[Federal Register Volume 67, Number 189 (Monday, September 30, 2002)]
[Notices]
[Pages 61361-61366]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 02-24745]



[[Page 61361]]

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SECURITIES AND EXCHANGE COMMISSION

[Release No. 34-46548; File No. SR-NQLX-2002-01]


Self-Regulatory Organizations; Notice of Filing of Proposed Rule 
Change by the Nasdaq Liffe Markets, LLC Relating to Margin Rules for 
Security Futures Products Other Than Options on Security Futures

September 25, 2002.
    Pursuant to Section 19(b)(1) of the Securities Exchange Act of 1934 
(``Act''),\1\ and Rule 19b-4 thereunder,\2\ notice is hereby given that 
on September 24, 2002, the Nasdaq Liffe Markets, LLC (``NQLX'') filed 
with the Securities and Exchange Commission (``Commission'') the 
proposed rule change as described in Items I, II, and III below, which 
Items have been prepared by NQLX. The Commission is publishing this 
notice to solicit comments on the proposed rule change from interested 
persons.
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    \1\ 15 U.S.C. 78s(b)(1).
    \2\ 17 CFR 240.19b-4.
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I. Self-Regulatory Organization's Statement of the Terms of Substance 
of the Proposed Rule Change

    NQLX is proposing new rule provisions and rule amendments related 
to customer margin for security futures contracts. These proposed rule 
and rule amendments would: (1) Define the term ``Security Futures 
Dealers;'' (2) add a provision stating that NQLX's customer margin rule 
would only apply to products traded on NQLX; (3) add a provision 
stating that NQLX's customer margin rule would not apply to (a) 
specified portfolio-margining systems, (b) margin requirements imposed 
by clearing organizations on their members, (c) ``exempted persons'' 
for activities in their own accounts, (d) market-making activities of 
``Security Futures Dealers,'' and (e) security futures contracts held 
in a securities account for a customer; (4) add a provision 
establishing the minimum initial and maintenance customer margin rates 
for security futures contracts; (5) add a provision requiring 
compliance with the customer margin rules jointly promulgated by the 
Commission and the Commodity Futures Trading Commission (``CFTC''); (6) 
add a provision establishing four strategy-based offsets, in table 
form, that would be allowed to reduce the customer margin requirements 
below the minimum initial and maintenance margin requirements; and (7) 
add a provision that would specify the requirements for a market maker 
to be designated as a Security Futures Dealer by NQLX, which would 
include, among other requirements (a) holding itself out as being 
willing to buy and sell specified Security Futures Contracts for its 
own account on a regular or continuous basis and (b) meeting specified 
affirmative, minimum two-sided quotation requirements, including 
requirements related to maximum bid/ask spreads and minimum contract 
sizes in the front-two delivery months of the security futures contract 
and/or requirements related to responding to requests for quotation in 
delivery months other than the first-two delivery months.
    Below is the text of the proposed rule change. Proposed new 
language is italicized.
* * * * *
Rule 101(a) Definitions. * * *
(72) ``Security Futures Dealer''--means a Market Maker designated by 
NQLX as a Security Futures Dealer that meets the requirements of Rule 
403(d) and Rule 403(e).

Rule 334 Customer Margin for Exchange Contracts

(a) General Rules:
    (1) This Rule only applies to Exchange Contracts and not other 
security futures or futures products listed or traded on other Contract 
Markets or national securities exchanges or national securities 
associations.
    (2) With respect to Security Futures Contracts, this Rule does not 
apply to:
    (i) Portfolio-margining systems meeting the requirements of CFTC 
rule 41.42(c)(2)(i) and SEC rule 400(c)(2)(i);
    (ii) margin requirements that a Clearing Organization imposes on 
its members as specified by CFTC rule 41.42(c)(2)(iii) and SEC rule 
400(c)(2)(iii);
    (iii) ``exempted persons'' for trading in their own accounts as 
specified in, and defined by, CFTC rules 41.42(c)(2)(iv) and 
41.43(a)(9) and SEC rules 400(c)(iv) and 401(a)(9);
    (iv) market-making activities by Security Futures Dealers as 
specified in, and defined by, CFTC rule 41.42(c)(2)(iii) and SEC rule 
400(c)(2)(iii); or
    (v) Security Futures Contracts held in a securities account for a 
Customer, which instead will be subject to the customer margin rules of 
the Member's designated examining authority pursuant to SEC rule 17d-1.
    (3) For Exchange Contracts, no Member shall effect a transaction or 
carry an account for a Customer without obtaining margin at the times, 
in the amounts, and in the forms required by this Rule.
    (4) If a Member fails to obtain and maintain the required minimum 
margin deposits for a Customer's account pursuant to this Rule, NQLX 
may require that the Member immediately liquidate all or part of the 
positions in the Customer's account to decrease or eliminate the margin 
deficiency.
    (5) Nothing in this Rule prevents NQLX, a Clearing Organization, or 
a Member from imposing margin rates or requirements on a Customer that 
are higher or more stringent than the rates or requirements imposed by 
this Rule.
    (6) Terms used in this Rule, but not otherwise defined by these 
Rules, have the meaning set forth in the Joint Audit Committee's 
Margins Handbook. In addition, a Member must follow the procedures 
specified in the Joint Audit Committee's Margins Handbook for the 
computation, issuance, collection, and offsets for margin calls and 
corresponding capital charges for the Member unless the Manual is 
inconsistent with these Rules, in which case these Rules prevail.
    (b) Rates and Requirements:
    (1) A Member carrying a Customer account with Exchange Contracts 
must collect at least the minimum margin requirements established by 
NQLX. Except as provided for in Rule 334(g)(2), a Member must collect 
at least twenty percent of the current market value (as that term is 
defined by CFTC rule 41.43(a)(4) and SEC rule 401(a)(4)) for each 
Security Future Contract (whether a long or short position) as minimum 
initial and maintenance margin from the Customer. For all Exchange 
Contracts other than Security Futures Contracts, NQLX will publish the 
minimum initial and maintenance margin rates and other requirements for 
each Exchange Contract or Group of Exchange Contracts through Notices 
to Members. Any changes imposed by NQLX to initial or maintenance 
margin rates or requirements apply to both new and existing positions 
and NQLX may, within its discretion, establish different margin rates 
or requirements for different types of accounts.
    (2) Unless otherwise required by this Rule, a Member must use a 
risk-based portfolio margining system acceptable to NQLX to calculate 
the margin rates imposed on a Customer by this Rule.
    (3) For a long option on an Exchange Contract other than a Security 
Futures Contract, when the transaction is initiated for a Customer, the 
Member must collect in full the premium on the long option.

