[Federal Register Volume 67, Number 61 (Friday, March 29, 2002)]
[Notices]
[Pages 15263-15268]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 02-7609]


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SECURITIES AND EXCHANGE COMMISSION

[Release No. 34-45630; File No. SR-CBOE-2002-03]


Self-Regulatory Organizations; Notice of Filing of Proposed Rule 
Change by the Chicago Board Options Exchange, Incorporated Relating to 
Customer Portfolio and Cross-Margining Requirements

March 22, 2002.
    Pursuant to section 19(b)(1) of the Securities Exchange Act of 1934 
(``Act'')\1\ and Rule 19b-4 thereunder,\2\ notice is hereby given that 
on January 15, 2002, the Chicago Board Options Exchange, Inc. (``CBOE'' 
or ``Exchange'') filed with the Securities and Exchange Commission 
(``SEC'' or ``Commission'') the proposed rule change as described in 
Items I, II, and III below, which Items have been prepared by the CBOE. 
The Commission is publishing this notice to solicit comments on the 
proposed rule change from interested persons.
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    \1\ 15 U.S.C. 78s(b)(1).
    \2\ 17 CFR 240.19b-4.
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I. Self-Regulatory Organization's Statement of the Terms of 
Substance of the Proposed Rule Change

    The CBOE proposes to amend its rules, for certain customer 
accounts, to allow member organizations to margin listed, broad-based, 
market index options, index warrants and related exchange-traded funds 
according to a portfolio margin methodology as an alternative to the 
current strategy-based margin methodology. The proposed rule change 
will also provide for cross-margining by allowing broad-based index 
futures and options on such futures to be included with listed, broad-
based index options, index warrants and related exchange-traded funds 
for portfolio margin treatment.
    The text of the proposed rule change is available at the Office of 
the Secretary, CBOE, at the Commission, and on the Commission's 
website.

II. Self-Regulatory Organization's Statement of the Purpose of, and 
Statutory Basis for, the Proposed Rule Change

    In its filing with the Commission, the CBOE included statements 
concerning the purpose of and basis for the proposed rule change and 
discussed any comments it received on the proposed rule change. The 
text of these statements may be examined at the places specified in 
Item IV below. The CBOE has prepared summaries, set forth in

[[Page 15264]]

Sections A, B, and C below, of the most significant aspects of such 
statements.

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

1. Purpose
a. Introduction
    The CBOE proposes to expand its margin rules by providing a 
portfolio margin methodology for listed, broad-based market index 
options, index warrants and related exchange-traded funds that clearing 
member organizations may extend to eligible customers as an alternative 
to the current strategy-based option margin requirements. The proposed 
rule change would also allow broad-based index futures and options on 
such futures to be included in a portfolio margin account, thus 
providing a cross-margin capability. The CBOE seeks to introduce the 
proposed new rule as a two-year pilot program that would be made 
available to member organizations on a voluntary basis.
    The proposed rule change would permit self-clearing member 
organizations to apply a prescribed portfolio margin methodology to an 
account\3\ of an affiliate, another broker-dealer, and an account of a 
member of a national futures exchange who is a futures floor trader. 
Any other customers of the clearing member would be required to have 
account equity of at least $5 million to be eligible for portfolio 
margin treatment. This circumscribes the number of accounts able to 
participate and adds safety in that such accounts are more likely to be 
of significant financial means and investment sophistication. Further, 
portfolio margining is most effective when applied to larger accounts 
with diverse option positions and related securities, and any related 
futures contracts. It is expected that institutional customers will be 
the primary participants. Whether the account equity requirement should 
be lowered to allow participation of more customers will be assessed at 
the end of the pilot program period. Application of portfolio margin, 
including cross-margin, to an IRA account would be prohibited under the 
proposed rule change.
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    \3\ An account dedicated to portfolio margining.
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    The proposed portfolio margin and cross-margin rules have been 
developed by the CBOE in cooperation with The Options Clearing 
Corporation (``The OCC''), the New York Stock Exchange, Inc. 
(``NYSE''), the American Stock Exchange, LLC (``AMEX''), the Board of 
Trade of the City of Chicago, Inc. (``CBOT''), and the Chicago 
Mercantile Exchange, Inc. (``CME''). The CBOE intends to provide a 
written overview describing the operational details of the portfolio 
margin and cross-margin pilot program to potential member organization 
participants to introduce and explain the pilot program.
    A committee of representatives from the member organizations 
identified as potential participants, and staff of the sponsoring 
exchanges and The OCC (the ``Portfolio Margin Committee'') was formed 
and met several times in 1999 and 2000 to refine the portfolio margin 
and cross-margin pilot program. This group has recommended adoption of 
the portfolio margin and cross-margin pilot program, as finalized by 
the group, and the related rule proposals. In addition, the portfolio 
margin and cross-margin pilot program has been presented to the NYSE's 
Rule 431 Committee \4\ on two occasions, with draft rules included on 
the second occasion, and has received the NYSE's Rule 431 Committee's 
support.
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    \4\ The NYSE Rule 431 Committee is comprised of securities 
industry representatives, primarily representatives of NYSE member 
organizations. NYSE Rule 431 contains the NYSE's margin rules. The 
function of the NYSE Rule 431 Committee is to assess the adequacy of 
NYSE Rule 431 on an ongoing basis, review proposals for changes to 
NYSE Rule 431, and recommend changes that are deemed appropriate.
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b. Overview--Portfolio Margin Computation

