[Federal Register Volume 67, Number 157 (Wednesday, August 14, 2002)]
[Rules and Regulations]
[Pages 53146-53180]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 02-19892]



[[Page 53145]]

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Part IV





Commodity Futures Trading Commission





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17 CFR Part 41





Securities and Exchange Commission





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17 CFR Part 242



Customer Margin Rules Relating to Security Futures; Joint Final Rules

  Federal Register / Vol. 67, No. 157 / Wednesday, August 14, 2002 / 
Rules and Regulations  

[[Page 53146]]


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COMMODITY FUTURES TRADING COMMISSION

17 CFR Part 41

RIN 3038-AB71

SECURITIES AND EXCHANGE COMMISSION

17 CFR Part 242

[Release No. 34-46292; File No. S7-16-01]
RIN 3235-AI22


Customer Margin Rules Relating to Security Futures

AGENCIES: Commodity Futures Trading Commission and Securities and 
Exchange Commission.

ACTION: Joint final rules.

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SUMMARY: The Commodity Futures Trading Commission (``CFTC'') and the 
Securities and Exchange Commission (``SEC'') (collectively, 
``Commissions'') are adopting rules to establish margin requirements 
for security futures. The final rules 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.

EFFECTIVE DATE: September 13, 2002.

FOR FURTHER INFORMATION CONTACT:
    CFTC: Phyllis P. Dietz, Special Counsel; or Michael A. Piracci, 
Attorney, Division of Clearing and Intermediary Oversight, 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: Onnig Dombalagian, Attorney Fellow, at (202) 942-0737; 
Theodore R. Lazo, Senior Special Counsel, at (202) 942-0745; Hong-anh 
Tran, Special Counsel, at (202) 942-0088; 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 adopting Rules 41.42 through 
41.49, 17 CFR 41.42 through 41.49, and the SEC is adopting Rules 400 
through 406, 17 CFR 242.400 through 242.406, (the ``Final Rules'') 
under authority delegated by the Federal Reserve Board pursuant to the 
Securities Exchange Act of 1934 (``Exchange Act'').

I. Background

A. Statutory Provisions
B. Proposed Rules
C. Overview of the Comment Letters
D. Overview of the Final Rules

II. Discussion of the Final Rules

A. Who is Covered by the Final Rules
B. Exclusions from Coverage
    1. Financial Relations between a Customer and a Security Futures 
Intermediary under a Portfolio Margining System
    2. Financial Relations between a Security Futures Intermediary 
and a Foreign Person
    3. Margin Requirements Imposed by Clearing Agencies or 
Derivatives Clearing Organizations
    4. Financial Relations between Security Futures Intermediaries 
and Broker-Dealers, and Certain Members of National Securities 
Exchanges
    a. Financial Relations with an Exempted Person
    b. Margin Arrangements with a Borrower Otherwise Excluded 
Pursuant to Section 7(c)(3) of the Exchange Act
    c. Financial Relations between a Security Futures Intermediary 
and a Member of a National Securities Exchange or Association in 
Connection with Market Making Activities
C. Interpretation of, and Exemptions from, the Final Rules
D. Definitions
E. Application of Regulation T to Security Futures
F. Account Administration Rules
    1. Separation and Consolidation of Accounts
    2. Accounts of Partners
    3. Contribution to a Joint Venture
    4. Extensions of Credit
G. Customer Margin Levels for Security Futures
    1. Definition of Current Market Value
    2. Margin Levels for Unhedged Positions
    3. Margin Offsets
    4. Higher Margin Levels
    5. Procedures for Certain Margin Level Adjustments
H. Satisfaction of Required Margin
    1. Type, Form and Use of Collateral
    a. Acceptable Collateral Deposits
    b. Use of Money Market Mutual Funds
    2. Computation of Equity
    a. Security Futures
    b. Option Value
    c. Open Trade Equity
    d. Margin Equity Securities
    e. Other Securities
    f. Foreign Currency
    g. Other Components of Equity
    h. Guarantees
    3. Satisfaction of Required Margin for Positions Other than 
Security Futures
I. When Margin May Be Withdrawn
    1. Withdrawal of Margin by the Customer
    2. Withdrawal of Margin by the Security Futures Intermediary
J. Consequences of Failure to Collect Required Margin
K. CFTC Procedures for Notification of Proposed Rule Changes Related 
to Margin

III. Paperwork Reduction Act

A. CFTC
B. SEC

IV. Costs and Benefits of the Final Rules

A. CFTC
B. SEC
    1. Costs
    a. Compliance with Regulation T
    b. Levels of Margin
    c. Computation of Margin
    d. Undermargined Accounts
    2. Benefits
    a. Benefits to Security Futures Intermediaries
    b. Benefits to Customers

V. Consideration of Burden on Competition, Promotion of Efficiency, and 
Capital Formation

VI. Regulatory Flexibility Act

A. CFTC
B. SEC

VII. Statutory Basis

Text of Rules

I. Background

A. Statutory Provisions

    The Commodity Futures Modernization Act of 2000 (``CFMA''),\1\ 
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 
security futures by the CFTC and the SEC.
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    \1\ Appendix E of Pub. L. No. 106-554, 114 Stat. 2763 (2000).
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    As part of the statutory scheme for the regulation of security 
futures, the CFMA provided for the issuance of rules governing customer 
margin for transactions in security futures. Specifically, the CFMA 
added a new subsection (2) to section 7(c) of the Exchange Act,\2\ 
which directs the Board of Governors of the Federal Reserve System 
(``Federal Reserve Board'') to prescribe rules establishing initial and 
maintenance customer margin requirements imposed by brokers, dealers, 
and members of national securities exchanges for security futures 
products. In addition, section 7(c)(2)(B) provides that the Federal 
Reserve Board may delegate this rulemaking authority jointly to the 
Commissions. On March 6, 2001, the Federal Reserve Board delegated its 
authority under Section 7(c)(2)(B) to the Commissions.\3\ Pursuant to 
that authority, the SEC and the CFTC have adopted customer

[[Page 53147]]

margin requirements for security futures.\4\
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    \2\ 15 U.S.C. 78g(c)(2).
    \3\ Letter from Jennifer J. Johnson, Secretary of the Board, 
Federal Reserve Board, to James E. Newsome, Acting Chairman, CFTC, 
and Laura S. Unger, Acting Chairman, SEC (March 6, 2001) (``FRB 
Letter'').
    \4\ Because section 6(h)(6) of the Exchange Act (15 U.S.C. 
78f(h)(6)) provides that options on security futures may not be 
traded for at least three years after the enactment of the CFMA, the 
margin requirements do not address options on security futures.
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    Section 7(c)(2) provides that the customer margin requirements for 
security futures must satisfy four requirements. First, they must 
preserve the financial integrity of markets trading security futures 
products. Second, they must prevent systemic risk. Third, they must (a) 
be consistent with the margin requirements for comparable option 
contracts traded on any exchange registered pursuant to section 6(a) of 
the Exchange Act; and (b) provide for initial and maintenance margin 
levels that are not lower than the lowest level of margin, exclusive of 
premium, required for comparable exchange-traded options. Fourth, they 
must be and remain consistent with the margin requirements established 
by the Federal Reserve Board under Regulation T.\5\
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    \5\ 12 CFR 220 et seq.
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B. Proposed Rules

    On September 26, 2001, the CFTC and the SEC issued for public 
comment proposed rules (the ``Proposed Rules'') relating to customer 
margin requirements for security futures.\6\ In response to a joint 
request from the Futures Industry Association (``FIA'') and the 
Securities Industry Association (``SIA'') for an extension of the 
public comment period, the Commissions granted a 30-day extension until 
December 5, 2001.\7\
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    \6\ Securities Exchange Act Release No. 44853 (September 26, 
2001), 66 FR 50720 (October 4, 2001). The FRB Letter was attached as 
Appendix B. See id. at 50741.
    \7\ See Securities Exchange Act Release No. 44996 (October 29, 
2001), 66 FR 55608 (November 2, 2001).
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C. Overview of the Comment Letters

    The Commissions received a total of 19 comment letters from 
securities and futures industry associations,\8\ exchanges,\9\ a 
clearing organization,\10\ financial services firms,\11\ systems 
vendors,\12\ a member of the academic community,\13\ and two members of 
the public.\14\ In general, the comment letters focused on three major 
issues raised by the Proposed Rules: the applicability of Regulation T 
and the desirability of an account-specific margin regime; the 
appropriateness of the proposed 20% margin level; and the 
permissibility of portfolio margining.
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    \8\ See letters from Mark E. Lackritz, President, SIA, and John 
M. Damgard, President, FIA, dated December 5, 2001 (``SIA/FIA 
Letter''); George Ruth, Chairman, Rules and Regulations Committee, 
Securities Industry Association Credit Division, dated December 4, 
2001 (``SIA Credit Division Letter''); Thomas W. Sexton, Vice 
President and General Counsel, National Futures Association, dated 
December 5, 2001 (``NFA Letter''); and John G. Gaine, President, 
Managed Funds Association, dated January 11, 2002 (``Manager Funds 
Letter'').
    \9\ See letters from James J. McNulty, Chicago Mercantile 
Exchange Inc., and David J. Vitale, Board of Trade of the City of 
Chicago, Inc., dated December 4, 2001 (``CME/CBOT Letter''); the 
American Stock Exchange, Chicago Board Options Exchange, The Options 
Clearing Corporation, International Securities Exchange, Pacific 
Exchange, and Philadelphia Stock Exchange, dated December 5, 2001 
(``Options Exchanges Letter''); Kathleen M. Hamm, Director of Market 
Regulation, Senior Vice President Regulation and Compliance, Nasdaq 
Liffe Markets, LLC, dated December 5, 2001 (``Nasdaq Liffe 
Letter''); Kenneth M. Rosenzweig, on behalf of OneChicago, LLC, 
dated December 6, 2001 (``OneChicago Letter''); Michael J. Ryan, 
Jr., Executive Vice President and General Counsel, American Stock 
Exchange, dated December 7, 2001 (``Amex Letter''); and William J. 
Brodsky, Chairman and Chief Executive Officer, Chicago Board Options 
Exchange, dated December 7, 2001 (``CBOE Letter''). The CBOE also 
joined in the Options Exchanges Letter.
    \10\ See letter from Susan Milligan, The Options Clearing 
Corporation, dated December 14, 2001 (``OCC Letter''). The OCC also 
joined in the Options Exchanges Letter.
    \11\ See letters from John P. Davidson III, Managing Director, 
Morgan Stanley, dated December 5, 2001 (``Morgan Stanley Letter''); 
James A. Gary, Executive Vice President, ABN AMRO Incorporated, 
dated December 5, 2001 (``ABN AMRO Letter''); and Russell R. 
Wasendorf, Sr., Chairman and Chief Executive Officer, Peregrine 
Financial Group, Inc., dated December 5, 2001 (``Peregrine 
Letter'').
    \12\ See letters from John Munro, Senior Vice President, Product 
Design, Rolfe and Nolan Systems Inc (``Rolfe and Nolan Letter''); 
and Stephen P. Auerbach, Chief Operating Officer, SunGard Futures 
Systems, dated December 5, 2001 (``SunGard Letter'').
    \13\ See letter from Frank Partnoy, Professor of Law, University 
of San Diego School of Law, dated October 29, 2001 (``Partnoy 
Letter'').
    \14\ See letter from Robert Drinkard, dated September 28, 2001 
(``Drinkard Letter''); and letter from Bernard E. Klein, dated 
December 18, 2001 (``Klein Letter'').
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    The majority of commenters expressed the view that Regulation T 
should not be applied to futures accounts. They stated their concern 
that application of Regulation T to security futures carried in futures 
accounts would impose heavy costs on carrying firms in the form of 
reprogramming of systems and training of staff. Some believed that it 
would discourage futures commission merchants (``FCMs'') from trading 
security futures. One commenter, however, supported the application of 
Regulation T to security futures, regardless of the type of account in 
which they are carried. Several commenters identified specific 
provisions of Regulation T that would have to be addressed in order to 
accommodate carrying security futures in a securities account, e.g., 
rules for variation margin payments.
    Ten of the commenters specifically endorsed the concept that the 
margin rules should build on the existing regulatory infrastructure and 
that, to the extent possible, the rules applicable to security futures 
should be determined by the type of account in which the security 
futures are carried. Under this ``account-specific'' approach, for 
example, rules relating to acceptable collateral, collateral haircuts, 
timing for collection of margin, and calculations of current market 
value would be determined in accordance with the rules otherwise 
applicable to a securities account or futures account, respectively. 
Several commenters observed that this would be consistent with the 
Commissions' proposed customer funds rules \15\ and would be the most 
prudent and cost effective approach.
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    \15\ See Securities Exchange Act Release No. 44854 (September 
26, 2001), 66 FR 50768 (October 4, 2001).
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    Most commenters found the proposed 20% minimum margin level to be 
acceptable, although some thought the minimum should instead be 25%. 
The SIA/FIA Letter noted that ``members of the Associations are 
divided'' as to whether the minimum level of initial and maintenance 
margin should be 20% or 25%. Another commenter expressed the view that 
the 20% level could be either too high or too low depending on the 
circumstances, and that for certain positions 50% initial margin would 
be appropriate.
    Eleven commenters supported the implementation of full portfolio 
margining for security futures, as soon as possible. Two other 
commenters emphasized the need for experience with a proposed pilot 
program.\16\ One commenter supported portfolio margining only for 
sophisticated customers, with another commenter joining in the view 
that portfolio margining might not be appropriate for all customers.
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    \16\ See Securities Exchange Act Release No. 45630 (March 22, 
2002), 67 FR 15263 (March 29, 2002) (notice of rules proposed by the 
CBOE related to customer portfolio and cross-margining 
requirements).
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    After carefully considering the public comments, the Commissions 
have adopted Final Rules that reflect modifications to the Proposed 
Rules in response to the views and concerns expressed by the 
commenters. The Commissions believe that the Final Rules fulfill the 
statutory requirements and that the changes made to the

[[Page 53148]]

Proposed Rules will more effectively promote market efficiency and 
liquidity.

D. Overview of the Final Rules

    The Commissions have carefully considered the commenters' views, 
and have modified the Proposed Rules in various respects. The Final 
Rules, among other things:
     Establish stand-alone requirements that are consistent 
with Regulation T, but do not apply Regulation T in its entirety to 
futures accounts.
     Establish minimum initial and maintenance margin levels 
for unhedged positions in security futures at 20% of their ``current 
market value.''
     Permit self-regulatory authorities to set margin levels 
lower than 20% of current market value for customers with certain 
strategy-based offset positions involving security futures and one or 
more related securities or futures.
     Identify the types of collateral acceptable as margin 
deposits and establish standards for the valuation of such collateral 
and other components of equity.
     Establish standards for the withdrawal of margin by 
customers and security futures intermediaries.
     Set forth procedures applicable to undermargined accounts.
     Set forth procedures for filing proposed rule changes with 
the CFTC.

II. Discussion of the Final Rules

A. Who Is Covered by the Final Rules

    The Commissions are adopting the Final Rules under the authority 
delegated to them by the Federal Reserve Board under section 7(c)(2) of 
the Exchange Act, which applies to brokers, dealers, and members of 
national securities exchanges extending credit to or for customers, or 
collecting margin from customers, in connection with security futures. 
In the Proposed Rules, the Commissions used the term ``creditor,'' as 
defined in Regulation T, to delineate those persons who would be 
subject to the margin rules.\17\ Because FCMs that effect transactions 
in security future products are broker-dealers,\18\ they were included 
in the definition of ``creditor'' under the Proposed Rules.
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    \17\ Under Section 220.2 of Regulation T (17 CFR 220.2), the 
term ``creditor'' means any broker or dealer, member of a national 
securities exchange, or any person associated with a broker or 
dealer other than business entities controlling or under common 
control with the broker-dealer.
    \18\ See sections 3(a)(4) and 3(a)(5) of the Exchange Act, 15 
U.S.C. 78c(a)(4) and 78c(a)(5).
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    To avoid characterizing the collection of margin for a security 
futures contract as involving an extension of credit, the Final Rules 
use the term ``security futures intermediary'' instead of the term 
``creditor.'' \19\ The term ``security futures intermediary'' is 
intended to include the same persons as are included in the Regulation 
T definition of ``creditor,'' but solely with respect to their 
financial relations involving security futures. SEC Rule 401(a)(29) 
defines security futures intermediary by reference to the term 
creditor. For the sole purpose of clarifying the scope of the Final 
Rules for market participants that are not subject to Regulation T, the 
definition of security futures intermediary in CFTC Rule 41.43(a)(29) 
specifies that the term includes FCMs and enumerated affiliated 
persons.\20\
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    \19\ For the same reason, the Final Rules do not use the term 
``borrower'' to refer to persons who deposit margin in connection 
with security futures transactions.
    \20\ See CFTC Rule 41.43(a)(29); SEC Rule 401(a)(29).
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    The Commissions believe that the term security futures intermediary 
is defined identically for all substantive purposes, and emphasize that 
the difference in the language used in the two rules to define a 
security futures intermediary is not intended to mean that the scope of 
the two rules is different.
    In addition, the term ``customer'' is defined under the Final Rules 
as any person or persons acting jointly on whose behalf a security 
futures intermediary effects a security futures transaction or carries 
a security futures position, or who would be considered a customer of 
the security futures intermediary according to the ordinary usage of 
the trade.\21\ The definition of customer further includes (i) any 
partner in a security futures intermediary that is organized as a 
partnership who would be considered a customer of the security futures 
intermediary absent the partnership relationship, and (ii) any joint 
venture in which a security futures intermediary participates and which 
would be considered a customer of the security futures intermediary if 
the security futures intermediary were not a participant.\22\ This 
definition is derived from the Regulation T definition of customer.\23\
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    \21\ See CFTC Rule 41.43(a)(5)(i); SEC Rule 401(a)(5)(i).
    \22\ See CFTC Rule 41.43(a)(5)(ii) and (iii); SEC Rule 
401(a)(5)(ii) and (iii).
    \23\ See 12 CFR 220.2.
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B. Exclusions From Coverage

    The Final Rules include specific exclusions for certain categories 
of financial relations, substantially as proposed. The exclusions are 
described below.
1. Financial Relations between a Customer and a Security Futures 
Intermediary Under a Portfolio Margining System
    The Proposed Rules provided an exclusion for margin calculated by a 
portfolio margining system that has been approved by the SEC and, as 
applicable, the CFTC.\24\ The Commissions are adopting this exclusion 
substantially as proposed.\25\ The Final Rules add a provision 
requiring that the portfolio margining system meet the criteria set 
forth in section 7(c)(2)(B) of the Exchange Act.\26\ This addition is 
intended to clarify that the portfolio margining system must be 
consistent with a risk-based system used for comparable exchange-traded 
options. This requirement does not preclude the use of an existing 
portfolio margining system that interfaces with an FCM's bookkeeping 
system, so long as the portfolio margining system is modified to 
produce results that comply with the Final Rules.\27\
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    \24\ See Proposed CFTC Rule 41.43(b)(3)(i); Proposed SEC Rule 
400(b)(3)(i).
    \25\ See CFTC Rule 41.42(c)(2)(i); SEC Rule 400(c)(2)(i).
    \26\ See CFTC Rule 41.42(c)(2)(i); SEC Rule 400(c)(2)(i). 
Section 7(c)(2)(B) requires that the margin requirements for 
security futures (i) be consistent with the margin requirements for 
comparable exchange-traded security options (and that margin levels 
for security futures not be lower than the levels of margin required 
for comparable exchange-traded options), and (ii) be and remain 
consistent with Regulation T of the Federal Reserve Board. 15 U.S.C. 
78g(c)(2)(B).
    \27\ Under the Final Rules, a portfolio margining system can be 
used to compute required initial or maintenance margin that results 
in margin levels that are equal to or higher than the margin levels 
required by the Final Rules. In this regard, for example, the 
minimum margin requirement for unhedged security futures positions 
must be 20%, and the system cannot recognize any offset for 
combination positions that is not permitted under self-regulatory 
authority rules, as provided in CFTC Rule 41.45(b)(2) and SEC Rule 
403(b)(2). See discussion of margin offsets, Section II.G.3. below.
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    Portfolio margining establishes margin levels by assessing the 
market risk of a ``portfolio'' of positions in 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 options and futures on the same underlying 
instrument). So that adequate margin is deposited to cover 
extraordinary market events, one or more additional adjustments may be 
applied in calculating a customer's required margin. A portfolio 
margining system may also be used in conjunction with a risk-based 
margining system,

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which assesses margin based on the historical performance of individual 
instruments, rather than as a fixed percentage of current market value. 
Depending upon the risks attributable to one or more positions, the 
amount of required margin in a portfolio margining system may be 
greater than or less than the margin levels currently required for 
securities positions in a fixed-percentage, strategy-based margining 
system.
    The Commissions received 14 comment letters that addressed the 
issue of portfolio margining, all of which supported the concept of 
portfolio margining for security futures.\28\ Ten of the commenters 
strongly supported the implementation of full portfolio margining for 
security futures as soon as possible.\29\
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    \28\ See SIA Credit Division Letter; Options Exchanges Letter; 
CME/CBOT Letter; SunGard Letter; SIA/FIA Letter; OCC Letter; 
Peregrine Letter; Nasdaq Liffe Letter; NFA Letter; Morgan Stanley 
Letter; OneChicago Letter; ABN AMRO Letter; Rolfe and Nolan Letter; 
and Managed Funds Letter.
    \29\ See CME/CBOT Letter; SunGard Letter; SIA/FIA Letter; 
Peregrine Letter; Nasdaq Liffe Letter; NFA Letter; OneChicago 
Letter; ABN AMRO Letter; Rolfe and Nolan Letter; and Managed Funds 
Letter.
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    Five commenters observed that portfolio margining recognizes the 
market risk associated with a specific position more accurately than a 
fixed-percentage margin scheme.\30\ One commenter criticized the 
Proposed Rules for limiting customers to an ``archaic strategy-based 
system.'' \31\
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    \30\ See SIA/FIA Letter at 2; Morgan Stanley Letter at 3; 
OneChicago Letter at 7-8; NFA Letter at 4-5; and Nasdaq Liffe Letter 
at 4.
    \31\ CME/CBOT Letter at 5.
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    One commenter stated its opinion that portfolio margining should be 
allowed immediately for security futures, and that the higher margin 
levels collected under a strategy-based approach would make it 
difficult for U.S. markets to attract liquidity in security 
futures.\32\ This commenter raised concerns that strategy-based 
margining would disadvantage U.S. markets and would encourage investors 
to seek foreign markets.\33\ Another commenter supported portfolio 
margining for security futures, securities, and securities options to 
promote global competitiveness.\34\ It observed that portfolio 
margining has become the international standard for major futures 
markets and without it, the U.S. markets will be at a disadvantage.\35\
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    \32\ SunGard Letter at 2.
    \33\ Id.
    \34\ Nasdaq Liffe Letter at 5-6.
    \35\ Id.
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    One commenter expressed the view that portfolio margining should 
not be approved for security futures before it is approved for options, 
and stated that it was critical that any portfolio margining system 
applicable to security futures apply to all related products, including 
options and the underlying securities.\36\ Another commenter supported 
implementation of a portfolio margining framework under which the 
margin requirements for portfolios comprised of securities and security 
futures would be determined through a risk-based analysis.\37\
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    \36\ Options Exchanges Letter at 4.
    \37\ SIA/FIA Letter at 11. This commenter also recommended that 
the Commissions permit FCMs to use the Standard Portfolio Analysis 
of Risk (``SPAN'') system for establishing the initial and 
maintenance margin requirements for security futures maintained in a 
futures account as long as the resulting margin levels are 
consistent with the margin requirements for security futures held in 
a securities account. Id. at 12.
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    Two other commenters, while strongly supporting the concept of 
portfolio margining, expressed the opinion that portfolio margining was 
not necessarily appropriate for all investors, and that it might be 
appropriate to limit the use of portfolio margining for security 
futures to sophisticated investors.\38\
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    \38\ See SIA Credit Division Letter at 2; Morgan Stanley Letter 
at 4.
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    The SEC and the CFTC have approved the use of portfolio margining 
systems for certain purposes. The CFTC has approved portfolio margining 
using the SPAN system for all currently traded futures contracts, at 
both the clearing level and the customer level.\39\ The SEC has 
approved portfolio margining using The Options Clearing Corporation's 
(``The OCC'') Theoretical Intermarket Margin System (``TIMS'') for 
margin collected by The OCC for the options positions of its clearing 
members.\40\ The SEC and CFTC also have approved self-regulatory 
organization (``SRO'') rules that permit the use of SPAN and TIMS in 
connection with certain cross-margining arrangements involving futures 
and securities.\41\ In addition, as noted previously, on March 22, 
2002, the SEC published notice of a proposed rule change filed by the 
CBOE to implement a portfolio margining system on a pilot basis for 
certain customers.\42\
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    \39\ The CFTC also has approved SPAN margining for all options 
on futures contracts.
    \40\ See Securities Exchange Act Release No. 28928 (March 1, 
1991), 56 FR 9995 (March 8, 1991); Securities Exchange Act Release 
No. 23167 (April 22, 1986), 51 FR 16127 (April 30, 1986).
    \41\ 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 (``BOTCC'') (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); 
BOTCC (2001); and CME (2001).
    \42\ See supra note 16 and accompanying text.
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    Section 7(c)(2)(B)(iii) of the Exchange Act \43\ provides that the 
margin requirements for security futures must be consistent with the 
margin requirements for comparable exchange-traded options, and that 
the initial and maintenance margin levels for security futures may not 
be lower than the lowest level of margin, exclusive of premium, 
required for any comparable exchange-traded option. After considerable 
deliberation about the application of this standard to security futures 
margin, the Commissions have determined that risk-based portfolio 
margining for security futures will not be permitted until a similar 
methodology is introduced for comparable exchange-traded options.
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    \43\ 15 U.S.C. 78g(c)(2)(B)(iii).
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    Three commenters expressed opinions regarding the future selection 
and use of SPAN or TIMS as a portfolio margining system.\44\ The 
Commissions will consider issues related to the use of any particular 
portfolio margining system at such time as the Commissions consider the 
actual implementation of portfolio margining for security futures.
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    \44\ See CME/CBOT Letter at 5; SIA/FIA Letter at 12-13 and 
Appendix I, Q 15; OCC Letter.
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    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 be in keeping with current practices in the 
futures industry and would 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.\45\
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    \45\ 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.'' The Federal Reserve Board 
further stated that ``[t]he 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.'' FRB 
Letter at 2.

