[Federal Register Volume 67, Number 218 (Tuesday, November 12, 2002)]
[Notices]
[Pages 68710-68713]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 02-28606]


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SECURITIES AND EXCHANGE COMMISSION

[Release No. 34-46771; File No. SR-NQLX-2002-01]


Self-Regulatory Organizations; Order Approving and Notice of 
Filing and Order Granting Accelerated Approval of Amendment No. 1 to 
the Proposed Rule Change, by Nasdaq Liffe Markets, LLC Relating to 
Margin Rules for Security Futures

November 5, 2002.
    On September 24, 2002, the Nasdaq Liffe Markets, LLC (``NQLX'') 
submitted to the Securities and Exchange Commission (``SEC'' or 
``Commission''), pursuant to section 19(b)(1) of the Securities 
Exchange Act of 1934 (``Act'') \1\ and Rule 19b-4 thereunder,\2\ a 
proposed rule change relating to margin rules for security futures 
products other than options on security futures. The proposed rule 
change was published for comment in the Federal Register on September 
30, 2002.\3\ The Commission received three comment letters on the 
proposed rule change.\4\ In addition, NQLX submitted a letter in 
response to the commenters.\5\ On November 4, 2002, NQLX filed an 
amendment to the proposed rule change.\6\ This order approves the 
proposed rule change, accelerates approval of Amendment No. 1, and 
solicits comments from interested persons on Amendment No. 1.
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    \1\ 15 U.S.C. 78s(b)(1).
    \2\ 17 CFR 240.19b-4.
    \3\ Securities Exchange Act Release No. 46548 (September 25, 
2002), 67 FR 61361 (SR-NQLX-2002-01).
    \4\ See letters to Jonathan Katz, Secretary, Commission, from: 
John P. Davidson, Managing Director, Morgan Stanley & Co. Inc., and 
Mitchell J. Lieberman, Managing Director, Goldman, Sachs & Co., 
dated October 23, 2002 (``Morgan/Goldman Letter''); Michael J. Ryan, 
Jr., Executive Vice President and General Counsel, American Stock 
Exchange LLC, dated October 23, 2002 (``Amex Letter''); and Michael 
R. Schaefer, Managing Director, Salomon Smith Barney, dated October 
25, 2002 (''SSB Letter'').
    \5\ Letter from Kathleen M. Hamm, Senior Vice President, 
Regulation and Compliance, NQLX, to Jonathan G. Katz, Secretary, 
Commission, dated October 30, 2002 (``NQLX Letter'').
    \6\ See letter from Kathleen M. Hamm, Senior Vice President of 
Regulation and Compliance, NQLX, to Theodore R. Lazo, Senior Special 
Counsel, Division of Market Regulation, Commission, dated November 
1, 2002 (``Amendment No. 1''). Amendment No. 1 amends proposed Rule 
403(e)(1) to provide that a security futures dealer must fulfill its 
market maker obligation in security futures contacts representing at 
least 20 percent of the total volume in all security futures 
contracts traded on NQLX for the preceding calendar quarter. In 
addition, Amendment No. 1 amends proposed Rule 403(e)(2) to provide 
that a security futures dealer must fulfill its market maker 
obligation in security futures contacts representing at least 75 
percent of the total trading in security futures contracts on NQLX 
for the preceding calendar quarter.
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I. Description of the Proposed Rule Change

Introduction

    On August 1, 2002, the Commodity Futures Trading Commission 
(``CFTC'') and SEC (collectively, the ``Commissions'') jointly adopted 
customer margin requirements for security futures.\7\ Under the 
Commissions' ``account specific'' approach, the Commissions' margin 
rules apply certain core requirements to all security futures, and 
direct that the more specific requirements depend on the type of 
account in which the security futures are held (i.e., a futures account 
or securities account).
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    \7\ Securities Exchange Act Release No. 46292, 67 FR 53146 
(August 14, 2002).
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Proposal

    The proposed rule change sets forth margin requirements for 
security futures traded on NQLX that are held in futures accounts. 
Specifically, the proposed rule change sets the minimum initial and 
maintenance customer margin rates for such security futures contracts 
and provides for lower margin levels for permitted strategy-based 
offset positions. The proposed rules exclude certain financial 
relations to which the Commissions' margin rules do not apply. In 
addition, the proposed rules do not apply to security futures held in a 
securities account. The proposed rule change also establishes standards 
under which members may qualify as Security Futures Dealers and 
therefore be excluded from NQLX's margin rules.