(1) Portfolio Margin
    Under a portfolio margin system, margin is required based on the 
greatest loss that would be incurred in a portfolio if the value of 
components (underlying instruments in the case of options) move up or 
down by a predetermined amount (e.g., +/-5%). Under the Exchange's 
proposed portfolio margin rule, listed index options and underlying 
instruments (also related instruments \5\ in the case of a cross-margin 
account) would be grouped by class \6\ (e.g., S&P 500, S&P 100, etc), 
each class group being a portfolio.\7\ The gain or loss on each 
position in a portfolio would be calculated at each of 10 equidistant 
points (``valuation points'') set at and between the upper and lower 
market range points. A theoretical options pricing model would be used 
to derive position values \8\ at each valuation point for the purpose 
of determining the gain or loss. Gains and losses would then be netted 
for positions within the class or portfolio at each valuation point. 
The greatest net loss among the 10 valuation points would be the margin 
required on the portfolio or class. The margin for all other portfolios 
within an account would be calculated in a similar manner. Broad-based 
index classes (portfolios) that are highly correlated would be allowed 
offsets such that, at the same valuation point, for example, 90% of a 
gain in one class may reduce or offset a loss in another class. The 
amount of offset allowed between portfolios would be the same amount 
that is permitted under the risk-based haircut methodology set forth in 
Appendix A of the Commission's net capital rule.\9\ A per contract 
minimum would be established and would override if a lesser requirement 
is rendered by the portfolio margin computation.\10\
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    \5\ Under the proposed rule change, the term ``related 
instrument'' would mean, with respect to an options class or product 
group, futures contracts and options on futures contracts covering 
the same underlying instrument.
    \6\ Under the proposed rule change, the term ``options class'' 
would refer to all options contracts covering the same underlying 
instrument.
    \7\ CBOE's pilot program would permit an exchange-traded fund 
structured to replicate the composition of the index to be included; 
however, stock baskets would not be permitted at this time.
    \8\ Position values would represent the difference between the 
position closing price and the theoretical value at each valuation 
point.
    \9\ Rule 15c3-1a under the Act, 17 CFR 240.15c3-1a.
    \10\ The proposed rules set a per contract minimum of $37.50.
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    Member organizations would not be permitted to use any theoretical 
pricing model to generate the prices used to calculate theoretical 
profits and losses. Under the proposed rule change, the theoretical 
prices used for computing profits and losses must come from a 
theoretical pricing model that, pursuant to the Commission's net 
capital rule,\11\ qualifies for purposes of determining the amount to 
be deducted in computing net capital under a portfolio-based 
methodology. CBOE believes that delineating acceptable theoretical 
pricing models is best achieved by applying the Commission's net 
capital rule by reference. In this way, consistency with the 
Commission's net capital rule is maintained. In addition, since 
theoretical pricing models must be approved by a Designated Examining 
Authority (``DEA'') and reviewed by the Commission to qualify, 
uniformity across models can be assured. As a result, portfolio margin 
and cross-margin requirements will not vary materially from firm to 
firm. Currently, the theoretical model used by The OCC is the only 
model qualified pursuant to the Commission's net capital rule.