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[[Page 53150]]

2. Financial Relations Between a Security Futures Intermediary and a 
Foreign Person
    The Proposed Rules provided an exclusion from the margin 
requirements for financial relations between a foreign branch of a 
creditor and a foreign person involving foreign security futures.\46\ 
This exclusion was intended to be consistent with the way Regulation T 
treats financial relations between a foreign branch of a creditor and a 
foreign person involving foreign securities.\47\ The Commissions are 
adopting this exclusion with two modifications.\48\
---------------------------------------------------------------------------

    \46\ See Proposed CFTC Rule 41.43(b)(3)(ii); Proposed SEC Rule 
400(b)(3)(ii).
    \47\ See 12 CFR 220.1(b)(3)(iv).
    \48\ See CFTC Rule 41.42(c)(2)(ii); SEC Rule 400(c)(2)(ii).
---------------------------------------------------------------------------

    First, in response to concerns raised by a commenter,\49\ the scope 
of the exclusion is being expanded so that it applies to the U.S. 
offices as well as foreign branch offices of a security futures 
intermediary. This commenter expressed the view that the exclusion, as 
proposed, would create a competitive disadvantage for U.S. firms whose 
existing foreign futures customers would likely migrate to foreign 
offices or competing foreign firms to obtain the margin levels 
available on the foreign exchange. After considering the commenter's 
view, the Commissions have concluded that expanding the exclusion is 
appropriate and, in light of the potential competitive issues, is not 
inconsistent with Regulation T.
---------------------------------------------------------------------------

    \49\ Meeting between SEC and CFTC staff and representatives of 
SIA/FIA (February 6, 2000).
---------------------------------------------------------------------------

    The second modification clarifies the scope of this exclusion. 
Because the Proposed Rules did not define the term ``foreign security 
future,'' the Final Rules provide that the exclusion applies to 
financial relations between a security futures intermediary and a 
foreign person involving ``security futures traded on or subject to the 
rules of a foreign board of trade.'' Thus, the exclusion applies 
regardless of whether the underlying security is issued in the United 
States or a foreign country.\50\
---------------------------------------------------------------------------

    \50\ This exclusion does not address the application of Section 
6(h)(1) of the Exchange Act (15 U.S.C. 78f(h)(1)) to transactions in 
security futures that are traded on or subject to the rules of a 
foreign board of trade.
---------------------------------------------------------------------------

3. Margin Requirements Imposed by Clearing Agencies or Derivatives 
Clearing Organizations
    The Proposed Rules provided an exclusion from the margin 
requirements for margin collected by registered clearing agencies from 
their members.\51\ The Commissions received no comments relating to 
this provision. The text of the proposed exclusion has been revised to 
specify that the Final Rules exclude clearing agencies registered under 
section 17A of the Exchange Act and derivatives clearing organizations 
registered under Section 5b of the CEA.\52\ These textual changes do 
not affect the meaning of the provision and, therefore, the Commissions 
have effectively adopted the provision as proposed.
---------------------------------------------------------------------------

    \51\ See Proposed CFTC Rule 41.43(b)(3)(iii); Proposed SEC Rule 
400(b)(3)(iii).
    \52\ See CFTC Rule 41.42(c)(2)(iii); SEC Rule 400(c)(2)(iii).
---------------------------------------------------------------------------

    Section 7(c)(2) of the Exchange Act directs the Federal Reserve 
Board to prescribe rules regarding customer margin for security futures 
products, but it does not confer authority over margin requirements for 
clearing agencies and derivatives clearing organizations. Accordingly, 
the Federal Reserve Board stated in its delegation letter 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.'' The margin rules of clearing 
agencies registered with the SEC are approved by the SEC pursuant to 
section 19(b)(2) of the Exchange Act.\53\ The CFTC has authority to 
ensure compliance with core principles for derivatives clearing 
organizations registered with the CFTC under Sections 5b and 5c of the 
CEA.\54\ This exclusion clarifies that margin requirements that 
clearing agencies registered with the SEC or derivatives clearing 
organizations registered with the CFTC impose on their members are not 
subject to the Final Rules.
---------------------------------------------------------------------------

    \53\ 15 U.S.C. 78s(b)(2).
    \54\ 7 U.S.C. 7a-1; 7 U.S.C. 7a-2.
---------------------------------------------------------------------------

4. Financial Relations Between Security Futures Intermediaries and 
Broker-Dealers, and Certain Members of National Securities Exchanges
    a. Financial Relations with an Exempted Person. The Proposed Rules 
provided an exclusion from the margin requirements for credit 
arrangements between a creditor and a borrower that is a member of a 
national securities exchange or is a registered broker-dealer 
(including an FCM registered as a broker-dealer under section 15(b)(11) 
of the Exchange Act) if the creditor made a good faith determination 
that the borrower was an ``exempted borrower'' under Regulation T.\55\ 
The Regulation T criteria for an ``exempted borrower'' establish 
standards for the exception from federal margin regulation for exchange 
members and registered brokers and dealers, a substantial portion of 
whose business consists of transactions with persons other than brokers 
or dealers.\56\ In addition, the Proposed Rules provided that a person 
that ceased to qualify for the exempted borrower exclusion would be 
required to notify the creditor of this fact before establishing any 
new security futures positions.\57\ Any security futures positions 
subsequently established by that person would be subject to the 
Commissions' customer margin requirements.
---------------------------------------------------------------------------

    \55\ See Proposed CFTC Rule 41.43(b)(3)(iv)(A); Proposed SEC 
Rule 400(b)(3)(iv)(A).
    \56\ The term ``exempted borrower'' is defined in Section 220.2 
of Regulation T 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% of its gross 
revenues on an annual basis from transactions with persons other 
than brokers, dealers, and persons associated with a broker or 
dealer. 12 CFR 220.2. section 7(c)(3)(A) of the Exchange Act (15 
U.S.C. 78g(c)(3)(A)) provides an exception from federal margin 
regulation for members of national securities exchanges and 
registered broker-dealers, ``a substantial portion of whose business 
consists of transactions with persons other than brokers or 
dealers.''
    \57\ See Proposed CFTC Rule 41.45(e); Proposed SEC Rule 402(e).
---------------------------------------------------------------------------

    One commenter addressed the exclusion, asserting that an FCM or 
floor broker whose only securities business consists of trading 
security futures would not likely qualify as an exempted borrower under 
Regulation T.\58\ The commenter asked the Commissions to clarify that 
the scope of the exclusion includes FCMs or floor brokers that do not 
have a substantial securities or security futures business, as long as 
they have a substantial customer futures business.
---------------------------------------------------------------------------

    \58\ OneChicago Letter at 8-9.
---------------------------------------------------------------------------

    After considering the commenter's view, the Commissions have 
adopted the exclusion with several modifications to clarify the 
application of the exclusion.\59\ As a preliminary matter, the 
Commissions are replacing the term ``exempted borrower'' with the new 
term, ``exempted person,'' to avoid characterizing the collection of 
margin for a security futures contract as involving an extension of 
credit.
---------------------------------------------------------------------------

    \59\ See CFTC Rule 41.42(c)(2)(iv); SEC Rule 400(c)(2)(iv).
---------------------------------------------------------------------------

    Consequently, the Commissions are also adding to the Final Rules a 
definition of ``exempted person.'' The Commissions believe that the 
definition of exempted person is consistent with

[[Page 53151]]

the definition of exempted borrower in Regulation T. More specifically, 
the Final Rules define an exempted person as a member of a national 
securities exchange, a registered broker or dealer, or a registered 
futures commission merchant, a substantial portion of whose business 
consists of transactions in securities, commodity futures, or commodity 
options with persons other than brokers, dealers, futures commission 
merchants, floor brokers, or floor traders, including a person who:
     Maintains at least 1000 active accounts on an annual basis 
for persons other than brokers, dealers, persons associated with a 
broker or dealer, futures commission merchants, floor brokers, floor 
traders, and persons affiliated with a futures commission merchant, 
floor broker, or floor trader that are effecting transactions in 
securities, commodity futures, or commodity options;
     Earns at least $10 million in gross revenues on an annual 
basis from transactions in securities, commodity futures, or commodity 
options with persons other than brokers, dealers, persons associated 
with a broker or dealer, futures commission merchants, floor brokers, 
floor traders, and persons affiliated with a futures commission 
merchant, floor broker, or floor trader; or
     Earns at least 10 percent of its gross revenues on an 
annual basis from transactions in securities, commodity futures, or 
commodity options with persons other than brokers, dealers, persons 
associated with a broker or dealer, futures commission merchants, floor 
brokers, floor traders, and persons affiliated with a futures 
commission merchant, floor broker, or floor trader.\60\
---------------------------------------------------------------------------

    \60\ See CFTC Rule 41.43(a)(9); SEC Rule 401(a)(9).
---------------------------------------------------------------------------

    Although the commenter recommended that floor brokers as well as 
FCMs be permitted to qualify as exempted borrowers, the Commissions 
have not included floor brokers in the definition of exempted person. 
This is because the exemption cannot readily be applied to floor 
brokers given that they do not carry the type of customer accounts 
contemplated by the Regulation T exempted borrower provision. The 
Commissions note that, although floor brokers are not included in the 
definition of exempted person, they may still qualify for an exclusion 
from the security futures margin requirements if they meet the criteria 
for a market maker under the Final Rules, as discussed below.\61\
---------------------------------------------------------------------------

    \61\ See CFTC Rule 41.42(c)(2)(v); SEC Rule 400(c)(2)(v).
---------------------------------------------------------------------------

    The Final Rules also set forth an express definition of ``persons 
affiliated with'' a futures commission merchant, floor broker, or floor 
trader,\62\ which parallels the definition in the Exchange Act of 
``person associated with a broker or dealer.'' \63\ The purpose of this 
definition is to establish consistency with the Regulation T definition 
of exempted borrower, which excludes transactions with ``persons 
associated with a broker or dealer,'' as that term is defined in 
section 3(a)(18) of the Exchange Act.\64\ The phrase ``persons 
affiliated with'' has been used in the definition with respect to 
transactions with FCMs, floor brokers and floor traders, and the phrase 
``persons associated with'' has been used with respect to transactions 
with brokers and dealers. This is not intended to create a substantive 
difference in the provisions applicable to the securities and futures 
industries. Rather, it is intended to avoid confusion insofar as the 
CFTC's definition of ``affiliated person'' (which includes corporate 
affiliates) \65\ more closely matches the Exchange Act definition of 
``persons associated with a broker or dealer,'' than does the CFTC 
definition of ``associated person,'' which is a registration 
category.\66\
---------------------------------------------------------------------------

    \62\ See CFTC Rule 41.43(a)(9)(ii); SEC Rule 401(a)(9)(ii).
    \63\ See CFTC Rule 41.43(a)(23); SEC Rule 401(a)(23).
    \64\ 15 U.S.C. 78c(a)(18).
    \65\ See 17 CFR 155.1; Section 4f(c)(1)(i) of the CEA, 7 U.S.C. 
6f(c)(1)(i).
    \66\ See 17 CFR 1.3(aa).
---------------------------------------------------------------------------

    The Final Rules clarify that a person may qualify as an exempted 
person based on transactions in commodity futures and commodity 
options, as well as securities. For purposes of the ``1000 active 
accounts'' threshold, an FCM or broker or dealer that clears a bona 
fide customer omnibus account for another FCM or broker or dealer may 
treat that account as a single customer account. For purposes of the 
$10 million and 10% thresholds, the gross revenues from transactions 
for bona fide customer omnibus accounts may be included in the 
computation. An omnibus account will not be considered a bona fide 
customer account if it is used to clear transactions for market 
professionals that would otherwise be excluded from the exempted person 
computation. A fully disclosed customer account will be considered a 
single customer account of the clearing firm, as well as the 
introducing firm.
    The exempted person provision further states that a member of a 
national securities exchange or a registered broker, dealer, or futures 
commission merchant that has been in existence for less than one year 
may meet the definition of exempted person based on a six-month 
period.\67\ This incorporates the standard set forth in Regulation 
T.\68\
---------------------------------------------------------------------------

    \67\ See CFTC Rule 41.43(a)(9)(iii); SEC Rule 401(a)(9)(iii).
    \68\ See 12 CFR 220.3(j)(1).
---------------------------------------------------------------------------

    In response to one commenter's suggestion,\69\ the Commissions are 
also defining the term ``good faith,'' consistent with the definition 
of that term in Regulation T,\70\ for the purposes of determining what 
steps a security futures intermediary must take to assure itself that a 
person is an exempted person.\71\ The Final Rules further provide that 
a person who ceases to qualify as an exempted person must notify the 
security futures intermediary of that fact, and become subject to the 
provisions of the Final Rules, but only before entering into any new 
security futures transaction or related transaction that would require 
additional margin to be deposited.\72\ This would permit a person to 
enter into new offsetting transactions that reduce the required margin 
in an account without triggering higher margin requirements.
---------------------------------------------------------------------------

    \69\ Meeting between SEC and CFTC staff and representatives of 
SIA/FIA (February 6, 2002).
    \70\ See 12 CFR 220.2.
    \71\ See CFTC Rule 41.43(a)(15); SEC Rule 401(a)(15).
    \72\ See CFTC Rule 41.44(f); SEC Rule 402(f).
---------------------------------------------------------------------------

    b. Margin Arrangements with a Borrower Otherwise Excluded Pursuant 
to section 7(c)(3) of the Exchange Act. The Proposed Rules included an 
exclusion for credit extended, maintained, or arranged by a creditor to 
or for a registered broker-dealer, or member of a national securities 
exchange (including an FCM registered as a broker-dealer under section 
15(b)(11) of the Exchange Act) that is otherwise excluded under section 
7(c)(3) of the Exchange Act.\73\ The Commissions have decided not to 
adopt this exclusion.
---------------------------------------------------------------------------

    \73\ See Proposed CFTC Rule 41.43(b)(3)(iv)(B); Proposed SEC 
Rule 400(b)(3)(iv)(B).
---------------------------------------------------------------------------

    Under section 7(c)(3)(B) of the Exchange Act,\74\ the financing of 
the market making or underwriting activities of a member of a national 
securities exchange or a registered broker-dealer is excluded from the 
scope of federal margin regulation. The Federal Reserve Board has 
expressed the view that floor traders on open-outcry futures exchanges 
act as market makers and therefore would be excluded from the margin 
requirements for security futures pursuant to Section 7(c)(3)(B).\75\

[[Page 53152]]

The proposed exclusion was intended to codify this view.
---------------------------------------------------------------------------

    \74\ 15 U.S.C. 78g(c)(3)(B).
    \75\ In its delegation 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].'' FRB Letter at 
2.
---------------------------------------------------------------------------

    One commenter addressed this exclusion and maintained that the 
exclusion was confusing because the Commissions did not provide any 
guidance as to the factors under which a broker-dealer would qualify 
for the exclusion.\76\ The commenter asked the Commissions to clarify 
the circumstances under which a floor trader on an open outcry exchange 
qualifies for the market maker exclusion.
---------------------------------------------------------------------------

    \76\ CBOE Letter.
---------------------------------------------------------------------------

    The Commissions have not adopted the proposed exclusion. As noted 
above, the Federal Reserve Board has taken the position that floor 
traders on open-outcry futures exchanges qualify for the statutory 
market maker exception. However, any further interpretation of section 
7(c)(3) of the Exchange Act is within the purview of the Federal 
Reserve Board. As a result, the Commissions would not be able to 
provide specific guidance as requested by the commenter as to the 
circumstances under which Section 7(c)(3) applies to floor traders on 
an open-outcry futures exchange. The Commissions emphasize that any 
person excluded from federal margin regulation under section 7(c)(3) of 
the Exchange Act is not subject to the rules adopted by the Commissions 
today. The Commissions encourage market participants to seek 
interpretive guidance from the Federal Reserve Board regarding the 
circumstances in which the exception under section 7(c)(3) of the 
Exchange Act applies.
    c. Financial Relations between a Security Futures Intermediary and 
a Member of a National Securities Exchange or Association in Connection 
with Market Making Activities. The Commissions proposed to exclude from 
the scope of the margin requirements credit extended, maintained, or 
arranged to or for members of a national securities exchange or a 
national securities association in connection with market making 
activities.\77\ As proposed, the exclusion had two conditions. First, 
the borrower could not directly or indirectly accept or solicit 
customer orders or provide advice to any customer in connection with 
the trading of security futures. Second, the borrower had to be 
registered with the exchange or association as a security futures 
dealer, pursuant to regulatory authority rules that require the 
borrower: (a) To be registered as a floor trader or floor broker with 
the CFTC, or as a dealer with the SEC; (b) to comply with applicable 
SEC or CFTC net capital requirements; (c) to maintain records 
sufficient to demonstrate compliance with the exclusion and the rules 
of the exchange or association; (d) to hold itself out as willing to 
buy and sell security futures for its own account on a regular or 
continuous basis; and (e) to be subject to disciplinary action if it 
failed to comply with the Commissions' margin rules or the rules of the 
exchange or association.\78\ The Commissions are adopting this 
exclusion with modifications in light of commenters' views.\79\
---------------------------------------------------------------------------

    \77\ See Proposed CFTC Rule 41.43(b)(3)(iv)(C); Proposed SEC 
Rule 400(b)(3)(iv)(C).
    \78\ Id.
    \79\ See CFTC Rule 41.42(c)(2)(v); SEC Rule 400(c)(2)(v). The 
Commissions note that the Final Rules include a definition of the 
term ``member,'' which clarifies the applicability of that term to 
persons with trading privileges on an exchange, even if that 
exchange does not have a ``membership'' structure. More 
specifically, the term ``member'' has the meaning provided in 
section 3(a)(3) of the Exchange Act and includes persons registered 
under section 15(b)(11) of the Exchange Act that are permitted to 
effect transactions on a national securities exchange without the 
services of another person acting as executing broker. See CFTC Rule 
41.43(a)(21); SEC Rule 401(a)(21).
---------------------------------------------------------------------------

    The Commissions received four comments on the exclusion.\80\ These 
comments generally supported the proposed exclusion, but suggested that 
the Commissions clarify certain aspects of the conditions.
---------------------------------------------------------------------------

    \80\ See Amex Letter; CBOE Letter; OneChicago Letter; SIA/FIA 
Letter. In addition, the ABN AMRO Letter endorsed the comments in 
the SIA/FIA Letter.
---------------------------------------------------------------------------

    One commenter expressed the view that a person is a market maker in 
security futures if it provides liquidity on a regular basis, even if 
it is not under an affirmative obligation to do so.\81\ Based on that 
view, the commenter suggested two alternatives to the Commissions' 
proposal to determine whether a trader is a liquidity provider. First, 
the commenter recommended that the Commissions consider a person to be 
a liquidity provider solely because that person is registered with 
either the SEC or the CFTC as a trading professional (e.g., as a 
broker-dealer or FCM) and is a member of an exchange. In the 
alternative, the commenter recommended that the Commissions consider a 
trader to be a liquidity provider if that person can demonstrate 
through its business activity that it is a professional liquidity 
provider, regardless of its regulatory status or membership in an 
exchange.\82\ This commenter further stated that the net capital 
requirements for persons acting as market makers in security futures 
should be uniform in order to prevent security futures market makers 
subject to CFTC financial responsibility rules from obtaining an unfair 
competitive advantage over security futures market makers (or security 
options market makers) subject to SEC financial responsibility 
rules.\83\
---------------------------------------------------------------------------

    \81\ CBOE Letter at 2-3.
    \82\ Id. at 4.
    \83\ Id. at 5-6.
---------------------------------------------------------------------------

    Another commenter asked the Commissions to modify the condition to 
the exclusion for exchange members that requires that the member ``hold 
itself out as being willing to buy and sell security futures for its 
own account on a regular or continuous basis.'' \84\ The commenter 
maintained that market makers on a screen-based trading system either 
should have an enforceable obligation to provide liquidity or should 
meet an objective standard for supplying liquidity.\85\ Specifically, 
the commenter suggested that the condition be narrowed further with 
respect to members of screen-based trading systems so that it would 
apply only to members of such systems that: (1) have a continuous, 
affirmative obligation to quote a two-sided market; or (2) effect more 
than two-thirds of their security futures trades on that exchange with 
persons other than registered market makers on that exchange.\86\
---------------------------------------------------------------------------

    \84\ Amex Letter.
    \85\ Id. at 2, 4.
    \86\ Id. at 4.
---------------------------------------------------------------------------

    A third commenter asked the Commissions to eliminate the condition 
to the exclusion for exchange members that requires that the member 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.'' \87\ The commenter maintained that a broker-dealer 
acting as a market maker should not be precluded from also carrying out 
a customer securities business.
---------------------------------------------------------------------------

    \87\ SIA/FIA Letter at 14, n.25; Appendix I, Q 17(a).
---------------------------------------------------------------------------

    The fourth commenter asked the Commissions to confirm that 
registered floor brokers and floor traders would qualify for the 
exclusion even if they are not subject to a net capital requirement 
under CFTC rules.\88\ In support of this request, the commenter stated 
that market makers in options are exempt from the SEC's net capital 
rule.\89\
---------------------------------------------------------------------------

    \88\ OneChicago Letter at 9.
    \89\ Id.
---------------------------------------------------------------------------

    After considering the commenters' views, the Commissions have 
adopted the exclusion with certain modifications. First, the 
Commissions are clarifying that the provision relating

[[Page 53153]]

to accepting or soliciting customer orders was not intended to bar a 
member from engaging in such activities. That provision was intended to 
limit the exclusion from the margin requirements to circumstances where 
the member was trading for its own account, not for the account of 
others. Accordingly, the rule has been modified to make clear that the 
exclusion is available to a member only with respect to trading 
activity for its own account.\90\ Thus, the member may conduct a 
customer business and still qualify for the exclusion from the 
Commissions' margin requirements for security futures with regard to 
its market making activity.
---------------------------------------------------------------------------

    \90\ See CFTC Rule 41.42(c)(2)(v); SEC Rule 400(c)(2)(v).
---------------------------------------------------------------------------

    The Commissions have also decided that it is unnecessary to restate 
the applicability of existing net capital requirements under CFTC and 
SEC rules, or to impose additional net capital requirements, as a 
condition of the exclusion for persons acting as market makers. Firms 
will continue to be subject to applicable CFTC or SEC net capital 
requirements. Further, even if a member is not subject to net capital 
requirements, the member's carrying firm will be subject to the 
treatment provided in existing SEC or CFTC net capital rules, whichever 
are applicable, with respect to the member's security futures 
transactions.
    As noted above, the Commissions received several comments regarding 
the circumstances under which an exchange member should be considered a 
market maker for purposes of the margin rules, other than in 
circumstances that fall within the exception in Section 7(c)(3) of the 
Exchange Act. These comments largely refer to the requirement that the 
exchange member ``hold itself out as being willing to buy and sell 
security futures for its own account on a regular or continuous basis' 
in order to qualify for the exclusion. The Commissions do not believe 
that registration with the SEC or CFTC is, by itself, sufficient to 
show that a market participant is holding itself out as willing to buy 
and sell security futures. However, the Commissions believe that there 
are a number of different ways that an exchange member could satisfy 
this condition. For example, an exchange's or association's rules could 
require the member to effect a certain percentage of its security 
futures trades on that exchange or association with persons other than 
registered market makers on that exchange or association.\91\
---------------------------------------------------------------------------

    \91\ National securities exchanges registered under section 6(a) 
of the Exchange Act require their options market makers to conduct 
at least 50% of their total contract volume in option classes to 
which they have been appointed. See Amex Rule 958; Philadelphia 
Stock Exchange (``Phlx'') Rule 1014. In some cases, market makers 
are required to conduct at least 75 percent of their total contract 
volume in option classes to which they have been appointed. See CBOE 
Rule 8.7.03; International Securities Exchange Rule 805; Pacific 
Exchange (``PCX'') Rule 6.37.
---------------------------------------------------------------------------

    Alternatively, such rules could require that a large majority of 
such exchange member's revenue is derived from business activities or 
occupations from trading listed financial-based derivatives (i.e., 
security futures, stock index futures, stock and index options, foreign 
currency futures and options, and interest rate futures and options) on 
any exchange in the capacity of a member. As another alternative, the 
exchange member could be subject to rules that impose on it an 
affirmative obligation to quote on a regular or continuous basis in 
security futures.

C. Interpretations of, and Exemptions From, the Final Rules

    The Commissions are adopting two provisions in the Final Rules to 
clarify the Commissions' authority to respond to issues that arise in 
connection with the implementation of the Final Rules. First, the 
Commissions are adding a provision regarding the interpretation of the 
security futures margin rules. The Final Rules provide that the 
Commissions shall jointly interpret the margin rules, consistent with 
the criteria set forth in clauses (i) through (iv) of section 
7(c)(2)(B) of the Exchange Act and Regulation T.\92\
---------------------------------------------------------------------------

    \92\ See CFTC Rule 41.42(b); SEC Rule 400(b).
---------------------------------------------------------------------------

    Second, the Final Rules add a provision providing that each 
Commission may issue an exemption from any provision of the Final 
Rules.\93\ CFTC Rule 41.42(d) provides that the CFTC may grant an 
exemption with respect to any provision of CFTC Rules 41.42 through 
41.49, provided that the CFTC finds that the exemption is consistent 
with the public interest and the protection of customers. Similarly, 
SEC Rule 400(d) provides that the SEC may grant an exemption with 
respect to any provision of SEC Rules 400 through 406, provided that 
the exemption is necessary or appropriate in the public interest and 
consistent with the protection of investors. Because financial 
relations involving security futures are subject to the Final Rules as 
adopted by both the CFTC and the SEC, any person seeking an exemption 
under these rules must request and obtain the same exemption from both 
the CFTC and SEC. The Commissions intend to work together on exemption 
requests to establish uniform policies for security futures trading.
---------------------------------------------------------------------------

    \93\ See CFTC Rule 41.42(d); SEC Rule 400(d). The SEC and CFTC 
exemption standards contained in the Final Rules are the same as 
those set forth in the recently adopted rules relating to cash 
settlement and regulatory halt requirements for security futures 
products. See Securities Exchange Act Release No. 45956 (May 17, 
2002), 67 FR 36740 (May 24, 2002). As noted in connection with those 
rules, the SEC version of the exemption provision refers to the 
protection of ``investors,'' and the CFTC version of the provision 
refers to the protection of ``customers.'' Id. at 36745, n.64. The 
difference in terminology is not intended to have any substantive 
significance. Rather, the terms are used for purposes of conformity 
with terminology used in the Exchange Act and CEA.
---------------------------------------------------------------------------

D. Definitions

    The definition section of the Proposed Rules has been expanded to 
include all applicable defined terms. Under the Proposed Rules, many of 
these definitions and provisions would have been incorporated through 
the application of Regulation T.
    The terms ``contract multiplier,'' ``daily settlement price,'' and 
``Regulation T'' are defined in the Final Rules as proposed.\94\ The 
Proposed Rules defined the terms ``examining authority,'' ``initial 
margin,'' and ``maintenance margin.'' \95\ These terms are not, 
however, included in the Final Rules because modifications made to the 
Proposed Rules make them unnecessary. The Final Rules also define the 
term ``self-regulatory authority,'' \96\ instead of the term 
``regulatory authority'' as proposed,\97\ and its definition has been 
revised to include a reference to registration under the CEA. In 
addition, the Final Rules define the term ``current market value'' with 
respect to a security other than a security future consistently with 
the Regulation T definition.\98\ Some of the defined terms incorporate 
by reference definitions from the CEA, the Exchange Act, or CFTC or SEC 
rules.\99\
---------------------------------------------------------------------------

    \94\ See CFTC Rules 41.43(a)(3), (a)(6), and (a)(24); SEC Rules 
401(a)(3), (a)(6), and (a)(24).
    \95\ See Proposed CFTC Rules 41.44(a)(3), (a)(4), and (a)(5); 
Proposed SEC Rules 401(a)(3), (a)(4), and (a)(5).
    \96\ See CFTC Rule 41.43(a)(30); SEC Rule 401(a)(30). The 
terminology was modified to eliminate confusion as to a ``regulatory 
authority'' being a governmental regulator rather than an SRO.
    \97\ See Proposed CFTC Rule 41.44(a)(7); Proposed SEC Rule 
401(a)(7).
    \98\ See CFTC Rule 41.43(a)(4); SEC Rule 401(a)(4); see also 12 
CFR 220.2.
    \99\ See, e.g., definitions of ``broker,'' CFTC Rule 41.43(a)(2) 
and SEC Rule 401(a)(2); ``dealer,'' CFTC Rule 41.43(a)(7) and SEC 
Rule 401(a)(7); ``exempted security,'' CFTC Rule 41.43(a)(10) and 
SEC Rule 401(a)(10); ``futures account,'' CFTC Rule 41.43(a)(13) and 
SEC Rule 401(a)(13); ``futures commission merchant,'' CFTC Rule 
41.43(a)(14) and SEC Rule 401(a)(14); and ``securities account,'' 
CFTC Rule 41.43(a)(28) and SEC Rule 401(a)(28).