[[Page 61362]]

    (c) Account Administration, Classification, and Aggregation:
    (1) Omnibus Accounts: A Member must calculate margin requirements 
for an omnibus account (whether domestic or foreign) on a gross basis. 
However, a Member may impose maintenance margin rates for positions in 
the omnibus account and need not impose the initial margin rates. To 
use spread or hedge margin rates, a Member must obtain a written 
representation from the omnibus account identifying the positions 
within the account that are spreads or bona fide hedges.
    (2) Bona Fide Hedge Accounts: For bona fide hedging transactions 
and positions as defined by CFTC regulation 1.3(z)(1), a Member may 
impose maintenance margin rates for the transactions and positions and 
need not impose the initial margin rates if the Member has a reasonable 
basis to believe, and the Customer represents in writing that, the 
transactions or positions are for bona fide hedging.
    (3) Aggregation:
    (i) When determining margin rates, margin calls, and the release of 
margin deposits, a Member may aggregate identically-owned accounts 
within the same regulatory account classification of Customer 
segregated, Customer secured, and non-segregated.
    (ii) To satisfy a margin deficiency, a Member may not apply 
available free funds from an identically-owned account that has a 
different regulatory account classification. Instead, the Member must 
transfer the free funds from one identically-owned account in one 
regulatory account classification to another identically-owned account 
with a different regulatory account classification that is 
undermargined.
    (iii) Except for omnibus accounts, a Member may calculate margin 
requirements on a net basis for concurrent long and short positions in 
identically-owned accounts within the same regulatory account 
classification.
    (4) Extension of Credit: No Member shall extend or maintain credit 
to or for a Customer to evade or circumvent any requirements of this 
Rule. A Member may extend or maintain (or arrange for the extension or 
maintenance of) credit to or for a Customer to meet the margin 
requirements of this Rule only if the credit or loan is secured as 
defined by CFTC regulation 1.17(c)(3) and the proceeds are treated by 
the Member in accordance with CFTC regulation 1.30.
    (d) Type, Form, and Value of Margin Deposits:
    (1) Subject to Rule 334(d)(2), a Member must only accept the 
following assets, securities, or instruments as margin deposits:
    (i) U.S. dollars and foreign currencies,
    (ii) U.S. government treasury and agency securities,
    (iii) municipal securities,
    (iv) readily marketable securities (which means securities traded 
on a ``ready market'' as defined by SEC rule 15c3-1(c)(11)),
    (v) money market mutual funds that meet the requirements of CFTC 
regulation 1.25 (other than securities issued by the Customer or an 
affiliate of the Customer), and/or
    (vi) irrevocable letters of credit in a form, and issued by banks 
or trust companies, approved by the Clearing Organization (other than 
letters of credit issued by the Customer or an affiliate of the 
Customer).
    (2) The assets, securities, and instruments accepted by a Member 
pursuant to Rule 334(d)(1) to meet a Customer's margin requirements 
must be and remain unencumbered by third party claims.
    (3) If a Member accepts foreign currencies as margin deposits, then 
the Member must obtain a subordination agreement and value the foreign 
currencies as required by CFTC Interpretation #12-Deposit of Customer 
Funds in Foreign Depositories.
    (4) If a Member accepts the securities identified in Rule 334(d)(1) 
as margin deposits, then the Member must value the securities at no 
greater than the current market value of the securities less any 
haircuts specified by SEC rule 15c3-1.
    (5) A Member must not consider any guarantee of a Customer's 
account when determining whether required margin in a Customer's 
account is satisfied.
    (e) Margin Calls and Liquidation:
    (1) Once additional margin deposits are required pursuant to this 
Rule, a Member must call for the additional margin as promptly as 
possible and in any event not more than one business day after the 
event giving rise to the call. Once the Member calls for the additional 
margin, the Member must collect the full amount of the required 
additional margin from a Customer as promptly as possible and in any 
event within a reasonable time. In a margin call, a Member must require 
that a Customer deposit additional margin so that the Customer's 
account at least meets the minimum initial margin requirement (i) when 
the margin equity in the account initially falls below the minimum 
maintenance margin requirements and (ii) subsequently when the margin 
equity plus existing margin calls on the account are less than the 
minimum maintenance margin requirements.
    (2) After a margin call is made by a Member but before the Customer 
makes the required additional margin deposit, the Member may only 
accept an Order from the Customer to establish a new position if the 
Member reasonably believes that the Customer will meet the outstanding 
margin call within a reasonable time. If a margin call to a Customer is 
outstanding for an unreasonable time, a Member may only accept Orders 
from the Customer that will reduce the Customer's margin requirements.
    (3) After a margin call is made by a Member, if the Customer fails 
to deposit the required additional margin deposit within a reasonable 
time, the Member may, but is not required to, liquidate all or a 
portion of the Customer's positions to restore the Customer's account 
to a properly margined level. However, the inability of a Member to 
liquidate all or a portion of the Customer's positions before the 
account equity results in a debit or deficit balance does not affect 
any liability of the Customer to the Member.
    (4) A Member must make and retain a written record of the date, 
time, amount, and other relevant information for all margin calls made 
(whether made by telephone, in writing, or by other means) as well as 
margin calls reduced, satisfied, or relieved.
    (5) A Member that liquidates all or a portion of the Customer's 
positions pursuant to Rule 334(e)(3) is not deemed to have extended 
credit or made a loan to the Customer in violation of this Rule.
    (f) Release of Margin;
    A Member may only release free funds in connection with a 
Customer's account if after release the Customer's account has at least 
free funds at the initial margin requirement level.
    (g) Security Futures Contracts:
    (1) Unless otherwise provided by this Rule, no Member shall effect 
a transaction for a Customer in, or carry a Customer account with, 
Security Futures Contracts without complying with (i) CFTC rules 41.42 
through and including 41.48 and SEC rules 400 through and including 406 
of the Securities Exchange Act (``CFTC/SEC Margin Regulations'') and 
(ii) Rule 334(a) through and including (g) to the extent consistent 
with the CFTC/SEC Margin Regulations.
    (2) Notwithstanding the initial and maintenance margin rate 
specified in Rule 334(b)(1) for Security Futures Contracts, a Member 
may collect at least the initial and maintenance margin rates specified 
in the table below for the following strategy-based offsetting 
positions:

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                                      Security underlying
       Description of offset         the security futures  Initial margin requirement   Maintenance requirement
                                           contract                                              margin
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1. Long Security Futures Contract   Individual stock \1\   The greater of: (a) 5% of   The greater of: (a) 5% of
 and short Security Futures          or narrow-based        the current market value    the current market value
 Contract on the same underlying     security index.        \2\ of the long Security    value of the long
 security (or index).                                       Futures Contract; or (b)    Security Futures
                                                            5% of the current market    Contract; or (b) 5% of
                                                            value of the short          the current market value
                                                            Security Futures Contract.  of the short Security
                                                                                        Futures Contract.
2. Long (short) a basket of         Narrow-based security  5% of the current market    5% of the current market
 Security Futures Contracts, each    index.                 value of the long (short)   value of the long
 based on a narrow-based security                           basket of Security          (short) basket of
 index that together tracks the                             Futures Contracts.          Security Futures
 broad-based index \3\ and short                                                        Contracts.
 (long) the broad based-index
 future.
3. Long (short) a basket of         Individual stock and   The greater of: (a) 5% of   The greater of: (a) 5% of
 Security Futures Contracts that     narrow-based           the current market value    the current market value
 together tracks a narrow-based      security index.        of the long Security        of the long Security
 index and short (long) a narrow                            Futures Contracts; or (b)   Futures Contracts; or
 based-index future.                                        5% of the current market    (b) 5% of the current
                                                            value of the short          market value of the
                                                            Security Futures            short Security Futures
                                                            Contracts.                  Contracts.
4. Long (short) a Security Future   Individual stock and   The greater of: (a) 3% of   The greater of: (a) 3% of
 Contract and short (long) an        narrow-based           the current market value    the current market value
 identical security futures          security index.        of the long Security        of the long Security
 contract traded on a different                             Futures Contract (or Non-   Futures Contract (or Non-
 market (``Non-NQLX Security                                NQLX Security Futures       NQLX Security Futures
 Futures Contract'').\4\.                                   Contract); or (b) 3% of     Contract); or (b) 3% of
                                                            the current market value    the current market value
                                                            of the short Security       of the short Security
                                                            Futures Contract (or Non-   Futures Contract (or Non-
                                                            NQLX Security Futures       NQLX Security Futures
                                                            Contract).                  Contract).
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\1\ For purposes of this table, ``individual stock'' includes common stock, American Depository Receipts, shares
  of exchange-traded funds, shares of closed-end management investment companies, or trust-issued receipts.
\2\ For purposes of this table, ``current market value'' is defined by CFTC rule 41.43(a)(4) and SEC rule
  401(a)(4).
\3\ Baskets of securities or Security Futures Contracts must replicate the securities that comprise the index,
  and in the same proportions.
\4\ For purposes of this table, a Security Futures Contract (which is traded on NQLX) is considered
  ``identical'' to a Non-NQLX Security Futures Contract if the two contracts are issued by the same clearing
  agency or cleared or guaranteed by the same Derivatives Clearing Organization, have identical contract
  specifications, and would offset each other at the clearing level.