[[Page 15265]]

Consequently, all member organizations participating in the pilot 
program would, at least for the foreseeable future, obtain their 
theoretical values from The OCC.
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    \11\ See Rule 15c3-1a(b)(1)(i)(B) under the Act, 17 CFR 
240.15c3-1a(b)(1)(i)(B).
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    The Exchange's proposed rule would propose a market range of +/-10% 
for computing theoretical gains and losses in broad-based, non-high 
capitalization index portfolios. A market range of +6%/-8% is proposed 
for broad-based, high capitalization index portfolios.\12\ These are 
the same ranges currently applied to options market makers for the 
purpose of computing portfolio or risk-based haircuts. On a historical 
basis, these ranges cover one day moves at a very high level of 
confidence, and would be competitive with the market range coverage 
applied for performance bond (margin) purposes in the futures industry 
on comparable index futures. The proposed rule change requires that a 
separate securities margin account (or subaccount of a securities 
margin account) be used for portfolio margining.
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    \12\ CBOE believes that it is imperative that these market move 
ranges be competitive with the range used in the futures industry 
for computing margin (performance bond) on broad-based index 
futures. The proposed ranges accomplish this goal. Customer 
performance bond in the futures industry is computed using a 
portfolio margining system known as the Standard Portfolio Analysis 
of Risk (``SPAN''). The terms ``high capitalization'' and ``non-high 
capitalization'' have the same meaning as they do for the purposes 
of risk-based haircuts (Rule 15c3-1 under the Act, 17 CFR 240.15c3-
1).
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(2) Cross-Margining
    Related index futures and options on such futures would be allowed 
to be carried in the portfolio margin account, thus affording a cross-
margin capability. Alternatively, the proposed rule change permits a 
clearing member to establish a separate portfolio margin account 
(securities margin account) exclusively for cross-margining. In a 
portfolio margin account, including one that is used exclusively for 
cross-margining, constituent portfolios may be formed containing index 
options, index warrants and exchange-traded funds structured to 
replicate the composition of the index underlying a particular 
portfolio, as well as related index futures and options on such 
futures. Cross-margining would operate similar to the cross-margin 
program that was approved by the Commission and the Commodity Futures 
Trading Commission (``CFTC'') for listed options market-makers and 
proprietary accounts of clearing member organizations. There is one 
major difference in that a securities account would be used instead of 
a futures account and, therefore, SEC customer protection rules and 
insurance coverage by the Securities Investor Protection Corporation 
(``SIPC'') would apply instead of CFTC rules concerning customer 
protection and liquidation proceedings. For determining theoretical 
gains and losses, and resultant margin requirements, the same portfolio 
margin computation program will be applied to portfolio margin accounts 
that contain a cross-margin element, to portfolio margin accounts that 
do not contain a cross-margin element, and to portfolio margin accounts 
used exclusively for cross-margining.

c. Margin or Minimum Equity Deficiency

    Under proposed CBOE Rule 12.4(h), positions in a portfolio margin 
account would be valued at current market prices, as currently defined 
in the Exchange's margin rules. Under the proposed rule change, account 
equity would be calculated and maintained separately for each portfolio 
margin account. For purposes of the $5 million minimum account equity 
requirement, all accounts owned by an individual or entity may be 
combined. Proposed CBOE Rule 12.4(i) requires that additional margin 
must be obtained with one business day (T+1) whenever equity is below 
the margin required, regardless of whether the deficiency is caused by 
the addition of new positions, the effect of unfavorable market 
movement on existing positions, or a combination of both. The portfolio 
margin requirement, therefore, would be both the initial and 
maintenance margin requirement, and no differentiation would be 
necessary. In addition, proposed CBOE Rule 12.4(g) would require that, 
in the event account equity falls below the $5 million minimum, 
additional equity must be deposited within 3 business days (T+3). If 
the deficiency were not resolved within 3 business days, the carrying 
member organization would be prohibited under the proposed rule change 
from accepting any new opening orders beginning on T+4, with the 
exception of opening orders that hedge existing positions. This 
prohibition would remain in effect until a $5 million equity was 
established.