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[[Page 53154]]

    Terms that are not otherwise defined in the definition section of 
the Final Rules will have the meaning set forth in the margin rules 
applicable to the account.\100\ Terms that are neither defined in the 
definition section nor in the margin rules applicable to the account 
will have the meaning set forth in the Exchange Act and the CEA.\101\ 
If the definitions of a term in the Exchange Act and the CEA are 
inconsistent as applied in particular circumstances, such term shall 
have the meaning set forth in rules, regulations, or interpretations 
jointly promulgated by the SEC and the CFTC.
---------------------------------------------------------------------------

    \100\ See CFTC Rule 41.43(b); SEC Rule 401(b). See also infra 
notes 125-126 and accompanying text.
    \101\ See CFTC Rule 41.43(c); SEC Rule 401(c).
---------------------------------------------------------------------------

E. Application of Regulation T to Security Futures

    Section 7(c)(2)(B)(iv) of the Exchange Act requires that the margin 
requirements for security futures (other than levels of margin), 
including the type, form, and use of collateral, must be consistent 
with the requirements of Regulation T.\102\ To carry out that statutory 
mandate, the Commissions proposed that Regulation T would apply to all 
transactions in security futures, to the extent consistent with the 
Proposed Rules. Thus, under the Proposed Rules, Regulation T would have 
applied both to securities accounts (which are already subject to 
Regulation T) and to futures accounts (which are not otherwise subject 
to Regulation T) that carry security futures.\103\ This approach also 
would have applied existing and future Federal Reserve Board 
interpretations of Regulation T to the margin requirements for security 
futures and kept the margin requirements consistent with Regulation T 
without the need for amendments to the Final Rules.
---------------------------------------------------------------------------

    \102\ 15 U.S.C. 78g(c)(2)(B)(iv).
    \103\ See Proposed CFTC Rule 41.43(b)(1); Proposed SEC Rule 
400(b)(1).
---------------------------------------------------------------------------

    The Commissions, however, also recognized that there could be more 
than one approach to prescribing rules that are ``consistent'' with 
Regulation T. Accordingly, the Commissions specifically requested 
commenters' views on alternative approaches to establishing consistency 
with Regulation T. In particular, the Commissions solicited comment on 
the approach of issuing comprehensive ``stand-alone'' margin rules that 
would parallel Regulation T requirements for securities to the extent 
that such requirements are relevant to security futures. Under that 
approach, 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. However, the stand-alone rules 
would not apply to any other securities or futures transactions.
    The Commissions received a total of 12 comment letters on the 
application of Regulation T to security futures transactions.\104\ One 
commenter supported the Commissions' proposed approach regarding 
Regulation T.\105\ Nine commenters opposed general application of 
Regulation T to security futures carried in futures accounts,\106\ and 
two other commenters specifically opposed applying the Regulation T 
account structure to FCMs.\107\
---------------------------------------------------------------------------

    \104\ See NFA Letter; SIA/FIA Letter; Nasdaq Liffe Letter; ABN 
AMRO Letter; CME/CBOT Letter; OneChicago Letter; Morgan Stanley 
Letter; Peregrine Letter; SunGard Letter; Options Exchanges Letter; 
Managed Funds Letter; and Rolfe and Nolan Letter.
    \105\ Options Exchanges Letter at 3.
    \106\ NFA Letter at 2-3; SIA/FIA Letter at 2, 4-7; ABN AMRO 
Letter at 1; CME/CBOT Letter at 2-3; OneChicago Letter at 3-7; 
Morgan Stanley Letter at 2, 5-6; Peregrine Letter at 2; Managed 
Funds Letter at 1; and Rolfe and Nolan Letter at 1-2.
    \107\ Nasdaq Liffe Letter at 6-7; and SunGard Letter at 2-3.
---------------------------------------------------------------------------

    The commenter that supported application of Regulation T to all 
security futures transactions believed that the alternative approach of 
stand-alone rules would not satisfy the statutory requirement that the 
margin requirements for security futures (other than levels of margin) 
be ``consistent'' with those imposed on securities.\108\ The commenter 
expressed the view that the term ``consistent'' should mean that there 
is no appreciable difference between rules applicable to exchange-
traded options and rules applicable to security futures. In addition, 
the commenter noted that if the Commissions adopt stand-alone margin 
rules there is a risk that over time such rules will vary materially 
from Regulation T because of the difficulty of promptly incorporating 
the Federal Reserve Board's future interpretations of Regulation T into 
stand-alone rules.
---------------------------------------------------------------------------

    \108\ Options Exchanges Letter at 3.
---------------------------------------------------------------------------

    Commenters opposing the general application of Regulation T to 
security futures did not believe that the CFMA required such 
application. One commenter contended that application of Regulation T 
to futures accounts ``is impractical and unnecessary'' and ``not 
required,'' and that the CFMA's ``consistent'' standard did not 
necessarily require rules ``identical'' or ``equivalent'' to the rules 
applicable to exchange-traded options.\109\ Rather, this commenter 
argued, Regulation T permits commodity futures to be recorded in an 
account other than a margin account (a ``good faith'' account) and, as 
a result, permitting security futures to be carried in a futures 
account (not a margin account) is ``consistent'' with Regulation 
T.\110\ Another commenter observed that while ``consistency requires 
reasonable comparability * * * [, i]f Congress had meant `consistent' 
to mean `identical,' however, it would have used that word'' or would 
have clearly directed that Regulation T be applied to security 
futures.\111\ Similarly, another commenter pointed out that ``the CFMA 
did not mandate the application of Reg[ulation] T to security futures 
maintained in a futures account'' and that the ``imposition of 
Reg[ulation] T with respect to security futures is inconsistent with 
Congress's goal of facilitating trading in security futures.'' \112\
---------------------------------------------------------------------------

    \109\ OneChicago Letter at 3.
    \110\ Id. at 3-4.
    \111\ NFA Letter at 2.
    \112\ SIA/FIA Letter at 5.
---------------------------------------------------------------------------

    Commenters that disagreed with the Commissions' proposed approach 
generally urged the Commissions to adopt ``stand-alone'' margin rules 
for security futures.\113\ All of these commenters maintained that the 
programming changes necessary to enable FCMs to comply with Regulation 
T would be overly costly.\114\ Generally, those commenters believed 
that it would be operationally difficult or impossible to carry 
security futures in a standard futures account without costly and time-
consuming reprogramming.\115\ Commenters were concerned that this would 
place FCMs at a considerable disadvantage in comparison to broker-
dealers and would discourage them from trading security futures. One 
commenter pointed out that a broker-dealer ``would need to do little, 
relative to an FCM, to bring itself into compliance with the Proposed 
Rules.'' \116\ Another commenter expressed concern that FCMs would have 
to undertake a substantial development project requiring `the

[[Page 53155]]

restructuring of FCMs' accounts and related systems changes.'' \117\ 
The commenter estimated that this would result in the expenditure of 
``several thousands of personnel hours,'' \118\ while another commenter 
believed that costs would ``run well into six figures.'' \119\
---------------------------------------------------------------------------

    \113\ See NFA Letter at 2; SIA/FIA Letter at 5; Nasdaq Liffe 
Letter at 7; ABN AMRO Letter at 1; CME/CBOT Letter at 10; OneChicago 
Letter at 7; SunGard Letter at 3; and Peregrine Letter at 2.
    \114\ See NFA Letter at 3; SIA/FIA Letter at 4; Nasdaq Liffe 
Letter at 6; ABN AMRO Letter at 1; CME/CBOT Letter at 3; OneChicago 
Letter at 5; SunGard Letter at 1; and Peregrine Letter at 2.
    \115\ See NFA Letter at 2; SIA/FIA Letter at 4-5; Nasdaq Liffe 
Letter at 6; ABN AMRO Letter at 1; CME/CBOT Letter at 3; OneChicago 
Letter at 4; SunGard Letter at 1; Peregrine Letter at 2.
    \116\ OneChicago Letter at 5.
    \117\ SIA/FIA Letter at 4.
    \118\ Id.
    \119\ Rolfe and Nolan Letter at 1.
---------------------------------------------------------------------------

    Eight commenters recommended the adoption of an account-specific 
margin regime for purposes of account administration.\120\ The adoption 
of an account-specific margin regime was effectively endorsed by two 
other commenters that advocated retention of specific existing 
practices \121\ and one other that believed the imposition of 
Regulation T on FCMs would be highly burdensome.\122\ One commenter 
argued against the adoption of an account-specific margin regime, 
stating that FCMs will have to revise a number of their operating 
procedures and there is no compelling reason to make an exception for 
margin procedures.\123\
---------------------------------------------------------------------------

    \120\ See NFA Letter at 1-2; SIA/FIA Letter at 3-4; Nasdaq Liffe 
Letter at 6-7; ABN AMRO Letter at 1; OneChicago Letter at 6-7; 
Peregrine Letter at 2; Morgan Stanley Letter at 1; and Managed Funds 
Letter at 2.
    \121\ See Rolfe and Nolan Letter at 2; and CME/CBOT Letter at 
10.
    \122\ SunGard Letter at 2.
    \123\ Options Exchanges Letter at 3-4.
---------------------------------------------------------------------------

    After considering the commenters' suggestions, the Commissions have 
determined that it is not necessary to apply Regulation T in its 
entirety to security futures transactions to satisfy the requirements 
under section 7(c)(2) of the Exchange Act.\124\ Given the relative 
infrequency of the Federal Reserve Board adopting amendments to 
Regulation T and issuing formal regulatory guidance, the Commissions do 
not believe that it will be unduly burdensome or impractical to amend 
these rules to maintain consistency with Regulation T. Accordingly, the 
Commissions have adopted stand-alone margin rules that include certain 
requirements of Regulation T. The Commissions believe that the 
inclusion of these requirements in the Final Rules satisfies the 
statutory requirement that margin requirements for security futures be 
and remain consistent with Regulation T.
---------------------------------------------------------------------------

    \124\ 15. U.S.C. 78g(c)(2).
---------------------------------------------------------------------------

    The Commissions believe that many of the rules governing margin for 
positions carried in securities accounts are similar enough to the 
rules governing margin for positions carried in futures accounts that 
the differences do not, by themselves, create an incentive for 
customers either to trade security futures instead of options, or to 
hold security futures in a futures account rather than a securities 
account. Accordingly, the Commissions are adopting an ``account-
specific'' approach for those aspects of account administration that 
need not be conformed to satisfy the requirement that the margin rules 
for security futures be consistent with Regulation T. Thus, the Final 
Rules provide that security futures held in a securities account are 
subject to the Final Rules, Regulation T, and to the margin 
requirements of the self-regulatory authorities of which the security 
futures intermediary is a member.\125\ Security futures held in a 
futures account, on the other hand, will be subject to the Final Rules 
and the margin requirements of the self-regulatory authorities of which 
the security futures intermediary is a member.\126\
---------------------------------------------------------------------------

    \125\ See CFTC Rule 41.44(a)(1); SEC Rule 402(a)(1).
    \126\ See CFTC Rule 41.44(a)(2); SEC Rule 402(a)(2).
---------------------------------------------------------------------------

    Notwithstanding the Commissions' determination not to apply 
Regulation T in its entirety to security futures, the Final Rules 
include certain uniform provisions that govern account administration, 
type, form, and use of collateral, calculation of equity, withdrawals 
from accounts, and treatment of undermargined accounts. The Commissions 
believe that the inclusion of these provisions in the Final Rules 
satisfies the statutory requirement that the margin rules for security 
futures be consistent with Regulation T.

F. Account Administration Rules

1. Separation and Consolidation of Accounts
    Regulation T establishes specific types of accounts for recording 
different types of customer transactions (e.g., a margin account, a 
cash account, a good faith account).\127\ Regulation T generally 
provides that a customer can have only one margin account.\128\ While a 
margin account may be divided into separate parts for bookkeeping 
purposes, as authorized by the customer, all parts must be considered 
as one unit in determining whether or not any transaction is 
permissible under Regulation T.\129\ The determination as to whether an 
account satisfies the requirements of Regulation T, moreover, may not 
take into consideration items in any other account; bookkeeping entries 
must be made whenever cash or securities in one account are used for 
purposes of meeting requirements in another account.\130\ Consistent 
with Regulation T, the Final Rules provide that the margin requirements 
for one account may not be met by considering items in another account, 
except where excess margin is transferred using appropriate bookkeeping 
entries.\131\ To facilitate the enforcement of this general 
prohibition, this provision also requires that if withdrawals of cash, 
securities, or other assets deposited as margin are permitted under the 
Final Rules, a security futures intermediary must make and keep 
accurate bookkeeping entries when those assets are used to meet 
requirements in another account.\132\ This provision parallels Section 
220.3(b)(1) of Regulation T, and is intended to be consistent with 
existing futures account practices under Section 4d of the CEA,\133\ 
CFTC Rules 1.20 and 1.22, and applicable futures exchange rules.
---------------------------------------------------------------------------

    \127\ See 12 CFR 220.4(a)(1).
    \128\ See 12 CFR 220.4(a)(2).
    \129\ Fed. Res. Reg. Serv. Sec. 5-634.11 (Staff Op. May 15, 
1978).
    \130\ See 12 CFR 220.3(b)(1).
    \131\ See CFTC Rule 41.44(b)(1); SEC Rule 402(b)(1).
    \132\ See CFTC Rule 41.44(b)(1); SEC Rule 402(b)(1); see also 
section 17(a) of the Exchange Act (15 U.S.C. 78q-1(a)), and the 
rules thereunder; Section 4g of the CEA (7 U.S.C. 6g), and the rules 
thereunder; National Association of Securities Dealers (``NASD'') 
Rule 3110; and NFA Rule 2-10.
    \133\ 7 U.S.C. 6d.
---------------------------------------------------------------------------

    Currently, futures exchange rules or practices similarly recognize 
accounts of different types for different customer transactions (e.g., 
customer segregated, customer secured, nonsegregated). Customers may 
maintain multiple accounts of the same regulatory classification or 
account type, although futures exchange rules provide that identically 
owned accounts within the same regulatory classification or account 
type should be combined for margin purposes.\134\ Moreover, an FCM may 
not apply free funds in an account under identical ownership but of a 
different regulatory classification or account type to an account's 
margin deficiency.\135\ As is the case under Regulation T, however, the 
Final Rules require the FCM to actually document through bookkeeping 
entries the transfer of funds from one account to satisfy the margin 
deficiency in another account. The Commissions do not believe that this 
provision will create any substantial operational burdens for FCMs 
carrying security futures in futures accounts.
---------------------------------------------------------------------------

    \134\ See Joint Audit Committee Handbook, Chapter 9 (June 1999), 
available at <http://www.nfa.futures.org/compliance/publications/Margins/MarginsHandbook.pdf.
    \135\ See id.
---------------------------------------------------------------------------

    The Final Rules provide that all futures accounts of the same 
regulatory

[[Page 53156]]

type or classification that carry security futures shall be considered 
a single account for purposes of the Regulation.\136\ The Final Rules 
also permit a securities futures intermediary to further consolidate 
all futures accounts of the same regulatory classification or account 
type, regardless of whether they carry security futures, for purposes 
of determining whether the required margin for all of a customer's 
futures positions (including security futures) is satisfied.\137\
---------------------------------------------------------------------------

    \136\ See CFTC Rule 41.44(b)(2); SEC Rule 402(b)(2).
    \137\ Id.
---------------------------------------------------------------------------

2. Accounts of Partners
    The Final Rules provide that if a partner of a security futures 
intermediary (organized as a partnership) has an account with the 
security futures intermediary in which security futures or related 
positions are held, the security futures intermediary must disregard 
the partner's financial relations with the firm (as shown in the 
partner's capital and ordinary drawing accounts) in calculating the 
margin or equity of any such account.\138\ This provision parallels 
Section 220.4(b)(5) of Regulation T,\139\ and is consistent with 
current futures exchange practices. The provision is intended to 
reinforce the principle of ``separation of accounts'' with respect to 
partners in a security futures intermediary organized as a partnership, 
when a partner maintains a trading account with the firm.
---------------------------------------------------------------------------

    \138\ See CFTC Rule 41.44(c); SEC Rule 402(c).
    \139\ 12 CFR 220.4(b)(5).
---------------------------------------------------------------------------

3. Contribution to a Joint Venture
    Under the Final Rules, if an account in which security futures or 
related positions are held is the account of a joint venture in which 
the security futures intermediary participates, any interest of the 
security futures intermediary in the joint account in excess of the 
interest which the security futures intermediary would have on the 
basis of its right to share in the profits must be margined in 
accordance with the Final Rules.\140\ This provision parallels Section 
220.4(b)(6) of Regulation T,\141\ which is intended to prevent firms 
from indirectly extending credit to customers in circumstances where 
the customer does not deposit equity in the account corresponding to 
its share of the profits in the account (e.g., if the customer is 
entitled to 90% of the profits in an account, but only deposits 40% of 
the equity at the outset, the broker-dealer is effectively extending 
credit to the customer in the amount of 50% of the equity in the 
account).
---------------------------------------------------------------------------

    \140\ See CFTC Rule 41.44(d); SEC Rule 402(d).
    \141\ 12 CFR 220.4(b)(6).
---------------------------------------------------------------------------

4. Extensions of Credit
    The Final Rules prohibit any extension of credit with respect to 
security futures, if the extension of credit is designed to evade or 
circumvent the security futures margin requirements.\142\ Among other 
things, this provision is intended to prevent security futures 
intermediaries from extending unsecured credit to customers, or 
extending credit secured by securities or other assets in excess of the 
value such assets would have under the Final Rules,\143\ to satisfy or 
maintain the required margin for security futures carried in the 
customer's account.\144\ For example, a security futures intermediary 
may not lend a customer $100 in cash secured by less than $200 in 
margin equity securities to meet a margin call for a security future. 
This provision does not, however, preclude a security futures 
intermediary from advancing funds to a customer to meet variation 
settlement calls on behalf of an undermargined customer account, in the 
ordinary course of business, provided that the security futures 
intermediary issues a margin call for the funds advanced.
---------------------------------------------------------------------------

    \142\ See CFTC Rule 41.44(e); SEC Rule 402(e). CFTC Rule 1.30 
permits FCMs to lend their own funds to customers on pledged 
securities; the proceeds of such loans are treated as customer funds 
for purposes of the CEA. 17 CFR 1.30. Extensions of credit by 
brokers and dealers with respect to securities are governed by 
Regulation T and the margin rules of the national securities 
exchanges and securities associations.
    \143\ See CFTC Rule 41.46(c); SEC Rule 404(c).
    \144\ Futures exchange rules also impose certain restrictions on 
the financing of futures positions. See, e.g., CME Rule 930.G 
(``Clearing members may not extend loans to account holders for 
performance bond purposes unless such loans are secured as defined 
in [17 CFR] 1.17(c)(3)''); New York Mercantile Exchange (``NYMEX'') 
Rule 4.03 (``Clearing Members shall not be permitted to make loans 
to any customers for the purpose of financing margins on NYMEX 
Division contracts unless such loans are secured, as such term is 
defined in [17 CFR] 1.17'').
---------------------------------------------------------------------------

    The Final Rules permit a security futures intermediary to arrange 
for an extension of credit to or for a customer by a person, provided 
that the extension of credit would not constitute a violation of 
Regulations T, U, or X by such person.\145\ In this connection, the 
Commissions believe that credit extended for the purpose of satisfying 
or maintaining the required margin for a security future is ``purpose 
credit'' for purposes of the Federal Reserve Board's credit 
regulations. For example, a security futures intermediary may not 
arrange for a Regulation T creditor to extend credit to a customer 
against securities or other assets in a nonpurpose or nonsecurities 
credit account to enable the customer to meet a margin requirement with 
respect to a security future. Likewise, a security futures intermediary 
may not arrange for a bank or other Regulation U lender to extend 
credit secured directly or indirectly by margin stock in excess of the 
maximum loan value of the collateral (i.e., 50% of current market 
value) securing the credit for the purpose of purchasing or carrying a 
security future. Similarly, a security futures intermediary may not 
arrange for a Regulation X borrower to obtain an extension of credit 
within or from outside the United States for the purpose of effecting 
or carrying a security futures transaction unless the credit conforms 
to the Federal Reserve Board's margin regulations, as provided in 
Regulation X.
---------------------------------------------------------------------------

    \145\ See CFTC Rule 41.44(e)(2); SEC Rule 402(e)(2).
---------------------------------------------------------------------------

G. Customer Margin Levels for Security Futures

    The Commissions proposed 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. The Commissions are adopting those 
requirements substantially as proposed.
1. Definition of Current Market Value
    The Commissions proposed to define the term ``current market 
value'' of a security future as the product of the daily settlement 
price of the security future (as shown by any regularly published 
reporting or quotation service) and either the applicable number of 
shares per contract (when the underlying instrument is a single stock), 
or the applicable contract multiplier (when the underlying instrument 
is a narrow-based security index).\146\ The Commissions also proposed 
to define the term ``current market value'' with respect to a narrow-
based security index future to mean 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.\147\
    The Commissions received one comment on these definitions, which 
suggested that the pricing convention for determining current market 
value need not be the same for security futures held in a security 
account and for

[[Page 53157]]

security futures held in a futures account.\148\ The Commissions, 
however, believe that a uniform definition of current market value is 
necessary to ensure that identical contracts are not subject to 
different margin requirements based on the type of account in which 
they are carried.
---------------------------------------------------------------------------

    \146\ See Proposed CFTC Rule 41.44(a)(2)(i); Proposed SEC Rule 
401(a)(2)(i).
    \147\ See Proposed CFTC Rule 41.44(a)(2)(ii); Proposed SEC Rule 
401(a)(2)(ii).
    \148\ SIA/FIA Letter at Appendix I, Q 18.
---------------------------------------------------------------------------

    As noted above, section 7(c)(2)(B)(3)(I) of the Exchange Act \149\ 
requires that the margin requirements for security futures be 
consistent with the margin requirements for comparable exchange-traded 
options. The Commissions believe that using the daily settlement price 
\150\ at the end of each trading day to calculate margin requirements 
for security futures on that day is consistent with the use of the 
closing price of the option and the underlying security for determining 
maintenance margin for equity options.\151\ In addition, the 
Commissions continue to believe that using the daily settlement price 
of a security future on the day of a transaction to calculate the 
initial margin (rather than the daily settlement price on the day 
preceding the transaction) 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. Accordingly, the Commissions 
are adopting the definition of ``current market value'' as proposed.
---------------------------------------------------------------------------

    \149\ 15 U.S.C. 78g(c)(2)(B)(3)(I).
    \150\ Under the Final Rules, the term ``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, clearing agency 
or derivatives clearing organization. See CFTC Rule 41.43(a)(6); SEC 
Rule 401(a)(6).
    \151\ Currently, the computation of the margin required on the 
sale of an uncovered option is based on the value of the security 
underlying the option. The initial margin on the sale of an 
uncovered option is based on the price at which the underlying 
security closed at the end of the business day before the day on 
which the option is sold. The maintenance margin on an uncovered 
short option is based on the closing price of the underlying 
security at the end of each business day.
---------------------------------------------------------------------------

2. Margin Levels for Unhedged Positions
    The Commissions proposed that the minimum initial and maintenance 
margin levels required of customers for each security future carried in 
a long or short position be 20% of the current market value of such 
security future.\152\ This proposed level was based on the requirement 
under section 7(c)(2) of the Exchange Act that 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 contracts traded on any exchange registered pursuant 
to section 6(a) of the Exchange Act.\153\
---------------------------------------------------------------------------

    \152\ See Proposed CFTC Rule 41.45(b); Proposed SEC Rule 402(b).
    \153\ 15 U.S.C. 78g(c)(2)(B)(iii)(II).
---------------------------------------------------------------------------

    Twelve commenters commented on this aspect of the Proposed 
Rules.\154\ Six commenters found 20% to be an acceptable level.\155\ 
Two commenters advocated a 25% margin level,\156\ and one commenter, 
joined by a second, stated that its members could not reach a consensus 
as between 20% and 25%.\157\ One commenter expressed the view 20% could 
be either too high or low, and suggested that for certain positions, 
50% initial margin would be appropriate.\158\
---------------------------------------------------------------------------

    \154\ See SIA Credit Division Letter; Morgan Stanley Letter; 
Drinkard Letter; Partnoy Letter; Klein Letter; SIA/FIA Letter; One 
Chicago Letter; NFA Letter; Peregrine Letter; Options Exchanges 
Letter; Nasdaq Liffe Letter; and Managed Funds Letter.
    \155\ See NFA Letter at 4; Nasdaq Liffe Letter at 5; Options 
Exchanges Letter at 5; OneChicago Letter at 2; Peregrine Letter at 
2; Managed Funds Letter at 3.
    \156\ See Morgan Stanley Letter at 6; SIA Credit Division Letter 
at 1.
    \157\ See SIA/FIA Letter at 2-3, 10-11; ABN AMRO Letter at 1.
    \158\ Partnoy Letter at 10-14.
---------------------------------------------------------------------------

