[Federal Register Volume 67, Number 195 (Tuesday, October 8, 2002)]
[Notices]
[Pages 62843-62844]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 02-25609]



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SECURITIES AND EXCHANGE COMMISSION

[Release No. 34-46576; File No. SR-NYSE-2002-19]


Self-Regulatory Organizations; Notice of Filing of Proposed Rule 
Change by the New York Stock Exchange, Inc. Relating to Customer 
Portfolio and Cross-Margining Requirements

October 1, 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 May 13, 2002, the New York Stock Exchange, Inc. (``NYSE'' or 
``Exchange'') filed with the Securities and Exchange Commission 
(``SEC'' or ``Commission'') the proposed rule change as described in 
Items I, II, and III below, which Items have been prepared by the 
Exchange. On August 21, 2002, the NYSE filed Amendment No. 1 to the 
proposed rule change.\3\ The Commission is publishing this notice to 
solicit comments on the proposed rule change, as amended, from 
interested persons.
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    \1\ 15 U.S.C. 78s(b)(1).
    \2\ 17 CFR 240.19b-4.
    \1\ See letter from Mary Yeager, Assistant Secretary, NYSE, to 
T.R. Lazo, Senior Special Counsel, Division of Market Regulation, 
Commission, dated August 20, 2002 (``Amendment No. 1''). In 
Amendment No. 1, the NYSE made technical corrections to its proosed 
rule language to eliminate any inconsistencies between its proposal 
and the Chicago Board Options Exchange, Inc.'s (``CBOE'') proposal 
pursuant to the rule 431 Committee's (``Committee'') 
recommendations. See Securities Exchange Act Release No. 45630 
(March 22, 2002), 67 FR 15263 (March 29, 2002) (File No. SR-CBOE-
2002-03) (``CBOE Proposal'').
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I. Self-Regulatory Organization's Statement of the Terms of Substance 
of the Proposed Rule Change

    The Exchange proposes to amend NYSE Rule 431 to permit self-
clearing members and member organizations to margin listed, broad-
based, market index options, index warrants and related exchange-traded 
funds according to a prescribed portfolio margin methodology relating 
to a portfolio margin account of a registered broker-dealer, any 
affiliate of a self-clearing member or member organization, certain 
qualified members of a national futures exchange, and any other person 
or entity that maintains account equity of at least $5 million.
    The Exchange further proposes to amend NYSE Rule 726 to require 
that a disclosure statement and written acknowledgement for use with 
the proposed portfolio margining and cross-margining changes be 
furnished to customers.
    The text of the proposed rule change is available at the Office of 
the Secretary, NYSE, at the Commission, and on the Commission's Web 
site.

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

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

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

1. Purpose
a. Background
    NYSE Rule 431 generally prescribes minimum maintenance margin 
requirements for customer accounts held at members and member 
organizations. In April 1996, the Exchange established the Committee to 
assess the adequacy of NYSE Rule 431 on an ongoing basis, review margin 
requirements, and make recommendations for change. A number of proposed 
amendments resulting from the Committee's recommendations have been 
approved by the Exchange's Board of Directors since the Committee was 
established. Similarly, the proposed amendments discussed below have 
been recommended by the Committee and have been adopted by the Exchange 
in this proposal, as amended.\4\ The Exchange represents that the 
proposed portfolio margin and cross-margin rules have been developed in 
conjunction with the CBOE, The Options Clearing Corporation, the 
American Stock Exchange, LLC, the Board of Trade of the City of 
Chicago, Inc., the Chicago Mercantile Exchange, Inc., and the National 
Association of Securities Dealers, Inc.
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    \4\ Many aspects of the proposed rule change are similar to the 
CBOE's proposed rule change to permit customer portfolio margining 
and cross-margining. See CBOE Proosal, supra note 3.
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b. Portfolio Margin
    The Exchange proposes to amend NYSE Rule 431 to expand the scope of 
its margin rule by providing a portfolio margin methodology for listed, 
broad-based market index options, index warrants and related exchange-
traded funds. The Exchange believes that the proposed amendments would 
allow clearing members and member organizations to extend to eligible 
customers portfolio margin methodology as an alternative to the current 
strategy-based margin requirements. The Exchange further believes that 
the proposed rule would also allow broad-based market index futures and 
options on such futures to be included in a portfolio margin account, 
thus providing a cross-margin capability. The Exchange proposes to 
introduce the amendments as a two-year pilot program that would be 
available on a voluntary basis to member organizations.
    Portfolio margining is a margin methodology that sets margin 
requirements for an account based on the greatest projected net loss of 
all positions in a product class or group as determined by the 
Commission-approved options pricing model using multiple pricing 
scenarios. These scenarios are designed to measure the theoretical loss 
of the positions given changes in both the underlying price and implied 
volatility inputs to the model. Accordingly, the margin required is 
based on the greatest loss that would be incurred in a portfolio if the 
value of its components move up or down by a predetermined amount.
    The Exchange represents that the purpose and benefit of portfolio 
margining is to efficiently set levels of margin that more precisely 
reflect actual net risk of all positions in the account. A customer 
benefits from portfolio margining in that margin requirements 
calculated on net position risk are generally lower than strategy-based 
margin methodologies currently in place. In permitting margin 
computation based on actual net risk, members and member organizations 
will no longer be required to compute margin requirement for each 
individual position or strategy in a customer's account.
    However, as a pre-condition to permitting portfolio margining, the 
member or member organization would be required to establish procedures 
and guidelines to monitor credit risk to the member or member 
organization's capital, including intra-day credit risk, and stress 
testing of portfolio margin accounts. Further, members and member 
organizations would have to establish procedures for regular review and 
testing of these required risk analysis procedures.