d. Risk Disclosure Statement and Acknowledgement

    In addition, the Exchange proposes that member organizations 
provide every portfolio margin customer with a written risk disclosure 
statement at or prior to the initial opening of a portfolio margin 
account.\13\ This disclosure statement highlights the risks and 
operation of portfolio margin accounts, including cross-margining, and 
the differences between portfolio margin and strategy-based margin 
requirements. The disclosure statement is divided into two sections, 
one dealing with portfolio margining and the other with cross-
margining. The disclosure statement clearly notes that additional 
leverage is possible in an account margined on a portfolio basis in 
relation to strategy-based margin. Among other things, the disclosure 
statement covers who is eligible to open a portfolio margin account, 
the instruments that are allowed, and when deposits to meet margin and 
minimum equity are due. The fact that long option positions held in a 
portfolio margin account are not segregated, as they generally would be 
in the case of a regular margin account under the Commission's customer 
protection rules, is explained. Also included within the portfolio 
margin section is a summary list of the special risks of portfolio 
margin accounts, such as: increased leverage; shorter time for meeting 
margin; involuntary liquidation if margin not received; inability to 
calculate future margin requirements because of the data and 
calculations required; and that long positions are subject to a lien. 
The risks and operation of a cross-margin feature are outlined in the 
cross-margin section of the disclosure statement, and a summary list of 
the special risks associated with cross-margining is included.
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    \13\ Even a customer that engages exclusively in cross-margining 
is a portfolio margin customer, as the proposed rule change permits 
cross-margining to be conducted only by applying the portfolio 
margin methodology.
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    Further, at or prior to the time a portfolio margin account is 
initially opened, member organizations would be required to obtain a 
signed acknowledgement concerning portfolio margining in general from 
the customer. In addition, prior to accommodating cross-margining, 
member organizations would be required to obtain a second signed 
acknowledgement within the same time frame that pertains to cross-
margin.
    By signing the general acknowledgement required of all customers, 
the customer would attest to having read the disclosure statement and 
being aware of the fact that long option positions in a portfolio 
margin account (which includes cross-margin accounts) are not subject 
to the segregation requirements under the customer protection rules of 
the Commission, and would be subject to a lien by The OCC. In signing 
the

[[Page 15266]]

additional acknowledgement applicable to cross-margining, the customer 
would attest to having read the disclosure statement and being aware of 
the fact that futures positions are being carried in a securities 
account, are subject to the Commission's customer protection rules,\14\ 
and fall under the authority of the SIPC in the event the carrying 
broker-dealer becomes financially insolvent. Within Chapter 9 of the 
Exchange's rules (``Doing Business with the Public''), the Exchange 
would prescribe the format of the written disclosure statement and 
acknowledgements in proposed Exchange Rule 9.15(d)--Delivery of Current 
Options Disclosure Documents and Prospectus. Like a current Exchange 
rule that prescribes the format for a Special Statement for Uncovered 
Options Writers (CBOE Rule 9.15(c)), proposed Exchange Rule 9.15(d) 
would allow member organizations to develop their own format, provided 
it contains substantially similar information and it is approved in 
advance by the Exchange.
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    \14\ As disclosed in the general acknowledgement form (required 
of any portfolio or cross-margin customer), portfolio margin and 
cross-margin accounts operate pursuant to an exception to the 
customer protection rules in that fully paid long positions will not 
be segregated.
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e. Net Capital

    The Exchange also proposes to add a new requirement in CBOE Rule 
13.5 to mandate that the gross customer portfolio margin requirements 
of a broker-dealer may at no time exceed 1,000 percent of a carrying 
broker-dealer's net capital (a 10:1 ratio). This requirement is 
intended to place a ceiling on the amount of margin a broker-dealer can 
extend to its customers in relation to its net capital.