Rule 403 Market Makers

    * * * (d) In addition to the requirements of Rule 403(a) through 
and including (c), a Market Maker in a Security Futures Contract that 
is designated as a Security Futures Dealer by NQLX must meet all of the 
following requirements:
    (1) Is a Member;
    (2) is registered as a floor trader or floor broker with the CFTC 
under section 4f(a)(1) of the CEA or as a dealer with the SEC under 
section 15(b) of the Securities Exchange Act;
    (3) holds itself out as being willing to buy and sell Security 
Futures Contracts for its own account on a regular or continuous basis 
and enters into a written agreement that meets, at a minimum, the 
requirements of Rule 403(e);
    (4) maintains records sufficient to prove compliance with the 
requirements of Rule 403(d) and Rule 403(e), including, but not limited 
to, documents concerning personnel effecting relevant Orders, relevant 
trade and cash blotters, relevant stock records, and documents 
concerning applicable internal system capacity and performance; and
    (5) is subject to disciplinary action under Chapter 5 of these 
Rules for failing to comply with CFTC rules 41.42 through and including 
41.48 and SEC rules 400 through and including 406 of the Securities 
Exchange Act, with sanctions up to and including removal of the 
Member's designation as a Security Futures Dealer.
    (e) To fulfill the requirements of Rule 403(d)(3), the Security 
Futures Dealer must meet, at a minimum, either the requirements of Rule 
403(e)(1) or the requirements of Rule 403(e)(2):
    (1) The Security Futures Dealer must:
    (i) Provide continuous two-sided quotations for the first-two 
delivery months of a specified Security Futures Contract throughout the 
trading day, subject to relaxation during unusual market conditions as 
determined by NQLX (such as a fast market in either the Security 
Futures Contract or the security underlying the Security Futures 
Contract) at which times the Security Futures Dealer must use its best 
efforts to quote continuously and competitively; and
    (ii) quote, for the first-two delivery months, with (A) a maximum 
bid/ask spread no more than the greater of $.10 or 150 percent of the 
bid/ask spread in the primary market for the security underlying the 
Security Futures Contract and (B) a minimum number of contracts no less 
than the lesser of 10 contracts or the corresponding contract size 
equivalent of the best bid and best offer for the security underlying 
the Security Futures Contract; and
    (iii) respond to requests for quotation in the specified Security 
Futures Contract within 5 seconds for all delivery months other than 
the first-two delivery months with a two-sided quotation that has (A) a 
maximum bid/ask spread no more than the greater of $.20 or 150 percent 
of the bid/ask spread in the primary market for the security underlying 
the Security Futures Contract and (B) a minimum number of contracts no 
less than the lesser of 5 contracts or the corresponding contract size 
equivalent of the best bid and best offer for the security underlying 
the Security Futures Contract.
    (2) The Security Futures Dealer must:
    (i) Respond to requests for quotation in a specified Security 
Futures Contract in specified delivery months other than the first-two 
delivery months with two-sided quotations throughout the trading day, 
subject to relaxation during unusual market conditions as determined by 
NQLX (such as a fast market in either the Security Futures Contract or 
the security underlying the Security Futures Contract) at which times 
the Security Futures Dealer must use its best efforts to quote 
competitively; and
    (ii) quote, when responding to requests for quotation, within 5 
seconds (A) with a maximum bid/ask spread no more than the greater of 
$.20 or 150 percent of the bid/ask spread in the primary market for the 
security underlying the Security Futures

[[Page 61364]]

Contract and (B) a minimum number of contracts no less than the lesser 
of 5 contracts or the corresponding contract size equivalent of the 
best bid and best offer for the security underlying the Security 
Futures Contract.
* * * * *

