[Federal Register Volume 66, Number 193 (Thursday, October 4, 2001)]
[Proposed Rules]
[Pages 50720-50741]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 01-24574]



[[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

  Federal Register / Vol. 66 , No. 193 / Thursday, October 4, 2001 / 
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