f. Internal Risk Monitoring Procedures

    The Exchange further proposes a separate, related rule that would 
require member organizations that carry portfolio margin or cross-
margin accounts to establish and maintain written procedures for 
assessing and monitoring the potential risks to their capital. 
Specifically, proposed CBOE Rule 15.8A (Risk Analysis of Portfolio 
Margin and Cross-Margin Accounts) would require that the member 
organization file and maintain its current procedures with its DEA, and 
provide the DEA with such information as the DEA may reasonably require 
regarding the member organization's risk analysis of any and all 
portfolio margin and cross-margin accounts carried for customers. 
Proposed CBOE Rule 15.8A would incorporate current Exchange Rule 15.8--
Risk Analysis of Market-Maker Accounts--by reference to require that 
the risk analysis be conducted in the same manner as prescribed in 
Exchange Rule 15.8. Additionally, proposed CBOE Rule 15.8A would set 
forth certain undertakings that must be included in the written 
procedures (e.g., review and approval of credit limits for each 
customer and across all accounts).
    Because member organizations would be required under the proposed 
rule change to have risk monitoring procedures, proposed CBOE Rule 
12.4(i) states that the current CBOE Rule 12.9--Meeting Margin Calls by 
Liquidation Prohibited--prohibiting excessive liquidations to meet 
margin requirements will not apply to portfolio margin and cross-margin 
accounts. Furthermore, given the proposed risk monitoring procedures, 
CBOE proposes that day trading margin requirements would not apply to 
portfolio margin and cross-margin accounts.\15\ Through these risk-
monitoring procedures, member organizations will be expected to oversee 
portfolio margin and cross-margin accounts for excessive liquidations 
and day trading and take appropriate action according to their 
procedures.
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    \15\ The CBOE currently does not have a day-trading margin rule. 
Accordingly, the proposal to make day trading margin requirements 
inapplicable to portfolio margin and cross-margin accounts would not 
apply until CBOE has filed, and the Commission has approved, a 
proposed rule change relating to day trading margin. Telephone 
conversation between Richard Lewandowski, Vice President, Division 
of Regulatory Services, CBOE, and Hong-Anh Tran, Special Counsel, 
Division of Market Regulation (``Division''), Commission, on 
February 12, 2002. The NYSE and the National Association of 
Securities Dealers, Inc. (``NASD'') have day trading margin rules 
and the CBOE does review its member organizations as necessary for 
compliance with day trading rules when the member is also a NYSE 
member or a NASD member.
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    It should be noted that the disclosure statement delivery 
requirement, the $5 million minimum equity requirement, and the next 
day deposit condition for additionally required margin were all added 
by the Portfolio Margin Committee. The Portfolio Margin Committee 
deemed these requirements prudent given that less margin is generally 
required under a portfolio margining approach than under the current 
strategy-based methodology, and these measures made the plan entirely 
acceptable to the member firm representatives.

g. Margin at the Clearing House Level \16\
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    \16\ The Commission anticipates that the clearing arrangements 
described in this section will be the subject of a separate proposed 
rule change filed by The OCC.
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    The Exchange proposes that all customer portfolio margin account 
transactions not involving a futures transaction (e.g., cross-margin) 
be cleared in one special omnibus account for the clearing firm at The 
OCC. In addition, the Exchange proposes that all transactions involving 
cross-margining, both the security and futures product, be cleared in 
one of two additional special omnibus accounts for cross-margining, 
depending on the entity that clears the futures product being cross-
margined. One cross-margin omnibus account corresponds to a cross-
margining agreement between The OCC, the CME and the New York Clearing 
Corporation. The other omnibus account corresponds to a cross-margining 
agreement between The OCC and the Board of Trade Clearing Corporation. 
The OCC will compute margin for the special omnibus accounts using the 
same portfolio margin methodology applied at the customer level. The 
OCC will continue to require full payment from the clearing firm for 
all long option positions. However, as previously noted, long positions 
will not be segregated like they are in the firm's regular customer 
range account at The OCC. This is necessary and preferred with a 
portfolio margining methodology because all long positions must be 
available for margin offset. Margin relief is based on a dollar offset 
basis as opposed to identifying specific contract to contract offsets 
under a strategy-based methodology. This may result in situations where 
the long positions of a given customer could serve to offset the risk 
in another customer's short position. Long positions would, therefore, 
be subject to The OCC lien. An OCC clearing member currently has the 
ability to unsegregate a long position in order to pair it with a short 
position (contract to contract basis) and form a qualified spread. 
Under the proposed treatment of long positions in a portfolio margin 
omnibus account at The OCC, all long positions would be unsegregated, 
freeing The OCC clearing member from the task of determining which long 
positions offset risk and from specifying each position to be 
unsegregated.

h. Rationale for Portfolio Margin

    Portfolio margining brings a modern approach to quantifying risk 
and offers a number of efficiencies. It eliminates the task of 
analyzing the portfolio and sorting it according to currently 
recognized strategies (e.g., spreads), and computing a margin 
requirement for each individual position or strategy. This process 
becomes quite cumbersome in an account with