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c. Cross-Margining Capability
    In addition, the proposed rule change permits a clearing member or 
member organization to establish a separate portfolio margin account 
(securities margin account) exclusively for cross-margining. In this 
regard, related index futures and options on such futures would be 
allowed to be carried in the portfolio margin account, thus affording a 
cross-margin capability. In a portfolio margin account that is used 
exclusively for cross-margining, separate portfolios may be established 
containing index options, index warrants and exchange-traded funds 
structured to replicate the composition of the index underlying a 
particular portfolio, as well as related index futures and options on 
such futures.
    To determine theoretical gains and losses, and resulting margin 
requirements, the same portfolio margin computation procedure will be 
applied to portfolio margin accounts that contain a cross-margin 
element.
d. Disclosure Document and Customer Attestation
    Exchange Rule 726 prescribes requirements for the delivery of 
options disclosure documents concerning the opening of customer 
accounts. As proposed by the Exchange, members and member organizations 
would be required to provide every portfolio margin customer with a 
written risk disclosure statement at or prior to the initial opening of 
a portfolio margin account. The disclosure statement is divided into 
two sections, one dealing with portfolio margining, and the other with 
cross-margining.
    The statement would disclose the risk and operation of portfolio 
margin accounts, including cross-margining, and the differences between 
portfolio margin and strategy-based margin requirements. The disclosure 
statement would also address who is eligible to open a portfolio margin 
account, the instruments that are allowed, and when deposits to meet 
margin and minimum equity are required.
    Included within the portfolio margin section of the disclosure 
statement would be a list of certain of the risks unique to portfolio 
margin accounts, such as: increased leverage; shorter time for meeting 
margin; involuntary liquidation if margin not received; inability to 
calculate future margin requirements because of the data and 
calculations required; and that long positions are subject to a lien. 
The risks and operation of a cross-margin feature are delineated in the 
cross-margin section of the disclosure statement, and a list of certain 
of the risks associated with cross-margining will be included as well.
    In addition, at or prior to the time a portfolio margin account is 
initially opened, members and member organizations would be required to 
obtain a signed acknowledgement regarding certain implications of 
portfolio margining (e.g., treatment under SEC Rules 8c-1, 15c2-1 and 
15c3-3 under the Act) from the customer. Further, prior to providing 
cross-margining, members and member organizations would be required to 
obtain a second signed customer acknowledgement relative to the 
segregation treatment for futures contracts and Securities Investor 
Protection Corporation coverage.
2. Statutory Basis
    The Exchange believes the proposed rule change, as amended, is 
consistent with section 6(b) of the Act \5\ in general, and furthers 
the objectives of section 6(b)(5) of the Act \6\ in particular, because 
it is designed to prevent fraudulent and manipulative acts and 
practices, to promote just and equitable principles of trade, to remove 
impediments to and perfect the mechanism of a free and open market and 
a national market system, and, in general, to protect investor and the 
public interest. In addition, the Exchange believes that section 
6(b)(5) of the Act \7\ requires that the rules of an exchange foster 
cooperation and coordination with persons engaged in regulating 
transactions in securities.
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    \5\ 15 U.S.C. 78f(b).
    \6\ 15 U.S.C. 78f(b)(5).
    \7\ 15 U.S.C. 78f(b)(5).
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B. Self-Regulatory Organization's Statement on Burden on Competition

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

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

    The Exchange has neither solicited nor received written comments on 
the proposed rule change, as amended.

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 that are 
filed with the Commission, and all written communications relating to 
the proposed rule change between the Commission and any person, other 
than those that may be withheld from the public in accordance with the 
provisions of 5 U.S.C. 552, will be available for inspection and 
copying in the Commission's Public Reference Room. Copies of such 
filing will also be available for inspection and copying at the 
principal office of the NYSE. All submissions should refer to File No. 
SR-NYSE-2002-19 and should be submitted by October 21, 2002.

    For the Commission by the Division of Market Regulation, 
pursuant to delegated authority.\8\
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    \8\ 17 CFR 200.30-2(a)(12).
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Margaret H. McFarland,
Deputy Secretary.
[FR Doc. 02-25609 Filed 10-7-02; 8:45 am]
BILLING CODE 8010-01-P