Margin Levels

    The Commissions' margin rules require that customers deposit in 
their accounts minimum margin of 20 percent of the current market value 
of security futures.\8\ In addition, the Commissions' rules permit 
national securities exchanges to set margin levels below 20 percent of 
the current market value of security futures for certain offsetting 
positions in security futures and other securities or futures.
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    \8\ Rule 403(b)(1) under the Act and Rule 41.45(b)(1) under the 
Commodity Exchange Act (``CEA'') 17 CFR 240.403(b)(1) and 17 CFR 
41.45(b)(1).
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    The proposed rule change establishes a minimum margin rate of 20 
percent for both long and short positions in security futures, except 
with respect to specified, permitted offsetting positions. Under the 
proposed rule change, NQLX permits reduced margin levels for specific 
offsetting positions held in futures accounts. Specifically, NQLX 
permits reduced margin levels for the following offsets:
    (1) For a long security future and a corresponding short security 
futures on the same underlying individual stock or narrow-based index, 
but with a different expiration month, both the initial margin and the 
maintenance margin are the greater of 5% of the current market value of 
the long security futures or 5% of the current market value of the 
short security futures.
    (2) For a long (short) basket of security futures (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) position of the 
applicable broad-based index future, both the initial and the 
maintenance margin are 5% of the

[[Page 68711]]

current market value of the long (short) basket of security futures.
    (3) For a long (short) basket of security futures that together 
tracks a narrow-based index future held in combination with a short 
(long) narrow-based index future, both the initial and the maintenance 
margin are the greater of (a) 5% of the current market value of the 
long security futures or (b) 5% of the current market value of the 
short security futures.
    (4) For a long (short) security future on either an individual 
stock or a narrow-based index held in combination with an identical 
short (long) security future listed by a different exchange, both the 
initial and maintenance margin level are 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.

Security Futures Dealers

    As noted above, the proposed rule change provides an exclusion from 
NQLX's margin rules for Security Futures Dealers. Under the proposed 
rule change, NQLX defines a ``Security Futures Dealer'' as a market 
maker \9\ designated by NQLX as a Security Futures Dealer that meets 
the requirements of NQLX Rules 403(d) and Rule 403(e). Rule 403(d) 
requires a Security Futures Dealer: (1) To be a member of NQLX; (2) to 
be 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 Act; (3) to hold itself out as being willing to buy and 
sell security futures for its own account on a regular or continuous 
basis and enters into a written agreement with NQLX that must meet, at 
a minimum, the requirements of NQLX Rule 403(e); (4) to maintain 
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) 
to be subject to disciplinary action under Chapter 5 of NQLX's Rules 
for failing to comply with CFTC Rules 41.42-41.48 and Rules 400-406 
under the Act, with sanctions up to and including removal of the 
member's designation as a Security Futures Dealer.
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    \9\ 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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    NQLX Rule 403(e) requires a Security Futures Dealer to meet one of 
two minimum affirmative trading obligations. Under the first 
alternative, an NQLX member is a Security Futures Dealer under Rule 
403(e)(1) if it satisfies the following requirements. First, the 
Security Futures Dealer must provide continuous two-sided quotations 
throughout the trading day, subject to relaxation during unusual market 
conditions as determined by NQLX,\10\ for the first two delivery months 
of Security Futures Contracts that in total account for at least 20% of 
the total volume in all Security Futures Contracts traded on NQLX. 
Second, the Security Futures Dealer must 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 future 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 future. Finally, the 
Security Futures Dealer must respond to requests for quotation in the 
specified security future 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 for the security underlying the security future.
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    \10\ NQLX has represented that it would only relax the 
affirmative obligations of a Security Futures Dealer during unusual 
market conditions such as a fast market in either the security 
futures or their underlying securities. See NQLX Letter, supra note 
5.
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    In the alternative, an NQLX member is a Security Futures Dealer 
under Rule 403(e)(2) if it satisfies the following requirements. First, 
the Security Futures Dealer must respond to all 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. Second, the Security Futures Dealer must 
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. Finally, 75% of 
the Security Futures Dealer's total trading in the preceding calendar 
quarter must be in Security Futures Contracts in which it fulfilled its 
obligations under this rule.
    While NQLX Rule 403(e)(1) and NQLX Rule 403(e)(2) both provide the 
minimum requirements imposed on market makers designated as Security 
Futures Dealers, NQLX and the particular Security Futures Dealer may 
enter into written agreements with more rigorous affirmative 
obligations (e.g., more narrow maximum bid/ask spreads as well as 
larger minimum contract sizes).