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

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

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

1. Purpose
    The Commodity Futures Modernization Act of 2000 (``CFMA'') lifted 
the ban on trading futures on single stocks as well as narrow-based 
stock indices. The CFMA also established a framework for joint 
regulation of security futures products by the Commission and the CFTC 
and gave the Board of Governors of the Federal Reserve System 
(``Federal Reserve Board'') authority to promulgate rules governing 
initial and maintenance customer margin for these newly permissible 
products. In turn, the Federal Reserve Board delegated its rulemaking 
authority under Section 7(c)(2)(B) of the Act \3\ to the Commission and 
the CFTC, to be exercised jointly by the two agencies.\4\ Pursuant to 
that authority, the Commission and the CFTC jointly adopted customer 
margin requirements for security futures, which are CFTC Rules 41.42 
through and including 41.49,\5\ and Rules 400 through and including 406 
under the Act,\6\ (``SEC/CFTC Margin Regulations'').\7\ The SEC/CFTC 
Margin Regulations went into effect on September 13, 2002. NQLX seeks 
to adopt these proposed rule provisions and rule amendments to comply 
with Sections 6(h)(3)(L) \8\ and 7(c)(2)(B) \9\ of the Act as well the 
SEC/CFTC Margin Regulations.
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    \3\ 15 U.S.C. 78g(c)(2)(B).
    \4\ See letter to James E. Newsome, Acting Chairman, CFTC, and 
Laura S. Unger, Acting Chairman, Commission, from Jennifer J. 
Johnson, Secretary of the Federal Reserve Board, dated March 6, 
2001.
    \5\ 17 CFR 41.42 through 41.49.
    \6\ 17 CFR 240.400 through 406.
    \7\ See Securities Exchange Act Release No. 46292 (August 1, 
2002), 67 FR 53146 (August 14, 2002).
    \8\ 15 U.S.C. 78f(h)(3)(L).
    \9\ 15 U.S.C. 78g(c)(2)(B).
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    NQLX proposes that its general customer margin rule, NQLX Rule 334, 
provide that NQLX's customer margin rule only applies to futures 
products traded on NQLX.\10\ NQLX further proposes adding a provision 
stating that its customer margin rule would not apply in five 
situations.\11\ First, while no portfolio-margining system currently 
meets the criteria of Section 7(c)(2)(B) of the Act \12\ and has been 
approved pursuant to Section 19(b)(2) Act,\13\ proposed NQLX Rule 
334(a)(2)(i) would state that NQLX Rule 334 would not apply to 
portfolio-margining systems meeting the requirements of Rule 
400(c)(2)(i) under the Act \14\ and CFTC Rule 41.42(c)(2)(i).\15\ 
Second, proposed NQLX Rule 334(a)(2)(ii) would state that NQLX Rule 334 
would not apply to margin requirements that ``Clearing Organizations'' 
impose on their members.\16\ Third, proposed NQLX Rule 334(a)(2)(iii) 
would state that NQLX Rule 334 would not apply to transactions made by 
``exempted persons'' for their own accounts.\17\ Fourth, proposed NQLX 
Rule 334(a)(2)(iv) would provide that NQLX Rule 334 would not apply to 
the market-making activities of a ``Security Futures Dealer,'' as that 
term is defined by proposed NQLX Rules 101(a)(72) and 403(d) and (e). 
Fifth, proposed NQLX Rule 334(a)(2)(v) would state that NQLX Rule 334 
would not apply to Security Futures Contracts that are held in a 
securities account for a customer, but instead the customer margin 
rules of the member's designated examining authority (``DEA'') pursuant 
to Rule 17d-1 under the Act \18\ would apply.\19\ NQLX proposes this 
last provision because even if NQLX was to impose its customer margin 
rules on customers that held Security Futures Contracts in securities 
accounts, NQLX members that have DEAs would still have to apply the 
customer margin rules of their respective DEA. Therefore, to eliminate 
unnecessary regulatory duplication, proposed NQLX Rule 334(a)(2)(v) 
would allow NQLX members to only apply the customer margin rules of 
their respective DEAs for Security Futures Contracts held in securities 
accounts.
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    \10\ See Proposed NQLX Rule 334(a)(1).
    \11\ See Proposed NQLX Rule 334(a)(2).
    \12\ 15 U.S.C. 78g(c)(2)(B).
    \13\ 15 U.S.C. 78s(b)(2).
    \14\ 7 CFR 242.400(c)(2)(i).
    \15\ 17 CFR 41.42(c)(2)(i).
    \16\ NQLX defines ``Clearing Organizations'' to mean ``any 
Derivatives Clearing Organization registered with the CFTC or a 
securities clearing agency registered with the Commission or both 
and designated by NQLX as a Clearing Organization for NQLX.'' NQLX 
Rule 101(a)(16). In turn, NQLX's rules define ``Derivative Clearing 
Organization'' to have the ``meaning attributed to it by section 
1a(9) of the Commodity Exchange Act (``CEA'') and the regulations 
promulgated thereunder.'' NQLX Rule 101(a)(26).
    \17\ For purposes of proposed NQLX Rule 334(a)(2)(iii), 
``exempted persons'' has the meaning prescribed by SEC/CFTC Margin 
Regulations. Generally, the SEC/CFTC Margin Regulations define an 
``exempted person'' as a member of a national securities exchange, a 
registered broker-dealer, or registered futures commission merchant 
that: (1) maintains at least 1,000 active stock, futures, or option 
accounts for customers other than for, in effect, professional 
traders such as broker-dealers, future commission merchants, floor 
brokers, or floor traders trading securities, futures, or commodity 
options; or (2) earns at least $10 million in gross revenues on an 
annual basis from transactions in securities, futures, or commodity 
options other than from professional traders; or (3) earns at least 
10 percent of its gross revenues on an annual basis from 
transactions in securities, futures, or commodity options other than 
from professional traders. 17 CFR 240.401(a)(9) and 17 CFR 
41.43(a)(9).
    \18\ 17 CFR 240.17d-1.
    \19\ See Proposed NQLX Rule 334(a)(2)(v).
---------------------------------------------------------------------------