    One commenter considered the 20% level to be consistent with the 
margin requirements for exchange-traded options, but ``more than 
adequate'' in terms of preserving the financial integrity of the market 
and preventing systemic risk.\159\ Another commenter stated that it 
``does not oppose'' the 20% level, but favors portfolio margining.\160\
---------------------------------------------------------------------------

    \159\ NFA Letter at 4.
    \160\ Nasdaq Liffe Letter at 5.
---------------------------------------------------------------------------

    One commenter said that its members were split between recommending 
20% and 25%.\161\ Those supporting the 20% level believed that it was 
consistent with the levels applicable to exchange-traded options and 
consistent with the intent of the CFMA. This margin level in 
combination with a T+1 settlement period and the fact that the Proposed 
Rules permit higher margin levels, made some members conclude that 20% 
is a prudent minimum level.\162\ Other members thought that 20% is too 
low, failing to take into account the varying volatility/share price 
profiles of equity securities and the credit risk implications of those 
differences. Those members favored a 25% minimum, finding this to be 
``consistent'' with margin levels for options.\163\ They further noted 
that a comparable option position consists of a long (short) call/short 
(long) put option pair struck at the forward price of the underlying 
security.\164\
---------------------------------------------------------------------------

    \161\ SIA/FIA Letter at 2.
    \162\ Id. at 10.
    \163\ Id.
    \164\ Id.
---------------------------------------------------------------------------

    Finally, one commenter urged the Commissions to adopt a 25% margin 
level, citing historical data and stating that this level is consistent 
with the minimum margin level applied under SRO rules to long equity 
positions.\165\ It argued that the 20% level would create an advantage 
for security futures as compared to listed option put/call pairs, 
noting margin levels in excess of 30% for combinations based on 
relatively high volatility stocks, and margin levels in excess of 20% 
for combinations based on relatively low volatility stocks.\166\
---------------------------------------------------------------------------

    \165\ Morgan Stanley Letter at 6-8.
    \166\ Id. at 7.
---------------------------------------------------------------------------

    After considering the commenters' views, the Commissions have 
adopted the margin levels as proposed. The Commissions believe that a 
security future is comparable to a short, at-the-money option, as 
discussed in the release accompanying the Proposed Rules (``Proposing 
Release'').\167\ Currently, the margin requirement for a short, at-the-
money option, where the underlying instrument is either an equity 
security (such as a stock or an instrument immediately convertible into 
a stock) or an index, is 100% of the option proceeds plus 20% of the 
value of the underlying security or index.\168\
---------------------------------------------------------------------------

    \167\ See Securities Exchange Act Release No. 44853 (September 
26, 2001), 66 FR at 50776 (October 4, 2001).
    \168\ See, e.g., Amex Rule 462; CBOE Rule 12.3; NASD Rule 2520; 
New York Stock Exchange (``NYSE'') Rule 431; PCX Rule 2.16; and Phlx 
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. As a result, both the buyer and the seller of a 
futures contract must post and maintain margin on a daily basis to 
assure contract performance and the integrity of the marketplace. In 
addition, all market participants pay or receive daily variation 
settlement as a result of all open futures positions being marked to 
current market value. Accordingly, the margin levels apply equally for 
both buyers and sellers of security futures.
    The Commissions have considered the comments, and have determined 
that a minimum margin level of 20% satisfies the comparability standard 
of section 7(c)(2) of the Exchange Act.\169\ In addition, the 
Commissions note that the Final Rules permit self-regulatory

[[Page 53158]]

authorities and security futures intermediaries to establish higher 
margin levels or to take appropriate action to preserve their own 
financial integrity.\170\ As a result, the Commissions are adopting the 
minimum initial and maintenance margin levels for unhedged positions, 
as proposed.
---------------------------------------------------------------------------

    \169\ See 15 U.S.C. 78g(c)(2).
    \170\ See CFTC Rule 41.42(c)(1); SEC Rule 400(c)(1).
---------------------------------------------------------------------------

3. Margin Offsets
    The Proposed Rules included a provision to allow national 
securities exchanges and national securities associations to adopt 
rules that reduce the margin levels below 20% of current market value 
for customers with certain positions in securities or futures that 
offset the risk of their positions in security futures.\171\ The 
Proposed Rules provided further that the resulting margin levels could 
not be lower than the lowest customer margin levels required for 
comparable offset positions involving exchange-traded options.\172\ In 
addition, the Commissions published a table that included offsets for 
security futures that the Commissions had preliminarily identified as 
consistent with those permitted for comparable offset positions 
involving options and that would qualify for reduced margin 
levels.\173\
---------------------------------------------------------------------------

    \171\ See Proposed CFTC Rule 41.45(d); Proposed SEC Rule 402(d).
    \172\ Id.
    \173\ See Securities Exchange Act Release No. 44853 (September 
26, 2001), 66 FR at 50727-29 (October 4, 2001).
---------------------------------------------------------------------------

    The Commissions received three comments with respect to the 
proposed offsets.\174\ One of the commenters stated that offsets 
involving security futures and options should be recognized only if the 
risk from the security future is completely offset by the option.\175\ 
Another commenter expressed concern that the offsets would produce 
margin levels that did not accurately reflect the risk of the positions 
and suggested that the Commissions adopt general provisions regarding 
margin levels for offsetting positions instead of providing specific 
examples. \176\ Finally, one commenter suggested modifying the existing 
strategy-based rules to put security futures on a par with cash 
equities in connection with offsetting strategies involving listed 
options and to reduce the margin requirements for certain calendar and 
basket spreads involving security futures.\177\ This commenter also 
suggested that the Commissions address the treatment of spreads 
involving non-fungible security futures.\178\
---------------------------------------------------------------------------

    \174\ See Options Exchanges Letter; Partnoy Letter; SIA/FIA 
Letter.
    \175\ Options Exchanges Letter at 6.
    \176\ Partnoy Letter at 14.
    \177\ SIA/FIA Letter at Appendix I, Q 19.
    \178\ Meeting between SEC and CFTC staff and representatives of 
SIA/FIA (February 6, 2002).
---------------------------------------------------------------------------

    After considering the commenters' views, the Commissions have 
adopted, substantially as proposed, rules that permit self-regulatory 
authorities to establish margin levels for offset positions involving 
security futures that are lower than the required margin levels for 
unhedged positions.\179\ Under the Final Rules, a self-regulatory 
authority may set the required initial or maintenance margin level for 
an offsetting position involving security futures and related positions 
at a level lower than the level that would be required if the positions 
were margined separately. Such rules must meet the criteria set forth 
in section 7(c)(2)(B) of the Exchange Act \180\ and must be effective 
in accordance with section 19(b)(2) of the Exchange Act \181\ and, as 
applicable, Section 5c(c) of the CEA.\182\
---------------------------------------------------------------------------

    \179\ See CFTC Rule 41.45(b)(2); SEC Rule 403(b)(2).
    \180\ 15 U.S.C. 78g(c)(2)(B).
    \181\ 15 U.S.C. 78s(b)(2).
    \182\ 7 U.S.C. 7a-2(c).
---------------------------------------------------------------------------

    The Commissions have retained, with certain revisions, the table of 
offsets that they deem to be consistent with offsets recognized for 
comparable exchange-traded options. In particular, the revised table of 
offsets reflects an adjustment in the level of margin required for 
certain calendar and basket spreads involving security futures to more 
accurately reflect the risk of such positions relative to comparable 
spreads involving exchange-traded options. An offset position for 
spreads involving non-fungible security futures also has been added to 
the table.
    When it approved strategy-based offsets for options, 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.\183\ The SEC also 
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.
---------------------------------------------------------------------------

    \183\ 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).
---------------------------------------------------------------------------

    The table of offsets reflects a reduction in the minimum initial 
and maintenance margin requirement for calendar spreads \184\ and 
basket spreads,\185\ in response to the comment that the risk posed by 
certain spreads involving security futures is lower than the risk posed 
by comparable spreads involving exchange-traded options. \186\ In light 
of the observation that security futures are not subject to early 
exercise and therefore do not exhibit the same price volatility as 
options, the minimum initial and maintenance margin requirement 
recognized for calendar spreads and basket spreads has been reduced to 
5% of the current market value of the long or short position.\187\ The 
Commissions deliberated as to whether risk-based margin computations 
using SPAN could be applied to these strategies, so long as the 
offsetting positions were the only positions included in the margin 
computation. The Commissions have decided not to permit risk-based 
margin computations for these offsets at this time.
---------------------------------------------------------------------------

    \184\ A calendar spread is an offset position consisting of a 
long security future and short security future on the same 
underlying security, each contract expiring in a different month. 
See table of offsets, item 10.
    \185\ A basket spread is an offset consisting of a security 
future based on an index and a basket of security futures that 
replicates the index, i.e., a basket that contains the same 
securities, and in the same proportion, as the index. See table of 
offsets, items 17 and 18.
    \186\ Meeting between SEC and CFTC staff and representatives of 
SIA/FIA (February 6, 2002).
    \187\ By way of comparison, the minimum margin required for 
offsetting long and short positions in the same security under the 
rules of the national securities exchanges is 5% of the current 
market value of the long position. See, e.g., NYSE Rule 431(e)(1).
---------------------------------------------------------------------------

    The table of offsets, likewise, reflects a reduction in the 
required margin recognized for spreads involving a long or short 
security future and a short or long position in the same security 
underlying the security future, given that these spreads are 
economically

[[Page 53159]]

analogous to calendar spreads.\188\ The Commissions intend to review 
the margin levels for the offsets discussed above after six months of 
security futures trading to determine whether the margin levels have 
resulted in regulatory arbitrage with comparable positions involving 
exchange-traded options, and may jointly undertake appropriate action.
---------------------------------------------------------------------------

    \188\ See table of offsets, items 4 and 13.
---------------------------------------------------------------------------

    Based on the same commenter's suggestion, the Commissions believe 
that an additional offset should be recognized for spreads involving 
identical, non-fungible security futures.\189\ Because there is a 
possibility that certain security futures may not be fungible across 
markets, a customer may simultaneously hold a long security future and 
a short security future on the same underlying security even when those 
security futures have identical contract terms. As a result, the 
customer will be economically neutral but will be required to hold both 
positions to expiration and meet daily variation settlement calls with 
respect to each contract. The commenter expressed the view that a 
minimum margin level of 1% would be appropriate.\190\ The Commissions 
recognize that the rules of a clearing agency or derivatives clearing 
organization may effectively net the two contracts at final settlement. 
However, due to potential differences in daily settlement prices across 
markets or other market-specific events, the Commissions have 
determined that such offset positions will be subject to a minimum 
margin requirement of 3%.
---------------------------------------------------------------------------

    \189\ See table of offsets, item 19.
    \190\ Meeting between SEC and CFTC staff and representatives of 
SIA/FIA (February 6, 2002).
---------------------------------------------------------------------------

    The Commissions believe that the offsets identified in the 
following table are consistent with the strategy-based offsets 
permitted for comparable offset positions involving exchange-traded 
options. The Commissions expect that self-regulatory authorities 
seeking to permit trading in security futures will submit to the 
Commissions proposed rules that impose levels of required margin for 
offsetting positions involving security futures in accordance with the 
minimum margin requirements identified in the following table of 
offsets.

----------------------------------------------------------------------------------------------------------------
                                    Security underlying the        Initial margin          Maintenance margin
      Description of offset             security future              requirement               requirement
----------------------------------------------------------------------------------------------------------------
1. Long security future or short   Individual stock or        20% of the current        20% of the current
 security future.                   narrow-based security      market value of the       market value of the
                                    index.                     security future.          security future.
2. Long security future (or        Individual stock or        20% of the current        The lower of: (1) 10% of
 basket of security futures         narrow-based security      market value of the       the aggregate exercise
 representing each component of a   index.                     long security future,     price \3\ of the put
 narrow-based securities index                                 plus pay for the long     plus the aggregate put
 \1\) and long put option \2\ on                               put in full.              out-of-the-money \4\
 the same underlying security (or                                                        amount, if any; or (2)
 index).                                                                                 20% of the current
                                                                                         market value of the
                                                                                         long security future.
3. Short security future (or       Individual stock or        20% of the current        20% of the current
 basket of security futures         narrow-based security      market value of the       market value of the
 representing each component of a   index.                     short security future,    short security future,
 narrow-based securities index                                 plus the aggregate put    plus the aggregate put
 \1\) and short put option on the                              in-the-money amount, if   in-the-money amount, if
 same underlying security (or                                  any. Proceeds from the    any.\5\
 index).                                                       put. Proceeds from the
                                                               put sale may be applied.
4. Long security future and short  Individual stock or        The initial margin        5% of the current market
 position in the same security      narrow-based security      required under            value as defined in
 (or securities basket \1\)         index.                     Regulation T for the      Regulation T of the
 underlying the security future.                               short stock or stocks.    stock or stocks
                                                                                         underlying the security
                                                                                         future.
5. Long security future (or        Individual stock or        20% of the current        20% of the current
 basket of security futures         narrow-based security      market value of the       market value of the
 representing each component of a   index.                     long security future,     long security future,
 narrow-based securities index                                 plus the aggregate call   plus the aggregate call
 \1\) and Short call option on                                 in-the-money amount, if   in-the-money amount, if
 the same underlying security (or                              any. Proceeds from the    any.
 index).                                                       call sale may be
                                                               applied.
6. Long a basket of narrow-based   Narrow-based security      20% of the current        20% of the current
 security futures that together     index.                     market value of the       market value of the
 tracks a broad based index \1\                                long basket of narrow-    long basket of narrow-
 and short a broad-based security                              based security futures,   based security futures,
 index call option contract on                                 plus the aggregate call   plus the aggregate call
 the same index.                                               in-the-money amount, if   in-the-money amount, if
                                                               any. Proceeds from the    any.
                                                               call sale may be
                                                               applied.
7. Short a basket of narrow-based  Narrow-based security      20% of the current        20% of the current
 security futures that together     index.                     market value of the       market value of the
 tracks a broad-based security                                 short basket of narrow-   short basket of narrow-
 index \1\ and short a broad-                                  based security futures,   based security futures,
 based security index put option                               plus the aggregate put    plus the aggregate put
 contract on the same index.                                   in-the-money amount, if   in-the-money amount, if
                                                               any. Proceeds from the    any.
                                                               put sale may be applied.
8. Long security a basket a        Narrow-based security      20% of the current        The lower of: (1) 10% of
 narrow-based securities futures    index.                     market value of the       the aggregate exercise
 that together tracks a broad-                                 long basket of narrow-    price of the put, plus
 based security index \1\ and                                  based security futures,   the aggregate put out-
 long a broad-based security                                   plus pay for the long     of-the-money amount, if
 index put option contract on the                              put in full.              any; or (2) 20% of the
 same index.                                                                             current market value of
                                                                                         the long basket of
                                                                                         security futures.

[[Page 53160]]

 
9. Short a basket of narrow-based  Narrow-based security      20% of the current        The lower of: (1) 10% of
 security futures that together     index.                     market value of the       the aggregate exercise
 tracks a broad-based security                                 short basket of narrow-   price of the call, plus
 index \1\ and long a broad-based                              based security futures,   the aggregate call out-
 security index call option                                    plus pay for the long     of-the-money amount, if
 contract on the same index.                                   call in full.             any; or (2) 20% of the
                                                                                         current market value of
                                                                                         the short basket of
                                                                                         security futures
10. Long security future and       Individual stock or        The greater of: 5% of     The greater of: 5% of
 short security future on the       narrow-based security      the current market        the current market
 same underlying security (or       index.                     value of the long         value of the long
 index).                                                       security future; or 2)    security future; or (2)
                                                               5% of the current         5% of the current
                                                               market value of the       market value of the
                                                               short security future.    short security future.
11. Long security future, long     Individual stock or        20% of the current        10% of the aggregate
 put option and short call          narrow-based security      market value of the       exercise price, plus
 option. The long security          index.                     long security future,     the aggregate call in-
 future, long put and short call                               plus the aggregate call   the-money amount, if
 must be on the same underlying                                in-the-money amount, if   any.
 security and the put and call                                 any, plus pay for the
 must have the same exercise                                   put in full. Proceeds
 price. (Conversion).                                          from the call sale may
                                                               be applied.
12. Long security future, long     Individual stock or        20% of the current        The lower of: (1) 10% of
 put option and short call          narrow-based security      market value of the       the aggregate exercise
 option. The long security          index.                     long security future,     price of the put plus
 future, long put and short call                               plus the aggregate call   the aggregate put out-
 must be on the same underlying                                in-the-money amount, if   of-the-money amount, if
 security and the put exercise                                 any, plus pay for the     any; or (2) 20% of the
 price must be below the call                                  put in full. Proceeds     aggregate exercise
 exercise price. (Collar).                                     from call sale may be     price of the call, plus
                                                               applied.                  the aggregate call in-
                                                                                         the-money amount, if
                                                                                         any.
13. Short security future and      Individual stock or        The initial margin        5% of the current market
 long position in the same          narrow-based security      required under            value, as defined in
 security (or securities basket     index.                     Regulation T for the      Regulation T, of the
 \1\) underlying the security                                  long stock or stocks.     long stock or stocks.
 future.
14. Short security future and      Individual stock or        The initial margin        10% of the current
 long position in a security        narrow-based security      required under            market value, as
 immediately convertible into the   index.                     Regulation T for the      defined in Regulation
 same security underlying the                                  long security.            T, of the long security
 security future, without
 restriction, including the
 payment of money.
15. Short security future (or      Individual stock or        20% of the current        The lower of: (1) 10% of
 basket of security futures         narrow-based security      market value of the       the aggregate exercise
 representing each component of a   index.                     short security future,    price of the call, plus
 narrow-based securities index                                 plus pay for the call     the aggregate call out-
 \1\) and long call option or                                  in full.                  of-the-money amount, if
 warrant on the same underlying                                                          any; or (2) 20% of the
 security (or index).                                                                    current market value of
                                                                                         the short security
                                                                                         future.
16. Short security future, Short   Individual stock of        20% of the current        10% of the aggregate
 put option and long call option.   narrow-based security      market value of the       exercise price, plus
 The short security future, short   index.                     short security future,    the aggregate put in-
 put and long call must be on the                              plus the aggregate put    the-money amount, if
 same underlying security and the                              in-the-money amount, if   any.
 put and call must have the same                               any, plus pay for the
 exercise price. (Reverse                                      call in full. Proceeds
 Conversion).                                                  from put sale may be
                                                               applied.
17. Long (short) a basket of       Narrow-based security      5% of the current market  5% of the current market
 security futures, each based on    index.                     value of the long         value of the long
 a narrow-based security index                                 (short) basket of         (short) basket of
 that together tracks the broad-                               security futures.         security futures.
 based index \1\ and short (long)
 a broad based-index future.
18. Long (short) a basket of       Individual stock and       The greater of: (1) 5%    The greater of: (1) 5%
 security futures that together     narrow-based security      of the current market     of the current market
 tracks a narrow-based index \1\    index.                     value of the long         value of the long
 and short (long) a narrow based                               security future(s); or    security future(s); or
 index future.                                                 (2) 5% of the current     (2) 5% of the current
                                                               market value of the       market value of the
                                                               short security            short security
                                                               future(s).                future(s).
19. Long (short) a security        Individual stock and       The greater of: (1) 3%    The greater of: (1) 3%
 future and short (long) an         narrow-based security      of the current market     of the current market
 identical security future traded   index.                     value of the long         value of the long
 on a different market.\6\.                                    security future(s); or    security future(s); or
                                                               (2) 3% of the current     (2) 3% of the current
                                                               market value of the       market value of market
                                                               short security            value of the short
                                                               future(s).                security future(s).
----------------------------------------------------------------------------------------------------------------
\1\ Baskets of securities or security futures contracts must replicate the 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.

[[Page 53161]]

 
\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; and
(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; and
(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.
\6\ Two security futures will be considered ``identical'' for this purpose if they are issued by the same
  clearing agency or cleared and guaranteed by the same derivatives clearing organization, have identical
  contract specifications, and would offset each other at the clearing level.

    The Commissions note that positions in a securities account may not 
be cross-margined with positions in a futures account except in 
accordance with the rules of a self-regulatory authority that have 
become effective under section 19(b)(2) of the Exchange Act and, as 
applicable, section 5c(c) of the CEA. At present, the Commissions have 
not approved the use of a cross-margining methodology for customer 
securities and futures accounts. Accordingly, security futures or other 
positions carried in a futures account may not currently be offset 
against security futures or other positions carried in a securities 
account to reduce a customer's total margin requirement.
4. Higher Margin Levels
    The Proposed Rules expressly provided that self-regulatory 
authorities could impose on their members initial and maintenance 
margin levels that are higher than the minimum levels otherwise 
specified in the rules.\191\ The Proposed Rules also provided that 
self-regulatory authorities could permit their members to use a method 
for computing required margin that could result in margin levels that 
are higher than the minimum levels specified in the rules.\192\
---------------------------------------------------------------------------

    \191\ See Proposed CFTC Rule 41.45(b)(2)(i); Proposed SEC Rule 
402(b)(2)(i).
    \192\ See Proposed CFTC Rule 41.45(b)(2)(ii); Proposed SEC Rule 
402(b)(2)(ii).
---------------------------------------------------------------------------

    The Commissions have decided that it is not necessary to adopt 
these provisions of the Proposed Rules because other provisions of the 
Final Rules make clear the ability of a self-regulatory authority to 
establish higher margin levels. The Final Rules establish minimum 
levels and do not set any limitations as to maximum levels. Moreover, 
the Final Rules expressly do not preclude a self-regulatory authority 
or a security futures intermediary from imposing additional margin 
requirements, including higher initial and maintenance margin levels, 
consistent with the Final Rules.\193\
---------------------------------------------------------------------------

    \193\ See CFTC Rule 41.42(c)(1); SEC Rule 400(c)(1).
---------------------------------------------------------------------------

    As noted previously, a portfolio margining system such as SPAN may 
be used to compute required margin based on the parameters established 
in accordance with the Final Rules. Each security futures intermediary 
remains responsible for collecting margin in compliance with the Final 
Rules.
5. Procedures for Certain Margin Level Adjustments
    The Commissions proposed to allow national securities exchanges 
registered under section 6(g) of the Exchange Act \194\ and national 
securities associations registered under section 15A(k) of the Exchange 
Act \195\ to raise or lower margin levels in accordance with section 
19(b)(7) of the Exchange Act,\196\ as long as the resulting levels 
satisfy the minimum level requirements.\197\ The Commissions received 
no comments on this aspect of the proposal, and are adopting it as 
proposed.\198\
---------------------------------------------------------------------------

    \194\ 15 U.S.C. 78f(g).
    \195\ 15 U.S.C. 78o-3(k).
    \196\ 15 U.S.C. 78s(b)(7).
    \197\ See Proposed CFTC Rule 41.45(c); Proposed SEC Rule 402(c).
    \198\ See CFTC Rule 41.45(c); SEC Rule 403(c).
---------------------------------------------------------------------------

H. Satisfaction of Required Margin

    Section 7(c)(2)(B)(iv) of the Exchange Act \199\ requires that the 
type, form and use of collateral for security futures products be and 
remain consistent with the requirements of Regulation T. To fulfill 
this statutory requirement, the Commissions proposed to permit security 
futures intermediaries to accept as margin for security futures any of 
the types of collateral permitted under Regulation T to satisfy a 
margin deficiency in a margin account.\200\ The Commissions also 
proposed to allow self-regulatory authorities to establish their own 
margin collateral requirements as long as those requirements were 
consistent with the requirements of Regulation T.\201\
---------------------------------------------------------------------------

    \199\ 15 U.S.C. 78g(c)(2)(B)(iv).
    \200\ See Proposed CFTC Rule 41.47(a)(4); Proposed SEC Rule 
404(a)(4).
    \201\ See Proposed CFTC Rule 41.47(b); Proposed SEC Rule 404(b).
---------------------------------------------------------------------------

    The Final Rules continue to limit the type, form, and use of 
collateral deposits that security futures intermediaries may accept to 
satisfy the required margin for security futures to those permitted 
under Regulation T.\202\ The Commissions are, however, permitting 
security futures intermediaries to include the net value of certain 
additional items--specifically, long options \203\ and open trade 
equity \204\--in computing the equity in an account. Moreover, for 
purposes of determining whether the required margin in an account is 
satisfied, the final rules

[[Page 53162]]

permit security futures intermediaries to compute equity in accordance 
with applicable self-regulatory authority rules, subject to certain 
adjustments to ensure consistency with Regulation T.\205\
---------------------------------------------------------------------------

    \202\ See CFTC Rule 41.46(a); SEC Rule 404(a).
    \203\ See CFTC Rule 41.46(c)(1)(iv); SEC Rule 404(c)(1)(ii).
    \204\ See CFTC Rule 41.46(c)(1)(vi) and (c)(2)(iii); SEC Rule 
404(c)(1)(vi) and (c)(2)(iii).
    \205\ See CFTC Rule 41.46; SEC Rule 404.
---------------------------------------------------------------------------

1. Type, Form and Use of Collateral
    a. Acceptable Collateral Deposits. The Commissions proposed to 
permit security futures intermediaries to accept as margin for security 
futures a deposit of any combination of cash, margin securities as 
defined in Regulation T,\206\ exempted securities as defined in section 
3(a)(12) of the Exchange Act,\207\ and other collateral permitted under 
Regulation T to satisfy a margin deficiency in the margin account.\208\
---------------------------------------------------------------------------

    \206\ Under Section 202.2 of Regulation T (12 CFR 220.2), 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 (15 U.S.C. 80a-8); (5) any 
foreign margin stock; and (6) any debt security convertible into a 
margin security.
    \207\ 15 U.S.C. 78c(a)(12).
    \208\ See Proposed CFTC Rule 41.47(a)(4); Proposed SEC Rule 
404(a)(4).
---------------------------------------------------------------------------

    The Commissions received four comments on this issue.\209\ One 
commenter supported the Commissions' proposal with respect to 
permissible collateral.\210\ The other three commenters suggested that 
the Commissions should permit security futures intermediaries to accept 
other forms of collateral in addition to those permitted by Regulation 
T.\211\
---------------------------------------------------------------------------

    \209\ See Options Exchanges Letter; NFA Letter; CME/CBOT Letter; 
SIA/FIA Letter.
    \210\ Options Exchanges Letter at 6-7.
    \211\ See NFA Letter at 6-7; CME/CBOT Letter at 3-4; and SIA/FIA 
Letter 6-8.
---------------------------------------------------------------------------