[[Page 15267]]

multiple positions and complex strategies. More importantly, for a 
given market move, up or down, in a diverse portfolio there will be 
listed option positions that appreciate and other option positions that 
will depreciate. Under a portfolio margin system, offsets are fully 
realized, whereas, under the current strategy-based system, positions 
and/or a group of positions comprising a single strategy are margined 
independent of each other and offsets between them do not figure into 
the total margin requirement as efficiently. In addition, under a 
portfolio margin system, the volatility of an individual listed option 
series is used in the theoretical pricing model that renders the price 
used to compute a gain/loss on that option position at each valuation 
point. This links the margin required to the risk in each particular 
position in contrast to the strategy-based margin. Strategy-based 
margin applies a universal percentage requirement (of the underlying 
index value) to all short option positions in the same category (e.g., 
broad-based), irrespective of the fact that all options prices do not 
change equally (in percentage terms) with a change in the price or 
level of the underlying instrument.
    Theoretical options pricing models have become widely accepted and 
utilized since Fischer Black and Myron Scholes first introduced a 
formula for calculating the value of a European style option in 
1973.\17\ Other formulas, such as the Cox-Ross-Rubinstein model have 
since been developed. Option pricing formulas are now used routinely by 
option market participants to analyze and manage risk and have proven 
to be highly effective and preferred. In addition, essentially the same 
portfolio methodology described above has been used successfully by 
broker-dealers since 1994 to calculate haircuts on option positions for 
net capital purposes.\18\
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    \17\ In 1997, Fischer Black and Myron Scholes were awarded a 
Nobel Prize for the development of an options pricing formula.
    \18\ On March 15, 1994, the Commission issued a no-action letter 
allowing the implementation of a risk-based haircut pilot program. 
See letter from Brandon Becker, Director, Division, Commission, to 
Mary Bender, First Vice President, Division of Regulatory Services, 
CBOE, and Timothy Hinkes, Vice President, The OCC, dated March 15, 
1994. The risk-based haircut program took full effect on September 
1, 1997. See ``Net Capital Rule,'' Securities Exchange Act Release 
No. 38248 (February 6, 1997), 62 FR 6474 (February 12, 1997).
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    The Board of Governors of the Federal Reserve System (the ``Federal 
Reserve Board'' or ``FRB'') in its amendments to Regulation T in 1998 
permitted SROs to implement portfolio margin rules, provided they are 
approved by the Commission.\19\ A portfolio margin system recognizes 
the offsetting gains from positions that react favorably in market 
declines, while market rises are tempered by offsetting losses from 
positions that react negatively. A portfolio margin approach can thus 
have a neutralizing effect on option portfolio volatility. In times of 
market stress, the current strategy-based margin can result in margin 
calls and forced liquidations, thus contributing to the selling 
pressure in the market. The offset ability of portfolio margining can 
alleviate the need for liquidations, slowing acceleration of volatility 
in a crisis.
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    \19\ See Federal Reserve System, ``Securities Credit 
Transactions; Borrowing by Brokers and Dealers''; Regulations G, T, 
U and X; Docket Nos. R-0905, R-0923 and R-0944, 63 FR 2806 (January 
16, 1998).
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    More recently, the FRB encouraged the development of a portfolio 
margin approach in a letter to the Commission and the CFTC delegating 
authority to the agencies to jointly prescribe margin regulations for 
security futures products.\20\ In that letter, the FRB wrote that it 
``has encouraged the development of [portfolio margin approaches] by, 
for example, amending its Regulation T so that portfolio margining 
systems approved by the Commission can be used in lieu of the strategy-
based system embodied in the Board's regulation.'' The FRB concluded 
that letter by writing ``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.''
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    \20\ See letter from the FRB to James E. Newsome, Acting 
Chairman, CFTC, and Laura S. Unger, Acting Chairman, Commission, 
dated March 6, 2001.
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    An ability to cross-margin listed index options with index futures, 
and options on such futures, is critical because many professional 
investors hedge their listed index options with futures. Although 
haircuts assessed on broker-dealers with respect to computing their net 
capital requirement recognize offsets between securities index options 
and index futures, current margin practice does not allow these 
offsets. Cross-margin benefits the financial markets and clearing 
system in general, not just individual investors. Cross-margin would 
reduce the number of forced liquidations. Currently, an option 
(securities) account and futures account of the same customer are 
viewed as separate and unrelated. In addition, currently an option 
account must be liquidated if the risk in the positions has increased 
dramatically or margin calls cannot be met, even if gains in the 
customer's futures account offset the losses in the options account. If 
the accounts can be combined (i.e., cross-margin), there is little or 
no net change in risk and unnecessary liquidation can be avoided. The 
severity of a period of high volatility in the market is lessened if 
the number of liquidations is reduced because, for example, liquidating 
into a declining market exacerbates the decline. A capability to cross-
margin listed index options and index futures would further alleviate 
excessive margin calls, improve cash flows and liquidity, and reduce 
volatility, particularly in times of market downturns. Various 
government agencies and task groups have previously advocated 
implementation of a cross-margin system. Those groups include the 
Presidential Task Force on Market Mechanics (also known as the Brady 
Commission) \21\ and the Commission.\22\
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    \21\ See ``The Brady Report,'' Report of the Presidential Task 
Force on Market Mechanisms, January 1988, p. 59 and pp. 65-66.
    \22\ See ``The October 1987 Market Break: Report by the 
Division,'' Commission, February 1988, pp. 10-57. See also the 
interim report of the ``Working Group on Financial Markets,'' 
(Department of the Treasury, CFTC, Commission and FRB), May 1988, 
Appendix D III A.
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    Listed index options are now at a disadvantage to economically 
equivalent derivative products traded on futures exchanges in terms of 
margin requirements. Since 1988, index futures and options have been 
margined under a portfolio margin system known as SPAN. While the risks 
of listed index options are no greater than an equivalent position in 
an index future or option on the future, margin required on listed 
securities index options is significantly higher in many cases. 
Currently, listed index options margin (excluding the option premium) 
for a short at-the-money contract approximates 15% of the underlying 
index value while SPAN margin on a comparable futures index option 
contract is approximately 6% of the index value. When faced with such a 
disparity, investment managers discerningly choose futures products 
over listed index options for their hedging to reduce their costs. A 
portfolio style margin application for listed index options will reduce 
disparities between securities index options and futures products, thus 
making listed index products more competitive and more effective tools 
for investors.
    Relief provided by a portfolio margin system is also needed so that 
listed index options can compete with over-the-counter derivatives, 
which can be