    Consistent with the SEC/CFTC Margin Regulations, NQLX also proposes 
adding a sentence in its customer margin rule that would establish a 
minimum margin rate of at least 20 percent as the initial and 
maintenance margin for both a long and short position in a Security 
Futures Contract, except when specified offsets are allowed pursuant to 
proposed NQLX Rule 334(g)(2).\20\ NQLX further proposes adding 
subsection (g) to NQLX Rule 334, which would provide that NQLX members 
could not effect transactions for a customer in, or carry a customer 
account with, Security Futures Contracts without complying with the 
SEC/CFTC Margin Regulations as well as all other provisions of NQLX's 
customer margin rule to the extent they are not inconsistent with the 
SEC/CFTC Margin Regulations.\21\
    Consistent with the SEC/CFTC Margin Regulations, NQLX then proposes 
that subsection (g)(2) to NQLX Rule 334 would allow reduction of the 
minimum margin rate established in proposed NQLX Rule 334(b)(1) for 
specified strategy-based offsets for Security Futures Contracts held by 
customers. Because NQLX's customer margin rule, as proposed, would only 
apply to Security Futures Contracts held by customers in futures 
accounts, only four strategy-based offsets--of the eighteen offsets 
described in the SEC/CFTC joint release on the SEC/CFTC Margin 
Regulations--can apply.\22\ For strategy-

[[Page 61365]]

based offsets for Security Futures Contracts held in securities 
accounts, NQLX's members would need to apply the offsets adopted by the 
particular member's DEA. Described briefly below are the four offsets 
that NQLX proposes as part of NQLX Rule 334(g)(2).
---------------------------------------------------------------------------

    \20\ See Proposed NQLX Rule 334(b)(1).
    \21\ See Proposed NQLX Rule 334(g)(1).
    \22\ See Securities Exchange Act Release No. 46292 (August 1, 
2002), 67 FR 53146 (August 14, 2002); see also Rule 403(b)(2) under 
the Act, 17 CFR 243.403(b)(2); and CFTC Rule 41.45(b)(2), 17 CFR 
41.45(b)(2).
---------------------------------------------------------------------------