    Two of these commenters suggested that the type of collateral 
permitted should be determined based on the type of account. Under an 
account-specific approach, for security futures held in futures 
accounts, the types of permissible collateral would be determined by 
SRO rules; and for security futures held in securities accounts, the 
types of permissible collateral would be governed by Regulation T.\212\ 
The other commenter maintained that, unless the Commissions recognize 
other instruments that are commonly accepted as collateral within a 
futures account (e.g., letters of credit), the margin requirements 
would disadvantage the futures community and would make it unlikely 
that customers would carry security futures products in a futures 
account.\213\
---------------------------------------------------------------------------

    \212\ See NFA Letter at 7; SIA/FIA Letter at 6.
    \213\ CME/CBOT Letter at 4.
---------------------------------------------------------------------------

    The Commissions have considered the commenters' views, and have 
adopted the provisions regarding acceptable collateral deposits 
substantially as proposed. In particular, the Commissions do not 
believe that it would be consistent with the requirements regarding 
type, form, and use of collateral under Regulation T to permit 
customers to satisfy the required margin for security futures in a 
futures account using letters of credit or other types of collateral 
not currently permitted under Regulation T. Any types of collateral the 
Federal Reserve Board may subsequently permit in a Regulation T margin 
account, however, may also be used to satisfy the required margin for 
security futures under the Final Rules.\214\
---------------------------------------------------------------------------

    \214\ CFTC Rule 41.46(b)(1); SEC Rule 404(b)(1).
---------------------------------------------------------------------------

    b. Use of Money Market Mutual Funds. The definition of ``margin 
security'' under Regulation T includes, among other securities, money 
market mutual funds. A number of futures exchanges currently accept 
money market mutual fund shares as performance bond deposits for 
futures and options on futures, subject to certain conditions imposed 
under CFTC Rule 1.25.\215\ Regulation T also permits creditors to 
extend good faith loan value to shares in money market mutual funds and 
other mutual funds carried in a securities account, although the 
limitations on extensions of credit in connection with new issues of 
securities under section 11(d)(1) of the Exchange Act have limited the 
practicability of their use.\216\
---------------------------------------------------------------------------

    \215\ See, e.g., CME Rule 930.C.
    \216\ In a recent interpretive release providing guidance on the 
application of certain provisions of the federal securities laws to 
trading in security futures products, the SEC expressed the view 
that a security future is not an extension of credit under section 
11(d)(1) of the Exchange Act (15 U.S.C. 78k(d)(1)), and that margin 
collected in connection with a security futures transaction 
represents a good faith deposit against performance and not 
``partial payment'' for the security. Securities Exchange Act 
Release No. 46101 (June 21, 2002), 67 FR 43234, 43245 (June 27, 
2002). Accordingly, a deposit of money market mutual fund shares by 
a customer to satisfy the required margin for a security future does 
not, in the SEC's view, constitute a direct or indirect extension or 
maintenance of credit to or for the customer on such shares for 
purposes of Section 11(d)(1) (15 U.S.C. 78k(d)(1)).
---------------------------------------------------------------------------

    The Final Rules permit the use of money market mutual fund shares 
\217\ to satisfy the required margin for security futures and related 
positions carried in a securities account or futures account, subject 
to certain conditions.\218\ These conditions are intended to facilitate 
a security futures intermediary's hypothecation or liquidation of money 
market mutual fund shares deposited as margin for security futures, as 
necessary to meet a customer's clearing obligations.
---------------------------------------------------------------------------

    \217\ See CFTC Rule 41.43(a)(22); SEC Rule 401(a)(22).
    \218\ See CFTC Rule 41.46(b)(2); SEC Rule 404(b)(2).
---------------------------------------------------------------------------

    Specifically, a security futures intermediary may accept money 
market mutual fund shares as margin if the following conditions are met 
(e.g., under the rules of a self-regulatory authority or pursuant to a 
three-way agreement among the security futures intermediary, the 
customer, and the money market mutual fund or its transfer agent):
    (1) The customer waives any right to redeem the fund shares without 
the consent of the security futures intermediary and instructs the fund 
or its transfer agent accordingly;
    (2) The security futures intermediary (or clearing agency or 
derivatives clearing organization with which the security is deposited 
as margin) obtains the right to redeem the shares in cash, promptly 
upon request; and
    (3) The fund agrees to satisfy any conditions necessary or 
appropriate to ensure that the shares may be redeemed in cash, promptly 
upon request.
2. Computation of Equity
    The Proposed Rules would have required security futures 
intermediaries to compute the equity in an account in accordance with 
Regulation T for purposes of determining whether the required margin 
for security futures is satisfied.\219\ The Commissions received one 
comment on this issue.\220\ The commenter expressed the opinion that 
the rules governing collateral haircuts in securities and futures 
accounts need not be identical, as long as the relevant standards do 
not create a material incentive for customers to carry security futures 
positions in a futures account rather than a securities account.\221\
---------------------------------------------------------------------------

    \219\ See Proposed CFTC Rule 41.43(b); Proposed SEC Rule 400(b).
    \220\ SIA/FIA Letter.
    \221\ Id., at 6.
---------------------------------------------------------------------------

    The Commissions have considered this commenter's views and have 
determined not to require security futures intermediaries to compute 
equity in accordance with Regulation T. The Final Rules provide that, 
for purposes of determining whether the required margin for security 
futures carried in an account is satisfied, the equity in an account 
shall be computed in accordance with the margin rules

[[Page 53163]]

applicable to the account.\222\ However, so that that collateral and 
other components of equity are valued consistently in securities and 
futures accounts, the Final Rules require security futures 
intermediaries to make certain adjustments to equity when determining 
whether the required margin for security futures carried in an account 
is satisfied.\223\ Each of these components of equity is discussed in 
turn below.
---------------------------------------------------------------------------

    \222\ See CFTC Rule 41.46(c); SEC Rule 404(c). For purposes of 
determining whether the required margin for security futures and 
related positions is satisfied under the Final Rules, the equity in 
a futures account is defined to include the account's net 
liquidating equity plus the collateral value of margin securities, 
exempted securities, and other acceptable margin deposits. See Joint 
Audit Committee, Margins Handbook, Chapter 1 (June 1999) (definition 
of ``margin equity''). Securities may not be combined with security 
futures carried in a futures account to create an offset position 
except pursuant to a cross-margining arrangement, as described in 
Section II.G.3 of this release.
    \223\ See CFTC Rule 41.46(c), (d), and (e); SEC Rule 404(c), 
(d), and (e).
---------------------------------------------------------------------------

    a. Security Futures. The Proposed Rules provided that security 
futures would not be ``margin securities'' for purposes of the margin 
requirements and therefore would not have loan value for margin 
purposes.\224\ One commenter addressed this provision and supported the 
view that security futures should not have loan value for margin 
purposes.\225\
---------------------------------------------------------------------------

    \224\ See Proposed CFTC Rule 41.47(c); Proposed SEC Rule 404(c).
    \225\ Options Exchanges Letter at 6-7.
---------------------------------------------------------------------------

    The Commissions have considered the commenter's views and have 
adopted Final Rules that provide that security futures will have no 
value for purposes of determining whether the required margin in a 
securities or futures account is satisfied.\226\ This is consistent 
with the treatment of other futures contracts carried in futures 
accounts.
---------------------------------------------------------------------------

    \226\ See CFTC Rule 41.46(c)(1)(i) and (c)(2)(i); SEC Rule 
404(c)(1)(i) and (c)(2)(i). As discussed below, open trade equity 
resulting from the daily settlement of security futures can be used 
to satisfy the required margin.
---------------------------------------------------------------------------

    To avoid confusion as to whether extensions of credit in connection 
with security futures are considered ``purpose credit'' for purposes of 
the Federal Reserve Board's credit regulations,\227\ however, the 
Commissions have revised the Final Rules to eliminate the statement 
that security futures are not margin securities.
---------------------------------------------------------------------------

    \227\ See discussion of extensions of credit in Section II.F.4. 
of this release.
---------------------------------------------------------------------------

    b. Option Value. The Proposed Rules did not address the question of 
whether the net value of options in a securities or futures account 
could be applied to satisfy the required margin for security 
futures.\228\ The rules of the futures exchanges generally permit FCMs 
to include the value of listed options on contracts for future delivery 
in computing the equity in a futures account. The rules of the national 
securities exchanges and the NASD, however, generally deny value to 
options carried for a customer for the purpose of computing the equity 
in the customer's account.\229\
---------------------------------------------------------------------------

    \228\ Regulation T generally delegates the authority to specify 
the amount or other position to satisfy the required margin for put 
or call options on a security, certificate of deposit, securities 
index or foreign currency, or a warrant on a securities index or 
currency carried in a securities account to the registered 
securities exchange or association authorized to trade the option 
(in the case of exchange-listed options) and to the creditor's 
examining authority (in the case of all other options), subject in 
each case to approval by the SEC. See 12 CFR 220.12(f).
    \229\ The rules of the national securities exchanges and the 
NASD recognize an exception for long listed or OTC options and 
warrants with a remaining period to expiration exceeding 9 months. 
Such contracts are valued at their current market value (as defined 
in Section 220.2 of Regulation T (12 CFR 220.2)), subject to a 75% 
margin requirement. See, e.g., NYSE Rule 431(f)(2)(C).
---------------------------------------------------------------------------

    One commenter expressed concern that the exclusion of net option 
value from the calculation of equity in a futures account would create 
significant operational difficulties for security futures 
intermediaries that carry security futures in futures accounts.\230\ 
Two other commenters noted, however, that recognition of option value 
for purposes of determining whether the required margin for security 
futures is satisfied in a futures account would create a significant 
regulatory disparity with exchange-traded options carried in securities 
accounts.\231\
---------------------------------------------------------------------------

    \230\ Meeting between SEC and CFTC staff and representatives of 
SIA/FIA (February 6, 2002).
    \231\ Telephone conversations between SEC staff and The OCC 
staff (February 20, 2002) and between SEC staff and CBOE staff 
(February 5, 2002).
---------------------------------------------------------------------------

    The Commissions, having considered the commenters' concerns, are 
adopting Final Rules that provide that a net long or short position in 
a listed put or call option carried in a futures account shall be 
valued in accordance with the margin rules applicable to the account 
for purposes of determining whether the required margin for a security 
future in the account is satisfied.\232\ For these purposes, the term 
``listed option'' is defined to mean any put or call option that is (i) 
issued by a clearing agency that is registered under section 17A of the 
Exchange Act \233\ or cleared and guaranteed by a derivatives clearing 
organization that is registered under Section 5b of the CEA; \234\ and 
(ii) traded on or subject to the rules of a self-regulatory 
authority.\235\
---------------------------------------------------------------------------

    \232\ See CFTC Rule 41.46(c)(1)(ii); SEC Rule 404(c)(1)(ii).
    \233\ 15 U.S.C. 78q-1.
    \234\ 7 U.S.C. 7a-1.
    \235\ See CFTC Rule 41.43(a)(16); SEC Rule 401(a)(16).
---------------------------------------------------------------------------

    The SEC is willing to entertain proposed rule changes by the 
national securities exchanges and the NASD to grant value to listed 
options in a securities account under appropriate circumstances. In 
addition, the Commissions intend to review their determination to grant 
value to long options carried in futures accounts after six months of 
security futures trading to determine whether it has created a material 
disparity between the margin requirements for security futures and the 
margin requirements for comparable exchange-traded options, and may 
jointly undertake appropriate action.
    c. Open Trade Equity. The Proposed Rules did not address in detail 
how ``open trade equity'' (i.e., the daily marked-to-market gain or 
loss in value of futures or other exchange-traded contracts) would be 
included in the equity in an account for purposes of determining 
whether the required margin for security futures is satisfied. However, 
eight commenters raised the issue and requested clarification from the 
Commissions.\236\ Those commenters generally requested that the 
Commissions clarify that broker-dealers and FCMs could treat open trade 
equity on security futures positions as cash for purposes of margin and 
collateral.
---------------------------------------------------------------------------

    \236\ See Peregrine Letter; OneChicago Letter; NFA Letter; CME 
Letter; SIA/FIA Letter; Nasdaq Liffe Letter; SunGard Letter; and 
Morgan Stanley Letter.
---------------------------------------------------------------------------

    One of those commenters maintained that disallowing the use of open 
trade equity to satisfy margin on trades and position in other markets 
could dampen customers' interest in security futures.\237\ Another of 
the commenters suggested that FCMs would have to make costly systems 
changes if they were not allowed to recognize open trade equity for 
security futures as they are permitted to do for other futures 
positions.\238\
---------------------------------------------------------------------------

    \237\ OneChicago Letter at 6.
    \238\ SunGard Letter at 2.
---------------------------------------------------------------------------

    In light of commenters' views on this issue, the Final Rules 
clarify that ``open trade equity'' may be applied to satisfy the 
required margin for security futures and related positions. 
Specifically, the Final Rules define a new term, ``variation 
settlement,'' to mean any credit or debit to a customer account, made 
on a daily or intraday basis, for the purpose of marking to market a 
security future or any other contract that is: (i) issued by a clearing 
agency that is registered under section 17A of the

[[Page 53164]]

Exchange Act \239\ or cleared and guaranteed by a derivatives clearing 
organization that is registered under Section 5b of the CEA,\240\ and 
(ii) traded on or subject to the rules of a self-regulatory 
authority.\241\ The Final Rules provide that variation settlement 
receivable (or payable) by an account at the close of trading on any 
day shall be treated as a credit (or debit) to the account on that 
day.\242\
---------------------------------------------------------------------------

    \239\ 15 U.S.C. 78q-1.
    \240\ 7 U.S.C. 7a-1.
    \241\ See CFTC Rule 41.43(a)(32); SEC Rule 401(a)(32).
    \242\ See CFTC Rule 41.46(c)(1)(vi) and (c)(2)(iii); SEC Rule 
404(c)(1)(vi) and (c)(2)(iii).
---------------------------------------------------------------------------

    d. Margin Equity Securities. The Final Rules generally limit the 
value of a margin equity security deposited as margin for security 
futures in a futures account to the security's ``Regulation T 
collateral value,'' i.e., the current market value of the security 
(based on its most recent closing price) less the percentage of 
required margin for a position in the security held in a margin account 
under Regulation T.\243\ This amount, which is currently set at 50% of 
current market value, represents the amount of the value of a fully-
paid margin equity security deposited into a securities margin account 
that would be available to satisfy the required margin for other 
positions in the account under Regulation T, e.g., stock options. 
Margin equity securities deposited as collateral for security futures 
in a securities account remain subject to Regulation T margin 
requirements as well as the margin requirements of applicable self-
regulatory authority rules.
---------------------------------------------------------------------------

    \243\ See CFTC Rule 41.43(a)(25); SEC Rule 401(a)(25). The Final 
Rules define the ``current market value'' of a security other than a 
security future to mean the most recent closing sale price of the 
security, as shown by any regularly published reporting or quotation 
service. CFTC Rule 41.43(a)(4); SEC Rule 401(a)(4). If there is no 
recent closing sale price, the security futures intermediary may use 
any reasonable estimate of the market value of the security as of 
the most recent close of business. Id.
---------------------------------------------------------------------------

    By requiring FCMs to value margin equity securities as collateral 
for security futures at the levels established under Regulation T,\244\ 
the Commissions intend to provide that margin equity securities used to 
satisfy margin requirements for security futures are valued in a 
consistent manner, regardless of the type of account in which a 
security future is carried. The Commissions recognize, however, that 
the Regulation T margin requirement applies only to new transactions 
that create or increase a margin deficiency in an account.\245\ As a 
result, a uniform 50% haircut on margin equity securities in a futures 
account may result in the collection of more margin for security 
futures carried in a futures account than would be required for 
comparable positions carried in a securities account.
---------------------------------------------------------------------------

    \244\ See CFTC Rule 41.46(c)(1)(iii); SEC Rule 404(c)(1)(iii).
    \245\ The initial margin required for the purchase of a margin 
equity security in a securities account under Regulation T is 50% of 
its current market value. However, the maintenance margin required 
for a position in a margin equity security under the rules of the 
securities self-regulatory organizations is 25% of current market 
value. See, e.g., NYSE Rule 431(c)(1). Accordingly, a customer that 
seeks to use a fully paid equity security to satisfy the required 
margin for a new short option transaction may apply no more than 50% 
of the current market value of the security for that purpose. On 
subsequent days, the customer will not be required to deposit 
additional margin, regardless of changes in the price of the short 
option or equity security, unless the required margin for the short 
option exceeds 75% of the current market value of the equity 
security.
---------------------------------------------------------------------------

    Accordingly, the Final Rules provide an alternative method for 
valuing margin equity securities used as collateral for security 
futures in a futures account based on the same initial and maintenance 
computations required under Regulation T and securities SRO rules with 
respect to transactions in the account.\246\ Under this alternative 
method, the haircut for margin equity securities is equal to the lowest 
percentage of margin required for a margin equity security under the 
rules of a national securities exchange (currently, 25%). On any day 
when security futures transactions or related transactions \247\ are 
effected in the account, however, a customer must satisfy a special 
margin requirement equal to the amount of any margin deficiency created 
or increased in the account if the margin equity securities were valued 
at their Regulation T collateral value (i.e., 50% of current market 
value).
---------------------------------------------------------------------------

    \246\ See CFTC Rule 41.46(e); SEC Rule 404(e).
    \247\ A ``related transaction'' is defined to include any 
transaction in a related position that creates, eliminates, 
increases or reduces an offsetting position involving a security 
future, or any deposit or withdrawal of collateral (other than the 
deduction of variation settlement and other periodic deductions by a 
security futures intermediary from a customer account). CFTC Rule 
41.43(a)(27); SEC Rule 401(a)(27). For example, if a customer 
unwinds an offsetting position in a futures account, such as by 
liquidating a long broad-based index future offsetting a basket of 
security futures, any margin equity securities used to satisfy the 
additional margin in the account required as a result of the 
transaction would have to be valued at their Regulation T value.
---------------------------------------------------------------------------

    The Final Rules provide further that, if this alternative method 
for valuing margin equity securities is used in an account in which 
security futures or related positions are carried and such account is 
transferred from one security futures intermediary to another, the 
account may be treated as if it had been maintained by the transferee 
security futures intermediary from the date of its origin if the 
transferee accepts, in good faith, a signed statement of the transferor 
security futures intermediary (or, if that is not practicable, of the 
customer), that any margin call issued under the Final Rules has been 
satisfied.\248\ This provision parallels Section 220.4(b)(7) of 
Regulation T, and is consistent with futures industry practices under 
Section 4d of the CEA.\249\ It is intended to prevent one security 
futures intermediary from transferring an undermargined account to 
another security futures intermediary.
---------------------------------------------------------------------------

    \248\ See CFTC Rule 41.46(e)(3); SEC Rule 404(e)(3).
    \249\ 12 CFR 220.4(b)(7) and 7 U.S.C. 6d. See also NASD Rule 
11870(d) and NFA Rule 2-27.
---------------------------------------------------------------------------

    e. Other Securities. The Final Rules impose a haircut on exempt 
securities and nonequity securities deposited as margin for security 
futures carried in a futures account equal to the haircut established 
under the SEC's net capital rule.\250\ This provision is intended to 
codify the haircut currently imposed on Treasury securities and other 
debt securities deposited as collateral for futures and options on 
futures under the rules of the designated contract markets. Exempt 
securities and nonequity securities deposited as collateral for 
security futures in a securities account will remain subject to the 
higher margin requirements applicable to such securities under 
Regulation T and self-regulatory authority rules.
---------------------------------------------------------------------------

    \250\ See CFTC Rule 41.46(c)(1)(iv); SEC Rule 404(c)(1)(iv).
---------------------------------------------------------------------------

    f. Foreign Currency. The Final Rules provide that freely 
convertible foreign currency may be valued at an amount no greater than 
its daily marked-to-market U.S. dollar equivalent for purposes of 
determining whether the required margin for security futures carried in 
a securities or futures account is satisfied.\251\ This provision 
reflects the maximum value assigned to foreign currencies under 
Regulation T.\252\
---------------------------------------------------------------------------

    \251\ See CFTC Rule 41.46(c)(1)(v) and (c)(2)(ii); SEC Rule 
404(c)(1)(v) and (c)(2)(ii).
    \252\ Many foreign currencies already are subject to significant 
additional haircuts or margin requirements in securities and futures 
accounts under self-regulatory authority rules. As discussed above, 
security futures intermediaries and their customers would also have 
to observe limitations under applicable margin rules.
---------------------------------------------------------------------------

    g. Other Components of Equity. The Final Rules provide that each 
other acceptable margin deposit or component of equity in a securities 
or futures account shall be valued at an amount no greater than its 
value in a Regulation T securities margin account.\253\ This

[[Page 53165]]

provision is intended to provide that any additional forms of 
collateral permitted under Regulation T in the future or other items in 
an account are valued under the Final Rules in accordance with 
Regulation T.
---------------------------------------------------------------------------

    \253\ See CFTC Rule 41.46(c)(1)(vii); SEC Rule 404(c)(1)(vii).
---------------------------------------------------------------------------

    h. Guarantees. The Final Rules provide that no guarantee of a 
customer's account shall be given any effect for purposes of 
determining whether the required margin in an account is satisfied, 
except as permitted under the margin rules applicable to the 
account.\254\ This provision is consistent with both the requirements 
currently applicable to securities accounts under Regulation T \255\ 
and the requirements currently applicable to futures accounts under 
CFTC Rule 1.10.\256\ Thus, the account-specific practices related to 
guarantees that are currently followed in securities accounts and 
futures accounts, respectively, would remain effective under this 
provision.
---------------------------------------------------------------------------

    \254\ See CFTC Rule 41.46(f); SEC Rule 404(f).
    \255\ See 12 CFR 220.3(d). The Regulation T prohibition governs 
initial margin. The use of guarantees for purposes of maintenance 
margin is otherwise treated under applicable margin rules.
    \256\ 17 CFR 1.10. CFTC Rule 1.10(d) requires that an FCM's 
financial report be completed in accordance with the CFTC's Form 1-
FR-FCM Instructions for reporting an FCM's net capital position. 
These instructions provide further that ``an FCM may not consider a 
guarantee agreement as a substitute for margin'' in customers' 
accounts. Thus, margin deficits are only satisfied with the actual 
transfer of free funds from the guaranteeing account.
---------------------------------------------------------------------------

3. Satisfaction of the Required Margin for Positions Other than 
Security Futures
    Because the scope of the Final Rules is limited to security futures 
and related positions, the rules require additional margin to be 
deposited in an account only when the required margin for security 
futures is not satisfied by the equity in the account. The required 
margin for all other positions carried in an account, and acceptable 
collateral for such positions, shall be determined in accordance with 
the margin rules applicable to the account.
    The Final Rules do not prohibit security futures intermediaries 
from accepting different collateral or assigning greater collateral 
value to assets deposited as collateral with respect to other positions 
carried in an account, if permitted under applicable self-regulatory 
authority rules. For example, security futures intermediaries may use 
letters of credit to satisfy the required margin for commodity futures 
and commodity options (other than security futures) in a futures 
account, even if a security future is carried in the account, as long 
as the collateral or other equity allocated to the security future is 
sufficient to satisfy the requirement established under the Final 
Rules. Likewise, security futures intermediaries may value margin 
equity securities deposited to satisfy the required margin for 
commodity futures or commodity options (other than security futures) 
according to the rules of the applicable board of trade.
    Moreover, security futures intermediaries may allocate collateral 
or other components of equity among security futures and such other 
positions as they consider appropriate. For example, a security futures 
intermediary may elect to allocate cash, open trade equity, option 
value, and nonequity securities to satisfy the required margin for 
security futures and related positions in a futures account, and 
allocate margin equity securities to satisfy the required margin for 
commodity futures and commodity options (other than security futures). 
This allocation would allow the security futures intermediary to value 
the margin equity securities as permitted by the applicable margin 
rules, rather than at the security's Regulation T collateral value, 
provided that the security futures in the account are adequately 
margined by the other collateral in the account.
    To prevent assets used to satisfy the required margin for security 
futures from being counted twice for margin purposes, the Final Rules 
provide that transactions, positions or deposits used to satisfy the 
required margin for security futures or related positions shall be 
unavailable to satisfy the required margin for any other position or 
transaction or any other requirement.\257\ In particular, a related 
position used to reduce the required margin for a security future may 
not be used in a strategy-based offset with another item in the 
account. This provision is consistent with the satisfaction restriction 
in Section 220.4(c)(4) of Regulation T.\258\ For example:
     A deposit of $1000 in margin equity securities used to 
satisfy the required margin for a $500 margin call on a security future 
cannot also be used to satisfy a $350 margin call on a broad-based 
index future in a futures account, even if, under the margin rules 
applicable to the account, equity securities used as collateral for the 
broad-based index future may be valued at 85% of current market value 
(i.e. $850).
---------------------------------------------------------------------------

    \257\ See CFTC Rule 41.46(d); SEC Rule 404(d).
    \258\ 12 CFR 220.4(c)(4).
---------------------------------------------------------------------------

     A 100-share XYZ put option contract in a securities 
account may not be used to cover both a 100-share long XYZ security 
future contract as well as 100 shares of XYZ common stock.
    The collateral used to satisfy the margin requirement with respect 
to a security future may of course be used to satisfy the margin 
requirement with respect to the same position under self-regulatory 
authority rules.