[[Page 15268]]

margined on a good faith basis if hedged with a listed option.\23\
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    \23\ See ``OTC Derivatives Dealers,'' Securities Exchange Act 
Release No. 40594, (October 23, 1998), 63 FR 59362 (November 3, 
1998).
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2. Statutory Basis
    The Exchange believes that the proposed rule change described above 
is consistent with the provisions of section 6(b) of the Act,\24\ in 
general, and specifically furthers the objectives of section 6(b)(5) of 
the Act,\25\ in that it is designed to perfect the mechanisms of a free 
and open market and to protect investors and the public interest. The 
proposed portfolio margin rule change is intended to promote greater 
reasonableness, accuracy and efficiency in respect of Exchange margin 
requirements for complex, multiple position listed index option 
strategies, and to offer a cross-margin capability with related index 
futures positions in eligible accounts.
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    \24\ 15 U.S.C. 78f(b).
    \25\ 15 U.S.C. 78f(b)(5).
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B. Self-Regulatory Organization's Statement on Burden on Competition

    CBOE does not believe that the proposed rule change will impose any 
burden on competition that is not necessary or appropriate in 
furtherance of the purposes of the Act.

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

    No written comments were solicited or received with respect to the 
proposed rule change.

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

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

IV. Solicitation of Comments

    Interested persons are invited to submit written data, views, and 
arguments concerning the foregoing, including whether the proposed rule 
change is consistent with the Act. Persons making written submissions 
should file six copies thereof with the Secretary, Securities and 
Exchange Commission, 450 Fifth Street, NW, Washington, DC 20549-0609. 
Copies of the submission, all subsequent amendments, all written 
statements with respect to the proposed rule change that are filed with 
the Commission, and all written communications relating to the proposed 
rule change between the Commission and any person, other than those 
that may be withheld from the public in accordance with the provisions 
of 5 U.S.C. 552, will be available for inspection and copying in the 
Commission's Public Reference Room. Copies of such filing will also be 
available for inspection and copying at the principal office of the 
CBOE. All submissions should refer to File No. SR-CBOE-2002-03 and 
should be submitted by April 19, 2002. 
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    \26\ 17 CFR 200.30-3(a)(12).

    For the Commission, by the Division of Market Regulation, 
pursuant to delegated authority.\26\
Margaret H. McFarland,
Deputy Secretary.
[FR Doc. 02-7609 Filed 3-28-02; 8:45 am]
BILLING CODE 8010-01-P