    (1) The proposed first offset would be allowed for a calendar or 
inter-month spread. As proposed, for a long Security Futures Contract 
and a corresponding short Security Futures Contract on the same 
underlying individual stock \23\ or narrow-based index, both the 
initial margin and the maintenance margin would be the greater of 5% of 
the current market value of the long Security Futures Contract or 5% of 
the current market value of the short Security Futures Contract.
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    \23\ Because the Commission and CFTC have jointly held that 
American Depository Receipts, shares of exchange-traded funds, 
shares of closed-end funds, and trust-issued receipts can serve as 
the underlying for security futures contracts, for purposes of the 
offsets in the table that is proposed by NQLX Rule 334(g), 
``individual stock'' includes American Depository Receipts, shares 
of exchange-traded funds, shares of closed-end funds, and trust-
issued receipts. Proposed NQLX Rule 334(g), footnote 4 to offset 
table; see also Joint Order Granting the Modification of Listing 
Standards Requirements (ADRs), Securities Exchange Act Release No. 
44725 (August 20, 2001), and Joint Order Granting the Modification 
of Listing Standards Requirements (ETFs, TIRs and Closed-End Funds), 
Securities Exchange Act Release No. 46090 (June 19, 2002), 67 FR 
42760 (June 25, 2002).
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    (2) The proposed second offset would be allowed for an inter-index 
spread, which is subject to basis risk. As proposed, for a long (short) 
basket of Security Futures Contracts (each of which is based on a 
narrow-based security index that together tracks a broad-based index) 
held in combination with a short (long) of the applicable broad-based 
index, both the initial and the maintenance margin are proposed to be 
5% of the current market value of the long (short) basket of Security 
Futures Contracts.
    (3) The proposed third offset would be allowed for an index 
replication spread, which is subject to basis risk defined by the 
index's weighting scheme. As proposed, for a long (short) basket of 
Security Futures Contracts on individual stocks or narrow-based 
security index that together tracks a narrow-based index held in 
combination for a short (long) group of Security Futures Contracts held 
in combination with a short (long) narrow-based index, both the initial 
and the maintenance margin is proposed to be the greater of (a) 5% of 
the current market value of the long Security Futures Contracts or (b) 
5% of the current market value of the short Security Futures Contracts.
    (4) The proposed fourth offset would be allowed for inter-exchange 
spreads. As proposed, for a long (short) Security Futures Contract on 
either an individual stock or a narrow-based index held in combination 
with an identical (short) long security futures position listed by a 
different exchange (i.e., a Non-NQLX security futures contract), both 
the initial and maintenance margin level would be the greater of (a) 3% 
of the current market value of the long security futures position or 
(b) 3% of the current market value of the short security futures 
position.
    Finally, for purposes of implementing the exemption from NQLX's 
customer margin rules provided by proposed NQLX Rule 334(a)(2)(iv) for 
``Security Futures Dealers,'' NQLX proposes defining a ``Security 
Futures Dealer'' as a market maker \24\ designated by NQLX as a 
Security Futures Dealer that meets the requirements of NQLX Rules 
403(d) and Rule 403(e). Proposed NQLX Rule 403(d) would then require a 
Security Futures Dealer to meet all the following requirements: ``(1) 
Is a Member; (2) is registered as a floor trader or floor broker with 
the CFTC under section 4f(a)(1) of the CEA or as a dealer with the SEC 
under section 15(b) of the Securities Exchange Act; (3) holds itself 
out as being willing to buy and sell Security Futures Contracts for its 
own account on a regular or continuous basis and enters into a written 
agreement that must meet, at a minimum, the requirements of NQLX Rule 
403(e); (4) maintains records sufficient to prove compliance with the 
requirements of NQLX Rule 403(d) and NQLX Rule 403(e), including, but 
not limited to, documents concerning personnel effecting relevant 
Orders, relevant trade and cash blotters, relevant stock records, and 
documents concerning applicable internal system capacity and 
performance; and (5) is subject to disciplinary action under Chapter 5 
of these Rules for failing to comply with CFTC Rules 41.42 through and 
including 41.48 and Rules 400 through and including 406 of the 
Securities Exchange Act, with sanctions up to and including removal of 
the Member's designation as a Security Futures Dealer.''
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    \24\ NQLX's rules define a ``Market Maker'' as ``any Member or 
other Person that enters into a written agreement with NQLX to 
facilitate liquidity and orderliness for a specified Exchange 
Contract or Groups of Exchange Contracts pursuant Rule 403.'' See 
NQLX Rule 101(a)(48).
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    In turn, NQLX proposes adding NQLX Rule 403(e), which would require 
a Security Futures Dealer to meet, at least, specified affirmative 
minimum two-sided quotation requirements, including requirements 
related to maximum bid/ask spreads and minimum contract sizes in the 
front-two delivery months of a Security Futures Contract, as well as 
requirements when responding to requests for quotation in delivery 
months other than the first two delivery months. \25\ Pursuant to 
proposed Rule 403(d)(3), NQLX would enter into a written agreement with 
each market maker designated as a Security Futures Dealer. Then, the 
requirements of proposed Rule 403(e)(1) or the requirements of proposed 
Rule 403(e)(2) would specify the minimum affirmative quotation 
obligations that must be part of a written agreement between NQLX and a 
market maker that is designated as a Security Futures Dealer.
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    \25\ See Securities Exchange Act Release No. 46292 (August 1, 
2002), 67 FR 53146 (August14, 2002).
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    For example, proposed NQLX Rule 403(e)(1) would impose three 
minimum requirements on the Security Futures Dealer. First, the 
Security Futures Dealer would have to provide continuous two-sided 
quotations for the first two delivery months of a specified Security 
Futures Contract throughout the trading day, subject to relaxation 
during unusual market conditions as determined by NQLX.\26\ Second, the 
Security Futures Dealer would have to quote, for the first two delivery 
months, with (a) a maximum bid/ask spread of no more than the greater 
of $.10 or 150 percent of the bid/ask spread in the primary market for 
the security underlying the Security Futures Contract and (b) a minimum 
number of contracts no less than the lesser of 10 contracts or the 
corresponding contractual size equivalent of the best bid and best 
offer for the security underlying the Security Futures Contract.\27\ 
Finally, the Security Futures Dealer would have to respond to requests 
for quotation in the specified Security Futures Contract within 5 
seconds for all delivery months other than the first two delivery 
months with a two-sided quotation that has (a) a maximum bid/ask spread 
of no more than the greater of $0.20 or 150 percent of the bid/ask 
spread in the primary market for the security underlying the Security 
Futures Contract and (b) a minimum number of contracts no less than the 
lesser of 5 contracts or the corresponding contractual size equivalent 
of the best bid and best offer

[[Page 61366]]