I. When Margin May Be Withdrawn

    The Final Rules include provisions that specify when margin may be 
withdrawn from an account that contains security futures. Under the 
Proposed Rules, these provisions would have been incorporated into the 
Commissions' margin requirements through the application of Regulation 
T. Because the Final Rules do not expressly apply Regulation T, the 
Commissions have identified the circumstances in which a customer or a 
security futures intermediary may withdraw cash, securities or other 
collateral deposited as margin for security futures and related 
positions.\259\
---------------------------------------------------------------------------

    \259\ See CFTC Rule 41.47; SEC Rule 405.
---------------------------------------------------------------------------

1. Withdrawal of Margin by the Customer
    The Final Rules provide that a customer may withdraw cash, 
securities, or other assets deposited as margin for security futures or 
related positions, provided that the equity in the account after such 
withdrawal is sufficient to satisfy the required margin for the 
security futures and related positions in the account under the Final 
Rules.\260\
---------------------------------------------------------------------------

    \260\ See CFTC Rule 41.47(a); SEC Rule 405(a).
---------------------------------------------------------------------------

    Customers that use the alternative collateral valuation method for 
equity securities, pursuant to CFTC Rule 41.46(e) and SEC Rule 404(e), 
are subject to an additional restriction on withdrawals that parallels 
the withdrawal restrictions of Regulation T.\261\ Specifically, cash, 
securities or other assets may not be withdrawn with respect to an 
account that uses the alternative method if:
---------------------------------------------------------------------------

    \261\ See 12 CFR 220.4(e).
---------------------------------------------------------------------------

    (i) Additional cash, securities, or other assets are required to be 
deposited as margin for a transaction in the account on the same or a 
previous day pursuant to a special margin requirement; or
    (ii) The withdrawal, together with other transactions, deposits, 
and withdrawals on the same day, would create or increase a margin 
deficiency if the margin equity securities were valued at their 
Regulation T collateral value.\262\
---------------------------------------------------------------------------

    \262\ See CFTC Rule 41.46(e); SEC Rule 404(e).
---------------------------------------------------------------------------

    This restriction is intended to prevent a customer from withdrawing 
margin

[[Page 53166]]

deposited to satisfy a special margin requirement unless the customer's 
equity exceeds the required margin in the account or the customer 
substitutes securities of equivalent value.
2. Withdrawal of Margin by the Security Futures Intermediary
    The Final Rules provide that a security futures intermediary may 
deduct certain payments and charges from a customer account to meet the 
customer's obligations to the security futures intermediary and third 
parties.\263\ Specifically, without regard to the other provisions of 
the rule, the security futures intermediary may deduct the following 
items from an account:
---------------------------------------------------------------------------

    \263\ See CFTC Rule 41.47(b); SEC Rule 405(b).
---------------------------------------------------------------------------

    (i) Variation settlement payable, directly or indirectly,\264\ to a 
clearing agency or derivatives clearing organization to settle the 
customer's obligations under a security futures contract or other 
contracts cleared through the clearing agency or derivatives clearing 
organization;
---------------------------------------------------------------------------

    \264\ The phrase ``directly or indirectly'' is intended to 
encompass payments either directly to a clearing agency or 
derivatives clearing organization, or payments made through a 
clearing broker.
---------------------------------------------------------------------------

    (ii) Interest charged on credit maintained in the account;
    (iii) Communication or shipping charges with respect to 
transactions in the account;
    (iv) Payment of commissions, brokerage, taxes, storage and other 
charges lawfully accruing in connection with the positions and 
transactions in the account; and
    (v) Any service charges that the security futures intermediary may 
impose. These items reflect the permissible withdrawals from a 
securities account and a futures account under Regulation T \265\ and 
Section 4d of the CEA,\266\ respectively. The Final Rules also permit a 
security futures intermediary to deduct any other items that may be 
deducted under Regulation T (e.g., premiums on securities borrowed, 
dividends, interest, or other distributions due on borrowed 
securities), to the extent permitted under applicable margin rules.
---------------------------------------------------------------------------

    \265\ 12 CFR 220.4(f).
    \266\ 7 U.S.C. 6d.
---------------------------------------------------------------------------

J. Consequences of Failure To Collect Required Margin

    The Commissions proposed that the amount of initial or maintenance 
margin required would be obtained as promptly as possible and in any 
event within three business days or within such shorter time period as 
may be imposed by applicable regulatory authority rules.\267\ The 
Commissions also proposed that the time limits for collection of 
initial margin could be extended upon application by the creditor to 
its examining authority, as defined in Proposed CFTC Rule 41.44(a)(3) 
and Proposed SEC Rule 401(a)(3), to the extent permitted by applicable 
regulatory authority rules.\268\ Failure to collect additional margin 
within the established period would have required the creditor to 
liquidate the account, as required by Regulation T.\269\
---------------------------------------------------------------------------

    \267\ See Proposed CFTC Rule 41.46(a) and (b); Proposed SEC Rule 
403(a) and (b).
    \268\ See Proposed CFTC Rule 41.46(c); Proposed SEC Rule 403(c).
    \269\ 12 CFR 220.4(d).
---------------------------------------------------------------------------

    The Commissions received six comments on the issue of timing for 
collection of margin.\270\ One commenter supported the proposed time 
limit for collection of margin, stating that a time limit of three 
business days or shorter, with the opportunity for extensions upon 
application, would be a reasonable time frame for initial and 
maintenance margin calls.\271\
---------------------------------------------------------------------------

    \270\ See Peregrine Letter; SIA Credit Division Letter; SIA/FIA 
Letter; Morgan Stanley Letter; CME/CBOT Letter; and NFA Letter.
    \271\ Peregrine Letter at 2.
---------------------------------------------------------------------------

    One commenter disagreed with the proposed time limits and 
recommended that the Commissions adopt the time limits provided in 
Regulation T, which requires the collection of margin within five 
business days after the position is established (T+5), and the 
collection of maintenance margin as promptly as possible and in any 
event within fifteen business days.\272\ Another commenter supported a 
T+1 margin settlement cycle and a T+5 collection period.\273\ The same 
commenter observed that ``[g]iven that the initial margin collection 
period for securities and listed securities options is T+5, and that, 
as a result of required capital charges, futures have an effective 
collection period of T+5, the Associations' members feel strongly that 
a T+5 collection period should also apply to security futures.'' \274\
---------------------------------------------------------------------------

    \272\ SIA Credit Division Letter at 2.
    \273\ SIA/FIA Letter at 11.
    \274\ Id.
---------------------------------------------------------------------------

    Two other commenters urged the Commissions to recognize the 
existing time limits in both the securities and futures 
industries.\275\ Specifically, these commenters believed that although 
the provisions governing the time of collection in Regulation T are 
different from those set forth by the CFTC and the futures exchange 
rules, the outcome is substantially similar.
---------------------------------------------------------------------------

    \275\ See Morgan Stanley Letter at 10; CME/CBOT Letter at 5.
---------------------------------------------------------------------------

    Finally, another commenter recommended that the period for 
collecting initial and maintenance margin be extended to four days 
(T+4) in order to be consistent with existing requirements in the 
futures and securities industries.\276\ That commenter also expressed 
concern regarding the procedures that must be followed if margin is not 
received in the time prescribed, noting that the Proposed Rules would 
require liquidation of positions in accordance with Regulation T. The 
commenter believed that requiring a firm to liquidate positions if a 
margin call is not met, or providing that the time period for 
collection could be extended by the firm's examining authority, could 
create significant burdens for both an FCM and its examining authority 
because these are not the current practices in the futures industry.
---------------------------------------------------------------------------

    \276\ NFA Letter at 5.
---------------------------------------------------------------------------

    The Commissions have considered the commenters views and have 
decided not to adopt uniform time periods for collection of margin. The 
Commissions have determined that deference to account-specific rules in 
this instance will avoid operational costs that would be incurred in 
modifying existing practices, and will not provide an incentive for 
customers to select one type of account (securities or futures) over 
another.
    In addition, the Commissions have decided not to require immediate 
liquidation of the positions in a customer account if the customer 
fails to deposit additional required margin within a prescribed number 
of days. The Commissions believe that, in general, a security futures 
intermediary should be adequately protected against potential adverse 
movements in customers' positions if it takes a capital charge for the 
amount by which the customer's account is undermargined. Accordingly, 
the Final Rules provide that if any margin call required by this 
Regulation (Secs. 242.400 through 242.406) is not met in full, the 
security futures intermediary shall take the deduction required under 
CFTC or SEC rules,\277\ as applicable, in computing its net 
capital.\278\
---------------------------------------------------------------------------

    \277\ 17 CFR 1.17(c)(5)(viii) or (ix); 17 CFR 240.15c3-
1(c)(2)(xii).
    \278\ CFTC Rule 41.48(a); SEC Rule 406(a).
---------------------------------------------------------------------------

    The Commissions have decided, however, to require that a security 
futures intermediary liquidate positions in an account if the account 
would liquidate to a deficit.\279\ To provide

[[Page 53167]]

firms with the flexibility to control liquidation of positions during 
adverse market conditions, the Final Rules provide that firms shall 
liquidate such positions promptly and in an orderly manner. This is 
consistent with futures industry practices in which FCMs, pursuant to 
customer agreements, exercise discretion in making liquidation 
decisions. In this regard, the Commissions believe that it is prudent 
business practice for security futures intermediaries to take steps to 
liquidate customer accounts well before they are in a deficit 
condition. The uniform liquidation requirement adopted under the Final 
Rules differs from the liquidation requirements imposed under 
Regulation T and securities SRO rules with respect to undermargined 
accounts.\280\ The Final Rules clarify that this Regulation T 
liquidation requirement does not apply to security futures held in a 
securities account.\281\
---------------------------------------------------------------------------

    \279\ CFTC Rule 41.48(b); SEC Rule 406(b). This is the same 
standard that applies to options specialists under the SEC's net 
capital rule. Exchange Act Rule 15c3-1(c)(2)(x)(D) (17 CFR 240.15c3-
1(c)(2)(x)(D)).
    \280\ Under Regulation T, if any initial margin call is not met 
in full within one payment period after a margin deficiency is 
created or increased, a creditor must liquidate securities 
sufficient to meet the margin call or to eliminate any margin 
deficiency existing on the day such liquidation is required, 
whichever is less (unless the margin deficiency created or increased 
is $1000 or less). 12 CFR 220.4(d). The Regulation T payment period 
is currently five business days, although it may be extended for one 
or more limited periods upon application by the creditor to its 
examining authority. Id. at 12 CFR 220.2, 220.4(c)(3). NYSE Rule 431 
requires the amount of maintenance margin or mark to market required 
by any provision of the NYSE Rule 431 to be obtained within fifteen 
business days from the date such deficiency occurred, unless the 
Exchange has specifically granted the member organization additional 
time. NYSE Rule 431(f)(6).
    \281\ CFTC Rule 41.48(c); SEC Rule 406(c).
---------------------------------------------------------------------------

K. CFTC Procedures for Notification of Proposed Rule Changes Related to 
Margin

    In general, a designated contract market, including a ``notice-
designated'' contract market,\282\ or registered derivatives 
transaction execution facility (``DTF'') that proposes to make a rule 
change regarding its 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.\283\ 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.\284\ 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.
---------------------------------------------------------------------------

    \282\ 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).
    \283\ 15 U.S.C. 78s(b).
    \284\ 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.\285\ 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.\286\ 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.\287\
---------------------------------------------------------------------------

    \285\ See also 66 FR 42256 (August 10, 2001) (CFTC rules 
implementing these procedures, codified in a new Part 40 of Title 
17, CFTC Rules 40.5 and 40.6).
    \286\ 7 U.S.C. 7a-2(c)(1).
    \287\ 7 U.S.C. 7a-2(c)(2).
---------------------------------------------------------------------------

    Proposed CFTC Rule 41.48(a) required 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 \288\ to concurrently provide to the CFTC 
a copy of such a proposed rule change and any accompanying 
documentation filed with the SEC.\289\ Such notice-designated contract 
market was not required to provide any supplemental information, even 
if such information were subsequently provided to the SEC in the course 
of the SEC's review of the proposed rule change. The purpose of this 
Proposed Rule was to provide the CFTC, as a joint regulator of markets 
offering security futures products, with timely notification of a 
proposed rule change.
---------------------------------------------------------------------------

    \288\ 15 U.S.C. 78s(b)(2).
    \289\ The copy may be submitted to the CFTC electronically, by 
facsimile, or by delivery of a hard copy.
---------------------------------------------------------------------------

    Proposed CFTC Rule 41.48(b) established the notification process 
for contract markets designated pursuant to Section 5 of the CEA \290\ 
and registered DTFs. The process by which such an entity would notify 
the CFTC of having filed a proposed rule change with the SEC would 
depend on which procedure under Section 5c(c) of the CEA \291\ the 
entity elected to follow.
---------------------------------------------------------------------------

    \290\ 7 U.S.C. 7a-2.
    \291\ 7 U.S.C. 7a-2(c).
---------------------------------------------------------------------------

    Proposed CFTC Rule 41.48(b)(1) applied 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.\292\ In such 
case, the contract market or DTF would file its requests with the SEC 
and CFTC concurrently.
---------------------------------------------------------------------------

    \292\ 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 \293\ would be 
required to provide a copy of the proposed rule change and any 
accompanying documentation that was filed with the SEC, concurrent with 
the SEC filing. Promptly after the SEC approves the proposed rule 
change, the designated contract market or registered DTF would file the 
written certification with the CFTC.
---------------------------------------------------------------------------

    \293\ 7 U.S.C. 7a-2(c)(1).
---------------------------------------------------------------------------

    The CFTC requested comments on 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.
    The CFTC did not receive any comments relating to this issue, and 
it is therefore adopting the notification provisions as proposed, in 
all material respects.

III. Paperwork Reduction Act

A. CFTC

    The Paperwork Reduction Act of 1995 (``PRA'') \294\ 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 Final Rules that have been 
adopted do not require a new collection of information on the part of 
any entities subject to these rules. Accordingly, the requirements 
imposed by the PRA are not applicable to these rules.
---------------------------------------------------------------------------

    \294\ 44 U.S.C. 3501 et seq.
---------------------------------------------------------------------------

B. SEC

    The Paperwork Reduction Act does not apply because the rules do not 
impose recordkeeping or information collection requirements, or other 
collections of information that require

[[Page 53168]]

the approval of the Office of Management and Budget under 44 U.S.C. 
3501, et. seq.

IV. Costs and Benefits of the Final Rules

A. CFTC

    Section 15(a) of the CEA \295\ 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.
---------------------------------------------------------------------------

    \295\ 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.
    This rulemaking constitutes a package of related rule provisions. 
The Final Rules establish the amount of initial and maintenance 
customer margin for transactions in security futures. The CFTC believes 
that the 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.\296\ The CFTC has evaluated the 
costs and benefits of these rules in light of the specific 
considerations identified in Section 15(a) of the CEA:
---------------------------------------------------------------------------

    \296\ 15 U.S.C. 78f(a).
---------------------------------------------------------------------------

    1. Protection of market participants and the public. In general, 
the Final Rules should further the protection of market participants 
and the public.
    2. Efficiency and competition. As noted above, the 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. To the extent 
that the Final Rules permit FCMs and futures exchanges to maintain 
existing operational and business practices, the Final Rules enable 
market participants to minimize operational costs associated with the 
introduction of security futures, and preserve meaningful customer 
choice as to the type of account (securities or futures) in which the 
customer may elect to carry security futures. In certain respects, the 
Final Rules promote a level playing field between options exchanges and 
security futures exchanges, and between broker-dealers/securities 
accounts and FCMs/futures accounts. Accordingly, the Final Rules are 
not expected to have a negative impact on competition.
    3. Financial integrity of futures markets and price discovery. The 
Final 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 Final Rules are consistent 
with sound risk management practices.
    5. Other public considerations. The Final Rules are expected to 
preserve the financial integrity of markets trading security futures 
and prevent systemic risk, thereby benefiting the public. The CFTC 
believes that the Final Rules give rise to an acceptable level of cost 
in light of the expected benefits of the rules.
    After evaluating these considerations, the CFTC has determined to 
adopt the Final Rules discussed above. The CFTC invited public comment 
on its cost-benefit analysis, but did not receive any comments in 
response to this invitation. Moreover, insofar as the comments received 
raise any matters that might be deemed to relate to the cost-benefit 
analysis, the CFTC has addressed such comments in the foregoing 
discussion and through modifications to 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 security 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 Final Rules 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; \297\ 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.
---------------------------------------------------------------------------

    \297\ 15 U.S.C. 78f(a).
---------------------------------------------------------------------------

    The SEC provided an estimate of the costs and benefits of the 
Proposed Rules, and requested comments on all aspects of its estimate, 
including identification of any additional costs or benefits of the 
proposed rules. The SEC encouraged commenters to identify and supply 
any relevant data, analysis and estimates concerning the costs and 
benefits of the proposed rules. Several commenters expressed the view 
that certain aspects of the Proposed Rules would impose costs. However, 
none of the commenters provided specific data regarding the overall 
costs and benefits of the Proposed Rules.
    The SEC has considered the costs and benefits of the Final Rules. 
We are sensitive to the costs and benefits that might arise from 
compliance with our rules and amendments. In response to commenters' 
concerns about the potential costs related to the application of 
Regulation T to all transactions in security futures, the Commissions 
are adopting stand alone margin rules for security futures that apply 
only certain requirements of Regulation T that are necessary to satisfy 
the statutory requirement that the margin requirements for security 
futures be and remain consistent with Regulation T. The SEC understands 
that some aspects of the Final Rules may impose costs on some persons 
or entities. However, the Final Rules are being adopted pursuant to 
statutory directive and are necessary to permit trading in security 
futures. In addition, the SEC notes that the Final Rules will apply 
only to those broker-dealers and FCMs that choose to do a business in 
security futures.

[[Page 53169]]

1. Costs
    The Final Rules will impose administrative costs on security 
futures intermediaries. Further, security futures intermediaries are 
responsible for complying with the Final Rules and thus will incur 
various costs. The SEC has identified below areas where the Final Rules 
may impose costs.
    a. Compliance with Regulation T. The Proposed Rules would have 
applied 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. Accordingly, under the Proposed Rules, Regulation T would have 
applied to all transactions in security futures, whether they were 
effected in a securities account or a futures account. Several 
commenters expressed concern that applying Regulation T to security 
futures in futures accounts would result in substantial costs to FCMs 
resulting from the need to reprogram their margin systems to comply 
with Regulation T.
    As noted above, the Final Rules do not apply Regulation T to all 
security futures transactions. Instead, as noted above, the Final Rules 
incorporate certain requirements of Regulation T as necessary to 
satisfy the requirement under section 7(c)(2) of the Exchange Act that 
the Final Rules be and remain consistent with Regulation T. The SEC 
believes that this aspect of the Final Rules should only impose minimal 
administrative costs on security futures intermediaries. For broker-
dealers and members of national securities exchanges that trade 
security futures, there should be little or no cost imposed by this 
aspect of the Final Rules because they already are subject to 
Regulation T for other securities transactions. For FCMs, there will be 
some administrative costs associated with this aspect of the final 
rules to program their systems to comply with the specific provisions 
of Regulation T that are included in the Final Rules.
    b. Levels of Margin. SEC Rule 403(b)(1) sets the level of margin at 
20 percent of current market value, which is the same level that would 
have been set under the Proposed Rules. The 20 percent level is 
necessary to fulfill the requirement under Section 7(c)(2)(B)(iii) that 
the margin requirements for security futures be consistent with the 
margin requirements for comparable exchange-traded options.\298\
---------------------------------------------------------------------------

    \298\ 15 U.S.C. 78g(c)(2)(B)(iii).
---------------------------------------------------------------------------

    When the Proposed Rules were issued for comment, the SEC noted that 
the 20 percent margin level could appear to be high when compared to 
margining methodologies currently used for futures other than security 
futures. As a result, a potential cost of the margin levels is that 
they may lead to reduced interest in trading security futures and, 
therefore, foregone hedging opportunities.
    However, while margin requirements on futures other than security 
futures generally range from 2-10 percent,\299\ SEC staff estimated 
that applying traditional futures risk-based margining methods to 
security futures would require margin of greater than 10 percent.\300\ 
In addition, however, SEC staff estimated 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. Further, economic research has thus far not been able 
to establish a strong relationship between futures margin levels and 
interest in the product.\301\ Therefore, while the margin levels under 
the Final Rules may impose a cost, the SEC believes that the margin 
levels should 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 believes that the margin levels adopted in the 
Final Rules are appropriate.
---------------------------------------------------------------------------

    \299\ 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.
    \300\ 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 these 
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 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).
    \301\ 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.
---------------------------------------------------------------------------

    c. Computation of Margin. The Final Rules require security futures 
intermediaries to compute and collect, on a daily basis, required 
margin for each customer's security future carried or held by such 
entity. This requirement is designed to assure contract performance and 
the integrity of the marketplace. In addition, all security futures 
intermediaries will pay or receive daily variation settlement (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.
    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 security futures 
intermediaries will require these entities to program or reprogram 
their computer systems to implement the margin computations and the 
settlement variation procedures for security futures. These entities 
may also incur additional data storage costs and resource costs 
associated with these calculations.
    d. Undermargined Accounts. SEC Rule 406(a) requires a security 
futures intermediary to take a deduction in computing its net capital 
to the extent that any margin call required by the Final Rules is not 
met in full. In addition, SEC Rule 406(b) requires that a security 
futures intermediary liquidate positions in a prompt and orderly manner 
in any account in which security futures are held at any time there is 
a liquidating deficit in the account. The SEC believes that these 
aspects of the Final Rules may impose costs on security futures 
intermediaries by requiring them to evaluate information to determine 
for each customer's account involving security futures when margin 
calls required under the Final Rules have not been met. Security 
futures intermediaries may also incur costs in the form of capital 
charges with respect to customers that do not meet margin calls. In 
addition, security futures intermediaries that have customer accounts 
that fall into a liquidating deficit may incur costs in complying with 
the mandatory liquidation provisions of the Final Rules.
2. Benefits
    The benefits of the Final Rules are related to the benefits that 
will accrue as a result of the enactment of the CFMA. By repealing the 
ban on futures

[[Page 53170]]

on single securities 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 Security Futures Intermediaries. SEC Rule 403(b)(1) 
provides 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, SEC Rule 404(b) provides that a security 
futures intermediary may accept as collateral cash, margin securities, 
exempted securities, or other collateral permitted under Regulation T, 
as well as shares in money market mutual funds, to satisfy a margin 
deficiency. The SEC believes that these aspects of the Final Rules will 
provide sound protection from customer default by reducing chances of 
depletion of margin accounts. Accordingly, the Final Rules should 
reduce systemic risk associated with the trading of these new products.
    b. Benefits to Customers. SEC Rule 403(b)(2) provides that 
customers be permitted to offset positions involving security futures 
with certain related securities or futures. 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 and, as 
applicable, by the CFTC pursuant to Section 5c(c) of the CEA if such 
offsets were consistent with the requirements of section 7(c)(2)(B) of 
the Exchange Act, including the requirement that margin requirements 
for security futures be no less restrictive than those imposed on 
options. These offsets will provide benefits to customers because they 
will recognize the hedged nature of certain specified combined 
strategies and will permit lower margin requirements that better 
reflect the true risk of those strategies.

V. Consideration of Burden on Competition, Promotion of Efficiency and 
Capital Formation

    Section 3(f) of the Exchange requires the SEC, when 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 would promote efficiency, competition, and capital 
formation.\302\ Section 23(a)(2) requires the SEC, in adopting rules 
under the Exchange Act, to consider the impact any rule would have on 
competition.\303\ Section 23(a)(2) further provides that the SEC may 
not adopt a rule not necessary or appropriate in furtherance of the 
purposes of the Exchange Act. In the proposing release, the SEC 
requested comments on these statutory considerations. The SEC received 
no comments on the issue of competition, efficiency, or capital 
formation.
---------------------------------------------------------------------------

    \302\ 15 U.S.C. 78c(f).
    \303\ 15 U.S.C. 78w(a)(2).
---------------------------------------------------------------------------

    The SEC believes that the rules should promote efficiency by 
setting forth clear guidelines for security futures intermediaries when 
collecting customer margin related to security futures. Further, the 
SEC believes that the rules will provide sound protection from customer 
default by reducing the chances of depletion of margin accounts, 
thereby reducing systemic risk associated with the trading of these new 
products.
    The SEC also believes that the rules would not impose any 
significant burden on competition. The Final Rules provide that 
security futures generally will be governed by the existing margin 
rules applicable to securities accounts and to futures accounts, which 
are not identical in all cases. However, the Final Rules also include 
uniform provisions, applicable to security futures regardless of the 
type of account in which they are held, which are designed to prevent 
competitive advantages from arising simply because security futures are 
held in one type of account rather than the other. The rules serve only 
to set forth margin requirements for security futures. In addition, the 
Final Rules satisfy section 7(c)(2)(B)(iii) of the Exchange Act, which, 
among other things, requires that the margin rules for security futures 
be consistent with those for comparable exchange-traded options. 
Accordingly, the Final Rules are designed to prevent competitive 
advantages from arising solely out of differences between the margin 
requirements for security futures and those for exchange-traded 
options. Lastly, the SEC believes that the rules will not have any 
impact on capital formation because the rules, as adopted, merely 
establish requirements governing the collection of customer margin. The 
SEC reiterates that the margin requirements would protect security 
futures intermediaries from customers' default, thus encouraging 
participation by these market participants in the trading of futures on 
both single securities and narrow-based security indexes. Therefore, 
the SEC believes that there could be an increased demand for the 
underlying securities, resulting in increased capital formation.

VI. Regulatory Flexibility Act

A. CFTC

    The Regulatory Flexibility Act (``RFA'') \304\ requires that 
federal agencies, in promulgating rules, consider the impact of those 
rules on small entities. The Final Rules will 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.\305\
---------------------------------------------------------------------------

    \304\ 5 U.S.C. 601 et seq.
    \305\ 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.\306\ 
Recently, the CFTC determined that notice-designated contract markets 
are not small entities for purposes of the RFA.\307\ 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.\308\
---------------------------------------------------------------------------

    \306\ Id. at 18619.
    \307\ 66 FR 44960, 44964 (August 27, 2001).
    \308\ 66 FR 42256, 42268 (August 10, 2001).
---------------------------------------------------------------------------

    In the Proposing Release, it was observed that the CFTC 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.\309\ The CFTC proposed to determine that notice-
registered FCMs,\310\ for the reasons applicable to FCMs registered in 
accordance with Section 4f(a)(1) of the CEA,\311\ 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

[[Page 53171]]

relationship with their customers and must meet analogous minimum 
financial requirements.\312\
---------------------------------------------------------------------------

    \309\ 47 FR at 18619.
    \310\ 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)).
    \311\ 7 U.S.C. 6f(a)(1).
    \312\ See Exchange Act Rule 15c3-1(a)(2), 17 CFR 240.15c3-
1(a)(2).
---------------------------------------------------------------------------

    The CFTC invited the public to comment on its proposed 
determination that notice-registered FCMs would not be small entities 
for purposes of the RFA. The CFTC also invited comments on its finding 
that there would not be a significant economic impact on a substantial 
number of small entities. The CFTC notes that no comments were received 
regarding either of these issues. 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.\313\ In adopting the Final Rules, the Commissions have 
striven to fulfill this requirement in the least burdensome way 
possible. The CFTC hereby determines that notice-registered FCMs are 
not small entities for purposes of the RFA. Further, the CFTC believes 
that the Final Rules will not have a significant economic impact on a 
substantial number of small entities.
---------------------------------------------------------------------------

    \313\ 15 U.S.C. 78f(a).
---------------------------------------------------------------------------

B. SEC

    Pursuant to section 605(b) of the Regulatory Flexibility Act 
(``RFA''),\314\ the SEC certified that the adopted rule would not have 
a significant economic impact on a substantial number of small 
entities. This certification was attached to the Proposing Release No. 
34-50720 (October 4, 2001) as Appendix A.\315\ The SEC solicited 
comments concerning the impact on small entities and the RFA 
certification, but received no comments.
---------------------------------------------------------------------------

    \314\ 5 U.S.C. 601 et seq.
    \315\ See Proposing Release, supra note 6.
---------------------------------------------------------------------------

VII. Statutory Basis

    The SEC is adopting Rules 400 through 406 pursuant to the Exchange 
Act, particularly Sections, 3(b), 6, 7(c), 15A, and 23(a). Further, 
these rules are adopted 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).

