15 USC. 78f(b)(5).
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V. Solicitation of Comments

    Interested persons are invited to submit written data, views and 
arguments concerning the foregoing, including whether the proposed rule 
change is consistent with the Act. Persons making written submissions 
should file six copies thereof with the Secretary, Securities and 
Exchange Commission, 450 Fifth Street, NW, Washington, DC 20549-0609. 
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 Room. Copies of such filing will also be 
available for inspection and copying at the principal office of the 
Phix. All submissions should refer to File No. SR-Phix-99-30 and should 
be submitted by December 3, 1999.

VI. Conclusion

    It is therefore ordered, pursuant to Section 19(b)(2) of the 
Act,\16\ that the continued use of the existing four percent add-on 
margin for all non-customized Cross-Rate FCOs until February 4, 2000 is 
hereby approved on an accelerated basis.\17\

    \16\ 15 U.S.C. 78s(b)(2).
    \17\ In approving the proposal, the Commission has considered 
the rule's impact on efficiency, competition and capital formation. 
15 U.S.C. 78c(f).

    For the Commission by the Division of Market Regulation, 
pursuant to delegated authority.\18\
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    \18\ 17 CFR 200.30-3(a)(12).
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Margaret H. McFarland,
Deputy Secretary.
[FR Doc. 99-29599 Filed 11-10-99; 8:45 am]
BILLING CODE 8010-01-M