for the security underlying the Security Futures Contract.\28\
    In the alternative, proposed NQLX Rule 403(e)(2) would impose two 
minimum requirements on the Security Futures Dealer. First, the 
Security Futures Dealer would have to respond to requests for quotation 
in a specified Security Futures Contract in specified delivery months 
other than the first two delivery months with two-sided quotations 
throughout the trading day.\29\ Second, the Security Futures Dealer 
would have to quote, when responding to requests for quotation, within 
5 seconds (a) with a maximum bid/ask spread of no more than the greater 
of $0.20 or 150 percent of the bid/ask spread in the primary market for 
the security underlying the Security Futures Contract and (b) a minimum 
number of contracts no less than the lesser of 5 contracts or the 
corresponding contractual size equivalent of the best bid and best 
offer for the security underlying the Security Futures.\30\
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    \26\ See Proposed NQLX Rule 403(e)(1)(i).
    \27\ See Proposed NQLX Rule 403(e)(1)(ii).
    \28\ See Proposed NQLX Rule 403(e)(1)(iii).
    \29\ See Proposed NQLX Rule 403(e)(2)(i).
    \30\ See Proposed NQLX Rule 403(e)(2)(ii).
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    While proposed NQLX Rule 403(e)(1) and proposed NQLX Rule 403(e)(2) 
both would provide the minimum requirements imposed on market makers 
designated as Security Futures Dealers, NQLX and the particular 
Security Futures Dealer would be free to enter into written agreements 
with more rigorous affirmative obligations (e.g., more narrow maximum 
bid/ask spreads as well as larger minimum contract sizes). Subject to 
the requirements of proposed NQLX Rule 403(e)(1) or the requirements of 
proposed NQLX Rule 403(e)(2), the specific rights and obligations of 
Security Futures Dealers on NQLX will be a function of NQLX's market 
structure, which combines an anonymous central order book with a 
market-marker program to provide continuous liquidity and market depth.
    On NQLX, no Security Futures Dealer will have an exclusive 
franchise in any group or specified Security Futures Contracts. 
Instead, NQLX expects to have multiple Security Futures Dealers in each 
Security Futures Contract that will compete with one another (and other 
market participants) for orders and get rewarded with fills by equaling 
or bettering the central order book's best bid or offer. Each Security 
Futures Dealer will have to meet its own specific, affirmative 
contractual obligations, which cannot be less rigorous than those 
specified by proposed NQLX Rule 403(e)(1) or proposed NQLX Rule 
403(e)(2). In return for and commensurate with those obligations, the 
Security Futures Dealer will receive various benefits, which may 
include the ability to interact with customer orders pursuant to NQLX 
Rule 418, the ability to participate in a portion of block trades 
pursuant to NQLX Rule 419, fee rebates, and additional bandwidth 
allocations.
    NQLX will monitor the performance of its Security Futures Dealers 
and may take a number of actions up to and including termination of the 
contract of any Security Futures Dealer that fails to sufficiently 
discharge its contractual obligations. In addition, a Security Futures 
Dealer will be subject to disciplinary action under NQLX's Rules for 
failing to comply with the criteria established in proposed NQLX Rule 
403(d) as well as NQLX Rule 403(e), with sanctions up to and including 
removal of the member's designation as a Security Futures Dealer.\31\
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    \31\ Proposed NQLX Rule 403(d)(5); see also NQLX Rule 514 
(Sanction imposed in disciplinary proceedings can include 
``limitation on activities, functions, or operations, including, but 
not limited to, removal of designation as a Security Futures 
Dealer.'')
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2. Statutory Basis
    NQLX believes that these proposed rules are necessary to implement 
the requirements of the CFMA and to establish customer margin rules 
that: (1) Preserve the financial integrity of markets trading security 
futures products, (2) prevent systemic risk, (3) are consistent with 
the margin requirements for comparable exchange-traded options and 
require initial and maintenance margin levels no lower than the lowest 
level of margin, exclusive of premium, required for comparable 
exchange-traded options, and (4) are and will remain consistent with 
the margin requirements established by the Federal Reserve Board under 
regulation T. NQLX believes that its proposed rules and rule amendments 
comply with Sections 6(h)(3)(L) \32\ and 7(c)(2)(B) \33\ of the Act as 
well as the SEC/CFTC Margin Regulations.
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    \32\ 15 U.S.C. 78f(h)(3)(L).
    \33\ 15 U.S.C. 78g(c)(2)(B).
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B. Self-Regulatory Organization's Statement on Burden on Competition

    NQLX does not believe that these proposed rules and rule amendments 
will result in any burden on competition that is not necessary or 
appropriate in furtherance of the Act.

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

    NQLX neither solicited nor received written comments on these 
proposed rules or rule amendments.

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

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

IV. Solicitation of Comments

    Interested persons are invited to submit written data, views, and 
arguments concerning the foregoing, including whether the proposed rule 
change, as amended, is consistent with the Act. Persons making written 
submissions should file six copies thereof with the Secretary, 
Securities and Exchange Commission, 450 Fifth Street, NW, Washington, 
DC 20549-0609. Copies of the submission, all subsequent amendments, all 
written statements with respect to the proposed rule change, as 
amended, that are filed with the Commission, and all written 
communications relating to the proposed rule change between the 
Commission and any person, other than those that may be withheld from 
the public in accordance with the provisions of 5 U.S.C. 552, will be 
available for inspection and copying in the Commission's Public 
Reference Room. Copies of the filing will also be available for 
inspection and copying at the principal offices of the Exchange. All 
submissions should refer to File No. SR-NQLX-2002-01 and should be 
submitted by insert date 21 days from the date of publication.

    For the Commission, by the Division of Market Regulation, 
pursuant to delegated authority.\34\
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    \34\ 17 CFR 200.30-3(a)(12).
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Margaret H. McFarland,
Deputy Secretary.
[FR Doc. 02-24745 Filed 9-27-02; 8:45 am]
BILLING CODE 8010-01-P