Text of Rules

List of Subjects

17 CFR Part 41

    Brokers, Margin, Reporting and recordkeeping requirements, Security 
futures products.

17 CFR Part 242

    Brokers, 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 amended as follows:

PART 41--SECURITY FUTURES PRODUCTS

    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. The part heading for Part 41 is revised to read as set forth 
above.


Sec. 41.41  [Redesignated]

    3. In Part 41, Sec. 41.41 is redesignated as Sec. 41.3.
    4. Part 41 is amended by adding Subpart E (Secs. 41.42 through 
41.49) to read as follows:
Subpart E--Customer Accounts and Margin Requirements
Sec.
41.42  Customer margin requirements for security futures--authority, 
purpose, interpretation, and scope.
41.43  Definitions.
41.44  General provisions.
41.45  Required margin.
41.46  Type, form and use of margin.
41.47  Withdrawal of margin.
41.48  Undermargined accounts.
41.49  Filing proposed margin rule changes with the Commission.

Subpart E--Customer Accounts and Margin Requirements


Sec. 41.42  Customer margin requirements for security futures--
authority, purpose, interpretation, and scope.

    (a) Authority and purpose. Subpart E, Secs. 41.42 through 41.49, 
and 17 CFR 242.400 through 242.406 (``this Regulation'') are issued by 
the Commodity Futures Trading Commission (``Commission'') jointly with 
the Securities and Exchange Commission (``SEC''), 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 (``Exchange 
Act''). The principal purpose of this Regulation (Subpart E, 
Secs. 41.42 through 41.49) is to regulate customer margin collected by 
brokers, dealers, and members of national securities exchanges, 
including futures commission merchants required to register as brokers 
or dealers under section 15(b)(11) of the Exchange Act, relating to 
security futures.
    (b) Interpretation. This Regulation (Subpart E, Secs. 41.42 through 
41.49) shall be jointly interpreted by the SEC and the Commission, 
consistent with the criteria set forth in clauses (i) through (iv) of 
section 7(c)(2)(B) of the Exchange Act and the provisions of Regulation 
T (12 CFR part 220).
    (c) Scope.
    (1) This Regulation (Subpart E, Secs. 41.42 through 41.49) does not 
preclude a self-regulatory authority, under rules that are effective in 
accordance with section 19(b)(2) of the Exchange Act or section 
19(b)(7) of the Exchange Act and, as applicable, section 5c(c) of the 
Commodity Exchange Act (``Act''), or a security futures intermediary 
from imposing additional margin requirements on security futures, 
including higher initial or maintenance margin levels, consistent with 
this Regulation (Subpart E, Secs. 41.42 through 41.49), or from taking 
appropriate action to preserve its financial integrity.
    (2) This Regulation (Subpart E, Secs. 41.42 through 41.49) does not 
apply to:
    (i) Financial relations between a customer and a security futures 
intermediary to the extent that they comply with a portfolio margining 
system under rules that meet the criteria set forth in section 
7(c)(2)(B) of the Exchange Act and that are effective in accordance 
with section 19(b)(2) of the Exchange Act and, as applicable, section 
5c(c) of the Act;
    (ii) Financial relations between a security futures intermediary 
and a foreign person involving security futures traded on or subject to 
the rules of a foreign board of trade;
    (iii) Margin requirements that clearing agencies registered under 
section 17A of the Exchange Act or derivatives clearing organizations 
registered under section 5b of the Act impose on their members;
    (iv) Financial relations between a security futures intermediary 
and a person based on a good faith determination by the security 
futures intermediary that such person is an exempted person; and
    (v) Financial relations between a security futures intermediary 
and, or arranged by a security futures intermediary for, a person 
relating to trading in security futures by such person for its own 
account, if such person:
    (A) Is a member of a national securities exchange or national 
securities association registered pursuant to section 15A(a) of the 
Exchange Act; and

[[Page 53172]]

    (B) Is registered with such exchange or such association as a 
security futures dealer pursuant to rules that are effective in 
accordance with section 19(b)(2) of the Exchange Act and, as 
applicable, section 5c(c) of the Act, that:
    (1) Require such member to be registered as a floor trader or a 
floor broker with the Commission under section 4f(a)(1) of the Act, or 
as a dealer with the SEC under section 15(b) of the Exchange Act;
    (2) Require such member to maintain records sufficient to prove 
compliance with this paragraph (c)(2)(v) and the rules of the exchange 
or association of which it is a member;
    (3) 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
    (4) Provide for disciplinary action, including revocation of such 
member's registration as a security futures dealer, for such member's 
failure to comply with this Regulation (Subpart E, Secs. 41.42 through 
41.49) or the rules of the exchange or association.
    (d) Exemption. The Commission may exempt, either unconditionally or 
on specified terms and conditions, financial relations involving any 
security futures intermediary, customer, position, or transaction, or 
any class of security futures intermediaries, customers, positions, or 
transactions, from one or more requirements of this Regulation (Subpart 
E, Secs. 41.42 through 41.49), if the Commission determines that such 
exemption is necessary or appropriate in the public interest and 
consistent with the protection of customers. An exemption granted 
pursuant to this paragraph shall not operate as an exemption from any 
SEC rules. Any exemption that may be required from such rules must be 
obtained separately from the SEC.


Sec. 41.43  Definitions.

    (a) For purposes of this Regulation (Subpart E, Secs. 41.42 through 
41.49) only, the following terms shall have the meanings set forth in 
this section.
    (1) Applicable margin rules and margin rules applicable to an 
account mean the rules and regulations applicable to financial 
relations between a security futures intermediary and a customer with 
respect to security futures and related positions carried in a 
securities account or futures account as provided in Sec. 41.44(a) of 
this subpart.
    (2) Broker shall have the meaning provided in section 3(a)(4) of 
the Exchange Act.
    (3) 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.
    (4) Current market value means, on any day:
    (i) With respect to a security future:
    (A) 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
    (B) If the instrument underlying such security future is a narrow-
based security index, as defined in section 1a(25)(A) of the Act, 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.
    (ii) With respect to a security other than a security future, the 
most recent closing sale price of the security, as shown by any 
regularly published reporting or quotation service. If there is no 
recent closing sale price, the security futures intermediary may use 
any reasonable estimate of the market value of the security as of the 
most recent close of business.
    (5) Customer excludes an exempted person and includes:
    (i) Any person or persons acting jointly:
    (A) On whose behalf a security futures intermediary effects a 
security futures transaction or carries a security futures position; or
    (B) Who would be considered a customer of the security futures 
intermediary according to the ordinary usage of the trade;
    (ii) Any partner in a security futures intermediary that is 
organized as a partnership who would be considered a customer of the 
security futures intermediary absent the partnership relationship; and
    (iii) Any joint venture in which a security futures intermediary 
participates and which would be considered a customer of the security 
futures intermediary if the security futures intermediary were not a 
participant.
    (6) 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, 
clearing agency, or derivatives clearing organization.
    (7) Dealer shall have the meaning provided in section 3(a)(5) of 
the Exchange Act.
    (8) Equity means the equity or margin equity in a securities or 
futures account, as computed in accordance with the margin rules 
applicable to the account and subject to adjustment under 
Sec. 41.46(c), (d) and (e) of this subpart.
    (9) Exempted person means:
    (i) A member of a national securities exchange, a registered broker 
or dealer, or a registered futures commission merchant, a substantial 
portion of whose business consists of transactions in securities, 
commodity futures, or commodity options with persons other than 
brokers, dealers, futures commission merchants, floor brokers, or floor 
traders, and includes a person who:
    (A) Maintains at least 1000 active accounts on an annual basis for 
persons other than brokers, dealers, persons associated with a broker 
or dealer, futures commission merchants, floor brokers, floor traders, 
and persons affiliated with a futures commission merchant, floor 
broker, or floor trader that are effecting transactions in securities, 
commodity futures, or commodity options;
    (B) Earns at least $10 million in gross revenues on an annual basis 
from transactions in securities, commodity futures, or commodity 
options with persons other than brokers, dealers, persons associated 
with a broker or dealer, futures commission merchants, floor brokers, 
floor traders, and persons affiliated with a futures commission 
merchant, floor broker, or floor trader; or
    (C) Earns at least 10 percent of its gross revenues on an annual 
basis from transactions in securities, commodity futures, or commodity 
options with persons other than brokers, dealers, persons associated 
with a broker or dealer, futures commission merchants, floor brokers, 
floor traders, and persons affiliated with a futures commission 
merchant, floor broker, or floor trader.
    (ii) For purposes of paragraph (a)(9)(i) of this section only, 
persons affiliated with a futures commission merchant, floor broker, or 
floor trader means any partner, officer, director, or branch manager of 
such futures commission merchant, floor broker, or floor trader (or any 
person occupying a similar status or performing similar functions), any 
person directly or indirectly controlling, controlled by, or under 
common control with such futures commission merchant, floor broker, or 
floor trader, or any employee of such a futures commission merchant, 
floor broker, or floor trader.
    (iii) A member of a national securities exchange, a registered 
broker or dealer, or a registered futures commission merchant that has 
been in existence for less than one year may meet the

[[Page 53173]]

definition of exempted person based on a six-month period.
    (10) Exempted security shall have the meaning provided in section 
3(a)(12) of the Exchange Act.
    (11) Floor broker shall have the meaning provided in section 1a(16) 
of the Act.
    (12) Floor trader shall have the meaning provided in section 1a(17) 
of the Act.
    (13) Futures account shall have the meaning provided in 
Sec. 1.3(vv) of this chapter.
    (14) Futures commission merchant shall have the meaning provided in 
section 1a(20) of the Act.
    (15) Good faith, with respect to making a determination or 
accepting a statement concerning financial relations with a person, 
means that the security futures intermediary is alert to the 
circumstances surrounding such financial relations, and if in 
possession of information that would cause a prudent person not to make 
the determination or accept the notice or certification without 
inquiry, investigates and is satisfied that it is correct.
    (16) Listed option means a put or call option that is:
    (i) Issued by a clearing agency that is registered under section 
17A of the Exchange Act or cleared and guaranteed by a derivatives 
clearing organization that is registered under section 5b of the Act; 
and
    (ii) Traded on or subject to the rules of a self-regulatory 
authority.
    (17) Margin call means a demand by a security futures intermediary 
to a customer for a deposit of cash, securities or other assets to 
satisfy the required margin for security futures or related positions 
or a special margin requirement.
    (18) Margin deficiency means the amount by which the required 
margin in an account is not satisfied by the equity in the account, as 
computed in accordance with Sec. 41.46 of this subpart.
    (19) Margin equity security shall have the meaning provided in 
Regulation T.
    (20) Margin security shall have the meaning provided in Regulation 
T.
    (21) Member shall have the meaning provided in section 3(a)(3) of 
the Exchange Act, and shall include persons registered under section 
15(b)(11) of the Exchange Act that are permitted to effect transactions 
on a national securities exchange without the services of another 
person acting as executing broker.
    (22) Money market mutual fund means any security issued by an 
investment company registered under section 8 of the Investment Company 
Act of 1940 that is considered a money market fund under Sec. 270.2a-7 
of this title.
    (23) Persons associated with a broker or dealer shall have the 
meaning provided in section 3(a)(18) of the Exchange Act.
    (24) Regulation T means Regulation T promulgated by the Board of 
Governors of the Federal Reserve System, 12 CFR part 220, as amended 
from time to time.
    (25) Regulation T collateral value, with respect to a security, 
means the current market value of the security reduced by the 
percentage of required margin for a position in the security held in a 
margin account under Regulation T.
    (26) Related position, with respect to a security future, means any 
position in an account that is combined with the security future to 
create an offsetting position as provided in Sec. 41.45(b)(2) of this 
subpart.
    (27) Related transaction, with respect to a position or transaction 
in a security future, means:
    (i) Any transaction that creates, eliminates, increases or reduces 
an offsetting position involving a security future and a related 
position, as provided in Sec. 41.45(b)(2) of this subpart; or
    (ii) Any deposit or withdrawal of margin for the security future or 
a related position, except as provided in Sec. 41.47(b) of this 
subpart.
    (28) Securities account shall have the meaning provided in 
Sec. 1.3(ww) of this chapter.
    (29) Security futures intermediary means any creditor as defined in 
Regulation T with respect to its financial relations with any person 
involving security futures, including:
    (i) Any futures commission merchant;
    (ii) Any partner, officer, director, or branch manager (or person 
occupying a similar status or performing similar functions) of a 
futures commission merchant;
    (iii) Any person directly or indirectly controlling, controlled by, 
or under common control with (except for business entities controlling 
or under common control with) a futures commission merchant; and
    (iv) Any employee of a futures commission merchant (except an 
employee whose functions are solely clerical or ministerial).
    (30) Self-regulatory authority means a national securities exchange 
registered under section 6 of the Exchange Act, a national securities 
association registered under section 15A of the Exchange Act, a 
contract market registered under section 5 of the Act or section 5f of 
the Act, or a derivatives transaction execution facility registered 
under section 5a of the Act.
    (31) Special margin requirement shall have the meaning provided in 
Sec. 41.46(e)(1)(ii) of this subpart.
    (32) Variation settlement means any credit or debit to a customer 
account, made on a daily or intraday basis, for the purpose of marking 
to market a security future or any other contract that is:
    (i) Issued by a clearing agency that is registered under section 
17A of the Exchange Act or cleared and guaranteed by a derivatives 
clearing organization that is registered under section 5b of the Act; 
and
    (ii) Traded on or subject to the rules of a self-regulatory 
authority.
    (b) Terms used in this Regulation (Subpart E, Secs. 41.42 through 
41.49) and not otherwise defined in this section shall have the meaning 
set forth in the margin rules applicable to the account.
    (c) Terms used in this Regulation (Subpart E, Secs. 41.42 through 
41.49) and not otherwise defined in this section or in the margin rules 
applicable to the account shall have the meaning set forth in the 
Exchange Act and the Act; if the definitions of a term in the Exchange 
Act and the Act are inconsistent as applied in particular 
circumstances, such term shall have the meaning set forth in rules, 
regulations, or interpretations jointly promulgated by the SEC and the 
Commission.


Sec. 41.44  General provisions.

    (a) Applicable margin rules. Except to the extent inconsistent with 
this Regulation (Subpart E, Secs. 41.42 through 41.49):
    (1) A security futures intermediary that carries a security future 
on behalf of a customer in a securities account shall record and 
conduct all financial relations with respect to such security future 
and related positions in accordance with Regulation T and the margin 
rules of the self-regulatory authorities of which the security futures 
intermediary is a member.
    (2) A security futures intermediary that carries a security future 
on behalf of a customer in a futures account shall record and conduct 
all financial relations with respect to such security future and 
related positions in accordance with the margin rules of the self-
regulatory authorities of which the security futures intermediary is a 
member.
    (b) Separation and consolidation of accounts.
    (1) The requirements for security futures and related positions in 
one account may not be met by considering items in any other account, 
except as

[[Page 53174]]

permitted or required under paragraph (b)(2) of this section or 
applicable margin rules. If withdrawals of cash, securities or other 
assets deposited as margin are permitted under this Regulation (Subpart 
E, Secs. 41.42 through 41.49), bookkeeping entries shall be made when 
such cash, securities, or assets are used for purposes of meeting 
requirements in another account.
    (2) Notwithstanding paragraph (b)(1) of this section, the security 
futures intermediary shall consider all futures accounts in which 
security futures and related positions are held that are within the 
same regulatory classification or account type and are owned by the 
same customer to be a single account for purposes of this Regulation 
(Subpart E, Secs. 41.42 through 41.49). The security futures 
intermediary may combine such accounts with other futures accounts that 
are within the same regulatory classification or account type and are 
owned by the same customer for purposes of computing a customer's 
overall margin requirement, as permitted or required by applicable 
margin rules.
    (c) Accounts of partners. If a partner of the security futures 
intermediary has an account with the security futures intermediary in 
which security futures or related positions are held, the security 
futures intermediary shall disregard the partner's financial relations 
with the firm (as shown in the partner's capital and ordinary drawing 
accounts) in calculating the margin or equity of any such account.
    (d) Contribution to joint venture. If an account in which security 
futures or related positions are held is the account of a joint venture 
in which the security futures intermediary participates, any interest 
of the security futures intermediary in the joint account in excess of 
the interest which the security futures intermediary would have on the 
basis of its right to share in the profits shall be margined in 
accordance with this Regulation (Subpart E, Secs. 41.42 through 41.49).
    (e) Extensions of credit. (1) No security futures intermediary may 
extend or maintain credit to or for any customer for the purpose of 
evading or circumventing any requirement under this Regulation (Subpart 
E, Secs. 41.42 through 41.49).
    (2) A security futures intermediary may arrange for the extension 
or maintenance of credit to or for any customer by any person, provided 
that the security futures intermediary does not willfully arrange 
credit that would constitute a violation of Regulation T, U or X of the 
Board of Governors of the Federal Reserve System (12 CFR parts 220, 
221, and 224) by such person.
    (f) Change in exempted person status. Once a person ceases to 
qualify as an exempted person, it shall notify the security futures 
intermediary of this fact before entering into any new security futures 
transaction or related transaction that would require additional margin 
to be deposited under this Regulation (Subpart E, Secs. 41.42 through 
41.49). Financial relations with respect to any such transactions shall 
be subject to the provisions of this Regulation (Subpart E, Secs. 41.42 
through 41.49).


Sec. 41.45  Required margin.

    (a) Applicability. Each security futures intermediary shall 
determine the required margin for the security futures and related 
positions held on behalf of a customer in a securities account or 
futures account as set forth in this section.
    (b) Required margin.--(1) General rule. The required margin for 
each long or short position in a security future shall be twenty (20) 
percent of the current market value of such security future.
    (2) Offsetting positions. Notwithstanding the margin levels 
specified in paragraph (b)(1) of this section, a self-regulatory 
authority may set the required initial or maintenance margin level for 
an offsetting position involving security futures and related positions 
at a level lower than the level that would be required under paragraph 
(b)(1) of this section if such positions were margined separately, 
pursuant to rules that meet the criteria set forth in section 
7(c)(2)(B) of the Exchange Act and are effective in accordance with 
section 19(b)(2) of the Exchange Act and, as applicable, section 5c(c) 
of the Act.
    (c) Procedures for certain margin level adjustments. An exchange 
registered under section 6(g) of the Exchange Act, or a national 
securities association registered under section 15A(k) of the Exchange 
Act, may raise or lower the required margin level for a security future 
to a level not lower than that specified in this section, in accordance 
with section 19(b)(7) of the Exchange Act.


Sec. 41.46  Type, form and use of margin.

    (a) When margin is required. Margin is required to be deposited 
whenever the required margin for security futures and related positions 
in an account is not satisfied by the equity in the account, subject to 
adjustment under paragraph (c) of this section.
    (b) Acceptable margin deposits. (1) The required margin may be 
satisfied by a deposit of cash, margin securities (subject to paragraph 
(b)(2) of this section), exempted securities, any other asset permitted 
under Regulation T to satisfy a margin deficiency in a securities 
margin account, or any combination thereof, each as valued in 
accordance with paragraph (c) of this section.
    (2) Shares of a money market mutual fund may be accepted as a 
margin deposit for purposes of this Regulation (Subpart E, Secs. 41.42 
through 41.49), Provided that:
    (i) The customer waives any right to redeem the shares without the 
consent of the security futures intermediary and instructs the fund or 
its transfer agent accordingly;
    (ii) The security futures intermediary (or clearing agency or 
derivatives clearing organization with which the shares are deposited 
as margin) obtains the right to redeem the shares in cash, promptly 
upon request; and
    (iii) The fund agrees to satisfy any conditions necessary or 
appropriate to ensure that the shares may be redeemed in cash, promptly 
upon request.
    (c) Adjustments.-- (1) Futures accounts. For purposes of this 
section, the equity in a futures account shall be computed in 
accordance with the margin rules applicable to the account, subject to 
the following:
    (i) A security future shall have no value;
    (ii) Each net long or short position in a listed option on a 
contract for future delivery shall be valued in accordance with the 
margin rules applicable to the account;
    (iii) Except as permitted in paragraph (e) of this section, each 
margin equity security shall be valued at an amount no greater than its 
Regulation T collateral value;
    (iv) Each other security shall be valued at an amount no greater 
than its current market value reduced by the percentage specified for 
such security in Sec. 240.15c3-1(c)(2)(vi) of this title;
    (v) Freely convertible foreign currency may be valued at an amount 
no greater than its daily marked-to-market U.S. dollar equivalent;
    (vi) Variation settlement receivable (or payable) by an account at 
the close of trading on any day shall be treated as a credit (or debit) 
to the account on that day; and
    (vii) Each other acceptable margin deposit or component of equity 
shall be valued at an amount no greater than its value under Regulation 
T.
    (2) Securities accounts. For purposes of this section, the equity 
in a securities account shall be computed in accordance with the margin 
rules

[[Page 53175]]

applicable to the account, subject to the following:
    (i) A security future shall have no value;
    (ii) Freely convertible foreign currency may be valued at an amount 
no greater than its daily mark-to-market U.S. dollar equivalent; and
    (iii) Variation settlement receivable (or payable) by an account at 
the close of trading on any day shall be treated as a credit (or debit) 
to the account on that day.
    (d) Satisfaction restriction. Any transaction, position or deposit 
that is used to satisfy the required margin for security futures or 
related positions under this Regulation (Subpart E, Secs. 41.42 through 
41.49), including a related position, shall be unavailable to satisfy 
the required margin for any other position or transaction or any other 
requirement.
    (e) Alternative collateral valuation for margin equity securities 
in a futures account.
    (1) Notwithstanding paragraph (c)(1)(iii) of this section, a 
security futures intermediary need not value a margin equity security 
at its Regulation T collateral value when determining whether the 
required margin for the security futures and related positions in a 
futures account is satisfied, provided that:
    (i) The margin equity security is valued at an amount no greater 
than the current market value of the security reduced by the lowest 
percentage level of margin required for a long position in the security 
held in a margin account under the rules of a national securities 
exchange registered pursuant to section 6(a) of the Exchange Act;
    (ii) Additional margin is required to be deposited on any day when 
the day's security futures transactions and related transactions would 
create or increase a margin deficiency in the account if the margin 
equity securities were valued at their Regulation T collateral value, 
and shall be for the amount of the margin deficiency so created or 
increased (a ``special margin requirement''); and
    (iii) Cash, securities, or other assets deposited as margin for the 
positions in an account are not permitted to be withdrawn from the 
account at any time that:
    (A) Additional cash, securities, or other assets are required to be 
deposited as margin under this section for a transaction in the account 
on the same or a previous day; or
    (B) The withdrawal, together with other transactions, deposits, and 
withdrawals on the same day, would create or increase a margin 
deficiency if the margin equity securities were valued at their 
Regulation T collateral value.
    (2) All security futures transactions and related transactions on 
any day shall be combined to determine the amount of a special margin 
requirement. Additional margin deposited to satisfy a special margin 
requirement shall be valued at an amount no greater than its Regulation 
T collateral value.
    (3) If the alternative collateral valuation method set forth in 
paragraph (e) of this section is used with respect to an account in 
which security futures or related positions are carried:
    (i) An account that is transferred from one security futures 
intermediary to another may be treated as if it had been maintained by 
the transferee from the date of its origin, if the transferee accepts, 
in good faith, a signed statement of the transferor (or, if that is not 
practicable, of the customer), that any margin call issued under this 
Regulation (Subpart E, Secs. 41.42 through 41.49) has been satisfied; 
and
    (ii) An account that is transferred from one customer to another as 
part of a transaction, not undertaken to avoid the requirements of this 
Regulation (Subpart E, Secs. 41.42 through 41.49), may be treated as if 
it had been maintained for the transferee from the date of its origin, 
if the security futures intermediary accepts in good faith and keeps 
with the transferee account a signed statement of the transferor 
describing the circumstances for the transfer.
    (f) Guarantee of accounts. No guarantee of a customer's account 
shall be given any effect for purposes of determining whether the 
required margin in an account is satisfied, except as permitted under 
applicable margin rules.


Sec. 41.47  Withdrawal of margin.

    (a) By the customer. Except as otherwise provided in 
Sec. 41.46(e)(1)(ii) of this subpart, cash, securities, or other assets 
deposited as margin for positions in an account may be withdrawn, 
provided that the equity in the account after such withdrawal is 
sufficient to satisfy the required margin for the security futures and 
related positions in the account under this Regulation (Subpart E, 
Secs. 41.42 through 41.49).
    (b) By the security futures intermediary. Notwithstanding paragraph 
(a) of this section, the security futures intermediary, in its usual 
practice, may deduct the following items from an account in which 
security futures or related positions are held if they are considered 
in computing the balance of such account:
    (1) Variation settlement payable, directly or indirectly, to a 
clearing agency that is registered under section 17A of the Exchange 
Act or a derivatives clearing organization that is registered under 
section 5b of the Act;
    (2) Interest charged on credit maintained in the account;
    (3) Communication or shipping charges with respect to transactions 
in the account;
    (4) Payment of commissions, brokerage, taxes, storage and other 
charges lawfully accruing in connection with the positions and 
transactions in the account;
    (5) Any service charges that the security futures intermediary may 
impose; or
    (6) Any other withdrawals that are permitted from a securities 
margin account under Regulation T, to the extent permitted under 
applicable margin rules.


Sec. 41.48  Undermargined accounts.

    (a) Failure to satisfy margin call. If any margin call required by 
this Regulation (Subpart E, Secs. 41.42 through 41.49) is not met in 
full, the security futures intermediary shall take the deduction 
required with respect to an undermargined account in computing its net 
capital under SEC or Commission rules.
    (b) Accounts that liquidate to a deficit. If at any time there is a 
liquidating deficit in an account in which security futures are held, 
the security futures intermediary shall take steps to liquidate 
positions in the account promptly and in an orderly manner.
    (c) Liquidation of undermargined accounts not required. 
Notwithstanding Sec. 41.44(a)(1) of this subpart, Sec. 220.4(d) of 
Regulation T (12 CFR 220.4(d)) respecting liquidation of positions in 
lieu of deposit shall not apply with respect to security futures 
carried in a securities account.


Sec. 41.49  Filing proposed margin rule changes with the Commission.

    (a) Notification requirement for notice-designated contract 
markets. Any self-regulatory authority that is registered with the 
Commission as a designated contract market under section 5f of the Act 
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, concurrently provide to the Commission a 
copy of such proposed rule change and any accompanying documentation 
filed with the SEC.
    (b) Filing requirements under the Act. Any self-regulatory 
authority that is

[[Page 53176]]

registered with the Commission as a designated contract market under 
section 5 of the Act or a derivatives transaction execution facility 
under section 5a of the Act 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, 
submit such proposed rule change to the Commission as follows:
    (1) If the self-regulatory authority elects to request the 
Commission's prior approval for the proposed rule change pursuant to 
section 5c(c)(2) of the Act, it shall concurrently file the proposed 
rule change with the Commission in accordance with Sec. 40.5 of this 
chapter.
    (2) If the self-regulatory authority elects to implement a proposed 
rule change by written certification pursuant to section 5c(c)(1) of 
the Act, it shall concurrently provide to the Commission 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 self-regulatory authority shall file its written 
certification with the Commission in accordance with Sec. 40.6 of this 
chapter.

    Dated: July 31, 2002.

    By the Commodity Futures Trading Commission.
Catherine D. Dixon,
Assistant 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 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. Part 242 is amended by adding the undesignated center heading 
``Regulation M'' before Sec. 242.100.

    3. An undesignated center heading and Secs. 242.400 through 242.406 
are added to read as follows:

Customer Margin Requirements for Security Futures

Sec.
242.400   Customer margin requirements for security futures--
authority, purpose, interpretation, and scope.
242.401   Definitions.
242.402   General provisions.
242.403   Required margin.
242.404   Type, form and use of margin.
242.405   Withdrawal of margin.
242.406   Undermargined accounts.

Customer Margin Requirements for Security Futures


Sec. 242.400  Customer margin requirements for security futures--
authority, purpose, interpretation, and scope.

    (a) Authority and purpose. Sections 242.400 through 242.406 and 17 
CFR 41.42 through 41.49 (``this Regulation, Secs. 242.400 through 
242.406'') are issued by the Securities and Exchange Commission 
(``Commission'') jointly with the Commodity Futures Trading Commission 
(``CFTC''), 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)). The 
principal purpose of this Regulation (Secs. 242.400 through 242.406) is 
to regulate customer margin collected by brokers, dealers, and members 
of national securities exchanges, including futures commission 
merchants required to register as brokers or dealers under section 
15(b)(11) of the Act (15 U.S.C. 78o(b)(11)), relating to security 
futures.
    (b) Interpretation. This Regulation (Secs. 242.400 through 242.406) 
shall be jointly interpreted by the Commission and the CFTC, consistent 
with the criteria set forth in clauses (i) through (iv) of section 
7(c)(2)(B) of the Act (15 U.S.C. 78g(c)(2)(B)) and the provisions of 
Regulation T (12 CFR part 220).
    (c) Scope. (1) This Regulation (Secs. 242.400 through 242.406) does 
not preclude a self-regulatory authority, under rules that are 
effective in accordance with section 19(b)(2) of the Act (15 U.S.C. 
78s(b)(2)) or section 19(b)(7) of the Act (15 U.S.C. 78s(b)(7)) and, as 
applicable, section 5c(c) of the Commodity Exchange Act (``CEA'') (7 
U.S.C. 7a-2(c)), or a security futures intermediary from imposing 
additional margin requirements on security futures, including higher 
initial or maintenance margin levels, consistent with this Regulation 
(Secs. 242.400 through 242.406), or from taking appropriate action to 
preserve its financial integrity.
    (2) This Regulation (Secs. 242.400 through 242.406) does not apply 
to:
    (i) Financial relations between a customer and a security futures 
intermediary to the extent that they comply with a portfolio margining 
system under rules that meet the criteria set forth in section 
7(c)(2)(B) of the Act (15 U.S.C. 78g(c)(2)(B)) and that are 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 CEA (7 U.S.C. 7a-2(c));
    (ii) Financial relations between a security futures intermediary 
and a foreign person involving security futures traded on or subject to 
the rules of a foreign board of trade;
    (iii) Margin requirements that clearing agencies registered under 
section 17A of the Exchange Act (15 U.S.C. 78q-1) or derivatives 
clearing organizations registered under section 5b of the CEA (7 U.S.C. 
7a-1) impose on their members;
    (iv) Financial relations between a security futures intermediary 
and a person based on a good faith determination by the security 
futures intermediary that such person is an exempted person; and
    (v) Financial relations between a security futures intermediary 
and, or arranged by a security futures intermediary for, a person 
relating to trading in security futures by such person for its own 
account, if such person:
    (A) 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
    (B) Is registered with such exchange or such association as a 
security futures dealer pursuant to rules that are 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 CEA (7 U.S.C. 7a-2(c)), that:
    (1) 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 Commission under section 15(b) of 
the Act (15 U.S.C. 78o(b));
    (2) Require such member to maintain records sufficient to prove 
compliance with this paragraph (c)(2)(v) and the rules of the exchange 
or association of which it is a member;
    (3) 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
    (4) Provide for disciplinary action, including revocation of such 
member's registration as a security futures dealer, for such member's 
failure to comply with this Regulation (Secs. 242.400 through 242.406) 
or the rules of the exchange or association.
    (d) Exemption. The Commission may exempt, either unconditionally or 
on specified terms and conditions, financial relations involving any 
security futures intermediary, customer, position, or transaction, or 
any class of

[[Page 53177]]

security futures intermediaries, customers, positions, or transactions, 
from one or more requirements of this Regulation (Secs. 242.400 through 
242.406), if the Commission determines that such exemption is necessary 
or appropriate in the public interest and consistent with the 
protection of investors. An exemption granted pursuant to this 
paragraph shall not operate as an exemption from any CFTC rules. Any 
exemption that may be required from such rules must be obtained 
separately from the CFTC.


Sec. 242.401  Definitions.

    (a) For purposes of this Regulation (Secs. 242.400 through 242.406) 
only, the following terms shall have the meanings set forth in this 
section.
    (1) Applicable margin rules and margin rules applicable to an 
account mean the rules and regulations applicable to financial 
relations between a security futures intermediary and a customer with 
respect to security futures and related positions carried in a 
securities account or futures account as provided in Sec. 242.402(a) of 
this Regulation (Secs. 242.400 through 242.406).
    (2) Broker shall have the meaning provided in section 3(a)(4) of 
the Act (15 U.S.C. 78c(a)(4)).
    (3) 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.
    (4) Current market value means, on any day:
    (i) With respect to a security future:
    (A) If the instrument underlying such security future is a stock, 
theproduct 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
    (B) 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.
    (ii) With respect to a security other than a security future, the 
most recent closing sale price of the security, as shown by any 
regularly published reporting or quotation service. If there is no 
recent closing sale price, the security futures intermediary may use 
any reasonable estimate of the market value of the security as of the 
most recent close of business.
    (5) Customer excludes an exempted person and includes:
    (i) Any person or persons acting jointly:
    (A) On whose behalf a security futures intermediary effects a 
security futures transaction or carries a security futures position; or
    (B) Who would be considered a customer of the security futures 
intermediary according to the ordinary usage of the trade;
    (ii) Any partner in a security futures intermediary that is 
organized as a partnership who would be considered a customer of the 
security futures intermediary absent the partnership relationship; and
    (iii) Any joint venture in which a security futures intermediary 
participates and which would be considered a customer of the security 
futures intermediary if the security futures intermediary were not a 
participant.
    (6) 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, 
clearing agency, or derivatives clearing organization.
    (7) Dealer shall have the meaning provided in section 3(a)(5) of 
the Act (15 U.S.C. 78c(a)(5)).
    (8) Equity means the equity or margin equity in a securities or 
futures account, as computed in accordance with the margin rules 
applicable to the account and subject to adjustment under 
Sec. 242.404(c), (d) and (e) of this Regulation (Secs. 242.400 through 
242.406).
    (9) Exempted person means:
    (i) A member of a national securities exchange, a registered broker 
or dealer, or a registered futures commission merchant, a substantial 
portion of whose business consists of transactions in securities, 
commodity futures, or commodity options with persons other than 
brokers, dealers, futures commission merchants, floor brokers, or floor 
traders, and includes a person who:
    (A) Maintains at least 1000 active accounts on an annual basis for 
persons other than brokers, dealers, persons associated with a broker 
or dealer, futures commission merchants, floor brokers, floor traders, 
and persons affiliated with a futures commission merchant, floor 
broker, or floor trader that are effecting transactions in securities, 
commodity futures, or commodity options;
    (B) Earns at least $10 million in gross revenues on an annual basis 
from transactions in securities, commodity futures, or commodity 
options with persons other than brokers, dealers, persons associated 
with a broker or dealer, futures commission merchants, floor brokers, 
floor traders, and persons affiliated with a futures commission 
merchant, floor broker, or floor trader; or
    (C) Earns at least 10 percent of its gross revenues on an annual 
basis from transactions in securities, commodity futures, or commodity 
options with persons other than brokers, dealers, persons associated 
with a broker or dealer, futures commission merchants, floor brokers, 
floor traders, and persons affiliated with a futures commission 
merchant, floor broker, or floor trader.
    (ii) For purposes of paragraph (a)(9)(i) of this section only, 
persons affiliated with a futures commission merchant, floor broker, or 
floor trader means any partner, officer, director, or branch manager of 
such futures commission merchant, floor broker, or floor trader (or any 
person occupying a similar status or performing similar functions), any 
person directly or indirectly controlling, controlled by, or under 
common control with such futures commission merchant, floor broker, or 
floor trader, or any employee of such a futures commission merchant, 
floor broker, or floor trader.
    (iii) A member of a national securities exchange, a registered 
broker or dealer, or a registered futures commission merchant that has 
been in existence for less than one year may meet the definition of 
exempted person based on a six-month period.
    (10) Exempted security shall have the meaning provided in section 
3(a)(12) of the Act (15 U.S.C. 78c(a)(12)).
    (11) Floor broker shall have the meaning provided in Section 1a(16) 
of the CEA (7 U.S.C. 1a(16)).
    (12) Floor trader shall have the meaning provided in Section 1a(17) 
of the CEA (7 U.S.C. 1a(17)).
    (13) Futures account shall have the meaning provided in 
Sec. 240.15c3-3(a) of this chapter.
    (14) Futures commission merchant shall have the meaning provided in 
Section 1a of the CEA (7 U.S.C. 1a).
    (15) Good faith, with respect to making a determination or 
accepting a statement concerning financial relations with a person, 
means that the security futures intermediary is alert to the 
circumstances surrounding such financial relations, and if in 
possession of information that would cause a prudent person not to make 
the determination or accept the notice or certification without 
inquiry, investigates and is satisfied that it is correct.

[[Page 53178]]

    (16) Listed option means a put or call option that is:
    (i) Issued by a clearing agency that is registered under section 
17A of the Act (15 U.S.C. 17q-1) or cleared and guaranteed by a 
derivatives clearing organization that is registered under Section 5b 
of the CEA (7 U.S.C. 7a-1); and
    (ii) Traded on or subject to the rules of a self-regulatory 
authority.
    (17) Margin call means a demand by a security futures intermediary 
to a customer for a deposit of cash, securities or other assets to 
satisfy the required margin for security futures or related positions 
or a special margin requirement.
    (18) Margin deficiency means the amount by which the required 
margin in an account is not satisfied by the equity in the account, as 
computed in accordance with Sec. 242.404 of this Regulation 
(Secs. 242.400 through 242.406).
    (19) Margin equity security shall have the meaning provided in 
Regulation T.
    (20) Margin security shall have the meaning provided in Regulation 
T.
    (21) Member shall have the meaning provided in section 3(a)(3) of 
the Act (15 U.S.C. 78c(a)(3)), and shall include persons registered 
under section 15(b)(11) of the Act (15 U.S.C. 78o(b)(11)) that are 
permitted to effect transactions on a national securities exchange 
without the services of another person acting as executing broker.
    (22) Money market mutual fund means any security issued by an 
investment company registered under section 8 of the Investment Company 
Act of 1940 (15 U.S.C. 80a-8) that is considered a money market fund 
under Sec. 270.2a-7 of this chapter.
    (23) Persons associated with a broker or dealer shall have the 
meaning provided in section 3(a)(18) of the Act (15 U.S.C. 78c(a)(18)).
    (24) Regulation T means Regulation T promulgated by the Board of 
Governors of the Federal Reserve System, 12 CFR part 220, as amended 
from time to time.
    (25) Regulation T collateral value, with respect to a security, 
means the current market value of the security reduced by the 
percentage of required margin for a position in the security held in a 
margin account under Regulation T.
    (26) Related position, with respect to a security future, means any 
position in an account that is combined with the security future to 
create an offsetting position as provided in Sec. 242.403(b)(2) of this 
Regulation (Secs. 242.400 through 242.406).
    (27) Related transaction, with respect to a position or transaction 
in a security future, means:
    (i) Any transaction that creates, eliminates, increases or reduces 
an offsetting position involving a security future and a related 
position, as provided in Sec. 242.403(b)(2) of this Regulation 
(Secs. 242.400 through 242.406); or
    (ii) Any deposit or withdrawal of margin for the security future or 
a related position, except as provided in Sec. 242.405(b) of this 
Regulation (Secs. 242.400 through 242.406).
    (28) Securities account shall have the meaning provided in 
Sec. 240.15c3-3(a) of this chapter.
    (29) Security futures intermediary means any creditor as defined in 
Regulation T with respect to its financial relations with any person 
involving security futures.
    (30) Self-regulatory authority means a national securities exchange 
registered under section 6 of the Act (15 U.S.C. 78f), a national 
securities association registered under section 15A of the Act (15 
U.S.C. 78o-3), a contract market registered under Section 5 of the CEA 
(7 U.S.C. 7) or Section 5f of the CEA (7 U.S.C. 7b-1), or a derivatives 
transaction execution facility registered under Section 5a of the CEA 
(7 U.S.C. 7a).
    (31) Special margin requirement shall have the meaning provided in 
Sec. 242.404(e)(1)(ii) of this Regulation (Secs. 242.400 through 
242.406).
    (32) Variation settlement means any credit or debit to a customer 
account, made on a daily or intraday basis, for the purpose of marking 
to market a security future or any other contract that is:
    (i) Issued by a clearing agency that is registered under section 
17A of the Act (15 U.S.C. 78q-1) or cleared and guaranteed by a 
derivatives clearing organization that is registered under Section 5b 
of the CEA (7 U.S.C. 7a-1); and
    (ii) Traded on or subject to the rules of a self-regulatory 
authority.
    (b) Terms used in this Regulation (Secs. 242.400 through 242.406) 
and not otherwise defined in this section shall have the meaning set 
forth in the margin rules applicable to the account.
    (c) Terms used in this Regulation (Secs. 242.400 through 242.406) 
and not otherwise defined in this section or in the margin rules 
applicable to the account shall have the meaning set forth in the Act 
and the CEA; if the definitions of a term in the Act and the CEA are 
inconsistent as applied in particular circumstances, such term shall 
have the meaning set forth in rules, regulations, or interpretations 
jointly promulgated by the Commission and the CFTC.


Sec. 242.402  General provisions.

    (a) Applicable margin rules. Except to the extent inconsistent with 
this Regulation (Secs. 242.400 through 242.406):
    (1) A security futures intermediary that carries a security future 
on behalf of a customer in a securities account shall record and 
conduct all financial relations with respect to such security future 
and related positions in accordance with Regulation T and the margin 
rules of the self-regulatory authorities of which the security futures 
intermediary is a member.
    (2) A security futures intermediary that carries a security future 
on behalf of a customer in a futures account shall record and conduct 
all financial relations with respect to such security future and 
related positions in accordance with the margin rules of the self-
regulatory authorities of which the security futures intermediary is a 
member.
    (b) Separation and consolidation of accounts.
    (1) The requirements for security futures and related positions in 
one account may not be met by considering items in any other account, 
except as permitted or required under paragraph (b)(2) of this section 
or applicable margin rules. If withdrawals of cash, securities or other 
assets deposited as margin are permitted under this Regulation 
(Secs. 242.400 through 242.406), bookkeeping entries shall be made when 
such cash, securities, or assets are used for purposes of meeting 
requirements in another account.
    (2) Notwithstanding paragraph (b)(1) of this section, the security 
futures intermediary shall consider all futures accounts in which 
security futures and related positions are held that are within the 
same regulatory classification or account type and are owned by the 
same customer to be a single account for purposes of this Regulation 
(Secs. 242.400 through 242.406). The security futures intermediary may 
combine such accounts with other futures accounts that are within the 
same regulatory classification or account type and are owned by the 
same customer for purposes of computing a customer's overall margin 
requirement, as permitted or required by applicable margin rules.
    (c) Accounts of partners. If a partner of the security futures 
intermediary has an account with the security futures intermediary in 
which security futures or related positions are held, the

[[Page 53179]]

security futures intermediary shall disregard the partner's financial 
relations with the firm (as shown in the partner's capital and ordinary 
drawing accounts) in calculating the margin or equity of any such 
account.
    (d) Contribution to joint venture. If an account in which security 
futures or related positions are held is the account of a joint venture 
in which the security futures intermediary participates, any interest 
of the security futures intermediary in the joint account in excess of 
the interest which the security futures intermediary would have on the 
basis of its right to share in the profits shall be margined in 
accordance with this Regulation (Secs. 242.400 through 242.406).
    (e) Extensions of credit. (1) No security futures intermediary may 
extend or maintain credit to or for any customer for the purpose of 
evading or circumventing any requirement under this Regulation 
(Secs. 242.400 through 242.406).
    (2) A security futures intermediary may arrange for the extension 
or maintenance of credit to or for any customer by any person, provided 
that the security futures intermediary does not willfully arrange 
credit that would constitute a violation of Regulation T, U or X of the 
Board of Governors of the Federal Reserve System (12 CFR parts 220, 
221, and 224) by such person.
    (f) Change in exempted person status. Once a person ceases to 
qualify as an exempted person, it shall notify the security futures 
intermediary of this fact before entering into any new security futures 
transaction or related transaction that would require additional margin 
to be deposited under this Regulation (Secs. 242.400 through 242.406). 
Financial relations with respect to any such transactions shall be 
subject to the provisions of this Regulation (Secs. 242.400 through 
242.406).


Sec. 242.403  Required margin.

    (a) Applicability. Each security futures intermediary shall 
determine the required margin for the security futures and related 
positions held on behalf of a customer in a securities account or 
futures account as set forth in this section.
    (b) Required margin.--(1) General rule. The required margin for 
each long or short position n a security future shall be twenty (20) 
percent of the current market value of such security future.
    (2) Offsetting positions. Notwithstanding the margin levels 
specified in paragraph (b)(1) of this section, a self-regulatory 
authority may set the required initial or maintenance margin level for 
an offsetting position involving security futures and related positions 
at a level lower than the level that would be required under paragraph 
(b)(1) of this section if such positions were margined separately, 
pursuant to rules that meet the criteria set forth in section 
7(c)(2)(B) of the Act (15 U.S.C. 78g(c)(2)(B)) and are 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 CEA (7 U.S.C. 7a-2(c)).
    (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 
for a security future 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)).


Sec. 242.404  Type, form and use of margin.

    (a) When margin is required. Margin is required to be deposited 
whenever the required margin for security futures and related positions 
in an account is not satisfied by the equity in the account, subject to 
adjustment under paragraph (c) of this section.
    (b) Acceptable margin deposits. (1) The required margin may be 
satisfied by a deposit of cash, margin securities (subject to paragraph 
(b)(2) of this section), exempted securities, any other asset permitted 
under Regulation T to satisfy a margin deficiency in a securities 
margin account, or any combination thereof, each as valued in 
accordance with paragraph (c) of this section.
    (2) Shares of a money market mutual fund may be accepted as a 
margin deposit for purposes of this Regulation (Secs. 242.400 through 
242.406), provided that:
    (i) The customer waives any right to redeem the shares without the 
consent of the security futures intermediary and instructs the fund or 
its transfer agent accordingly;
    (ii) The security futures intermediary (or clearing agency or 
derivatives clearing organization with which the shares are deposited 
as margin) obtains the right to redeem the shares in cash, promptly 
upon request; and
    (iii) The fund agrees to satisfy any conditions necessary or 
appropriate to ensure that the shares may be redeemed in cash, promptly 
upon request.
    (c) Adjustments.
    (1) Futures accounts. For purposes of this section, the equity in a 
futures account shall be computed in accordance with the margin rules 
applicable to the account, subject to the following:
    (i) A security future shall have no value;
    (ii) Each net long or short position in a listed option on a 
contract for future delivery shall be valued in accordance with the 
margin rules applicable to the account;
    (iii) Except as permitted in paragraph (e) of this section, each 
margin equity security shall be valued at an amount no greater than its 
Regulation T collateral value;
    (iv) Each other security shall be valued at an amount no greater 
than its current market value reduced by the percentage specified for 
such security in Sec. 240.15c3-1(c)(2)(vi) of this chapter;
    (v) Freely convertible foreign currency may be valued at an amount 
no greater than its daily marked-to-market U.S. dollar equivalent;
    (vi) Variation settlement receivable (or payable) by an account at 
the close of trading on any day shall be treated as a credit (or debit) 
to the account on that day; and
    (vii) Each other acceptable margin deposit or component of equity 
shall be valued at an amount no greater than its value under Regulation 
T.
    (2) Securities accounts. For purposes of this section, the equity 
in a securities account shall be computed in accordance with the margin 
rules applicable to the account, subject to the following:
    (i) A security future shall have no value;
    (ii) Freely convertible foreign currency may be valued at an amount 
no greater than its daily mark-to-market U.S. dollar equivalent; and
    (iii) Variation settlement receivable (or payable) to an account at 
the close of trading on any day shall be treated as a credit (or debit) 
by the account on that day.
    (d) Satisfaction restriction. Any transaction, position or deposit 
that is used to satisfy the required margin for security futures or 
related positions under this Regulation (Secs. 242.400 through 
242.406), including a related position, shall be unavailable to satisfy 
the required margin for any other position or transaction or any other 
requirement.
    (e) Alternative collateral valuation for margin equity securities 
in a futures account.
    (1) Notwithstanding paragraph (c)(1)(iii) of this section, a 
security futures intermediary need not value a margin equity security 
at its Regulation T collateral value when determining whether the 
required margin for the security futures and related positions in

[[Page 53180]]

a futures account is satisfied, provided that:
    (i) The margin equity security is valued at an amount no greater 
than the current market value of the security reduced by the lowest 
percentage level of margin required for a long position in the security 
held in a margin account under the rules of a national securities 
exchange registered pursuant to section 6(a) of the Act (15 U.S.C. 
78f(a));
    (ii) Additional margin is required to be deposited on any day when 
the day's security futures transactions and related transactions would 
create or increase a margin deficiency in the account if the margin 
equity securities were valued at their Regulation T collateral value, 
and shall be for the amount of the margin deficiency so created or 
increased (a ``special margin requirement''); and
    (iii) Cash, securities, or other assets deposited as margin for the 
positions in an account are not permitted to be withdrawn from the 
account at any time that:
    (A) Additional cash, securities, or other assets are required to be 
deposited as margin under this section for a transaction in the account 
on the same or a previous day; or
    (B) The withdrawal, together with other transactions, deposits, and 
withdrawals on the same day, would create or increase a margin 
deficiency if the margin equity securities were valued at their 
Regulation T collateral value.
    (2) All security futures transactions and related transactions on 
any day shall be combined to determine the amount of a special margin 
requirement. Additional margin deposited to satisfy a special margin 
requirement shall be valued at an amount no greater than its Regulation 
T collateral value.
    (3) If the alternative collateral valuation method set forth in 
paragraph (e) of this section is used with respect to an account in 
which security futures or related positions are carried:
    (i) An account that is transferred from one security futures 
intermediary to another may be treated as if it had been maintained by 
the transferee from the date of its origin, if the transferee accepts, 
in good faith, a signed statement of the transferor (or, if that is not 
practicable, of the customer), that any margin call issued under this 
Regulation (Secs. 242.400 through 242.406) has been satisfied; and
    (ii) An account that is transferred from one customer to another as 
part of a transaction, not undertaken to avoid the requirements of this 
Regulation (Secs. 242.400 through 242.406), may be treated as if it had 
been maintained for the transferee from the date of its origin, if the 
security futures intermediary accepts in good faith and keeps with the 
transferee account a signed statement of the transferor describing the 
circumstances for the transfer.
    (f) Guarantee of accounts. No guarantee of a customer's account 
shall be given any effect for purposes of determining whether the 
required margin in an account is satisfied, except as permitted under 
applicable margin rules.


Sec. 242.405  Withdrawal of margin.

    (a) By the customer. Except as otherwise provided in 
Sec. 242.404(e)(1)(ii) of this Regulation (Secs. 242.400 through 
242.406), cash, securities, or other assets deposited as margin for 
positions in an account may be withdrawn, provided that the equity in 
the account after such withdrawal is sufficient to satisfy the required 
margin for the security futures and related positions in the account 
under this Regulation (Secs. 242.400 through 242.406).
    (b) By the security futures intermediary. Notwithstanding paragraph 
(a) of this section, the security futures intermediary, in its usual 
practice, may deduct the following items from an account in which 
security futures or related positions are held if they are considered 
in computing the balance of such account:
    (1) Variation settlement payable, directly or indirectly, to a 
clearing agency that is registered under section 17A of the Act (15 
U.S.C. 78q-1) or a derivatives clearing organization that is registered 
under section 5b of the CEA (7 U.S.C. 7a-1);
    (2) Interest charged on credit maintained in the account;
    (3) Communication or shipping charges with respect to transactions 
in the account;
    (4) Payment of commissions, brokerage, taxes, storage and other 
charges lawfully accruing in connection with the positions and 
transactions in the account;
    (5) Any service charges that the security futures intermediary may 
impose; or
    (6) Any other withdrawals that are permitted from a securities 
margin account under Regulation T, to the extent permitted under 
applicable margin rules.


Sec. 242.406  Undermargined accounts.

    (a) Failure to satisfy margin call. If any margin call required by 
this Regulation (Secs. 242.400 through 242.406) is not met in full, the 
security futures intermediary shall take the deduction required with 
respect to an undermargined account in computing its net capital under 
Commission or CFTC rules.
    (b) Accounts that liquidate to a deficit. If at any time there is a 
liquidating deficit in an account in which security futures are held, 
the security futures intermediary shall take steps to liquidate 
positions in the account promptly and in an orderly manner.
    (c) Liquidation of undermargined accounts not required. 
Notwithstanding Section 402(a) of this Regulation (Secs. 242.400 
through 242.406), section 220.4(d) of Regulation T (12 CFR 220.4(d)) 
respecting liquidation of positions in lieu of deposit shall not apply 
with respect to security futures carried in a securities account.

    Dated: August 1, 2002.

    By the Securities and Exchange Commission.
Margaret H. McFarland,
Deputy Secretary.
[FR Doc. 02-19892 Filed 8-13-02; 8:45 am]
BILLING CODE 6351-01-P; 8010-01-P