II. Summary of Comments

    As noted above, the Commission received three comment letters on 
the proposal,\11\ and NQLX submitted a letter in response to the 
commenters.\12\ Two commenters expressed the view that NQLX's proposed 
market maker exclusion would encourage imprudent risk taking, 
speculation, and leverage because there would be no net capital 
requirements imposed either on a floor broker that qualifies for the 
market maker exclusion or on its carrying broker-dealer or FCM.\13\ In 
addition, those commenters maintained that the proposed rule change is 
not consistent with the margin requirements for comparable options 
contracts and, therefore, would create competitive disparities between 
security futures and exchange-traded options.
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    \11\ Morgan/Goldman Letter, Amex Letter, and SSB Letter, supra 
note 4. The SSB Letter stated that it agreed generally with the 
comments expressed in the Morgan/Goldman Letter.
    \12\ NQLX Letter, supra note 5.
    \13\ Morgan/Goldman Letter and SSB Letter, supra note 4.
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    The other commenter expressed concern with NQLX's second 
alternative for satisfying the definition of a security futures 
dealer.\14\ Specifically, the commenter maintained that the lack of a 
two-sided continuous quote commitment for all expiration or delivery 
months of a security futures contract, along with the ability to only 
quote farther term expiration or delivery month contracts, rendered the 
test in proposed NQLX Rule 403(e)(2) inconsistent with the obligations 
of a bona fide market maker. In addition, the commenter argued that the 
market

[[Page 68712]]

maker test under proposed NQLX Rule 403(e)(2) is not consistent with 
the current standard for receiving market maker margin treatment for 
exchange-traded options because it does not oblige market makers to 
make continuous markets in security futures.
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    \14\ Amex Letter, supra note 4.
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    In response to the Morgan/Goldman letter, NQLX stated that it has 
minimum capital requirements for all of its members, including all 
market makers designated as security futures dealers. NQLX noted that 
its rules require its members that are registered with the SEC as 
broker-dealers or with CFTC as futures commission merchants or 
introducing brokers to meet and maintain the minimum capital 
requirements of their respective regulators. Further, NQLX stated that 
for all other members, its rules require minimum net worth of not less 
than $250,000 and immediate notification to NQLX when one of those 
member's net worth declines below $300,000. NQLX maintained that its 
minimum net worth requirements as well as its ``early warning'' capital 
levels adequately address the concerns of potential systemic credit 
risk raised by the Morgan/Goldman letter.
    In response to the Amex Letter, NQLX stated that Rule 403(e)(2) 
places affirmative obligations on security futures dealers to respond 
``virtually instantaneously'' to all requests for quotation throughout 
the trading day in specified back-month contracts. NQLX maintained that 
this standard requires regular responses to quotations by the Security 
Futures Dealer. In addition, NQLX expressed the view that by complying 
with Rule 403(e)(2), Security Futures Dealers expose their capital in 
order to provide liquidity and depth for the benefit of all market 
participants.

III. Discussion

    Under Section 19(b)(2) of the Act, the Commission is directed to 
approve the proposed rule change if it finds that it is consistent with 
the requirements of the Act and the rules and the rules and regulations 
thereunder applicable to a national securities exchange.\15\ Section 
6(b)(5) of the Act \16\ requires, among other things, that the rules of 
a national securities exchange be designed to promote just and 
equitable principles of trade and, in general, to protect investors and 
the public interest.\17\ In addition, section 7(c)(2)(B) of the Act 
\18\ provides, among other things, that the margin rules for security 
futures must preserve the financial integrity of markets trading 
security futures, prevent systemic risk, and be consistent with the 
margin requirements for comparable exchange-traded options. Section 
7(c)(2)(B) also provides that the margin levels for security futures 
may be no lower than the lowest level of margin, exclusive of premium, 
required for any comparable exchange-traded option. For the reasons 
discussed below, after careful review and consideration of the 
commenters' views the Commission finds that the rule change is 
consistent with NQLX's obligations under the Act and the rules and 
regulations thereunder.
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    \15\ 15 U.S.C. 78s(b)(2).
    \16\ 15 U.S.C. 78f(b)(5), 78o-3(b)(6), and 78o-4(b)(2)(C).
    \17\ In approving this rule change, the Commission has 
considered its impact on efficiency, competition, and capital 
formation. 15 U.S.C. 78o-3(b)(9).
    \18\ 15 U.S.C. 78g(c)(2)(B).
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    The Commission believes that the rule change is generally 
consistent with the customer margin rules for security futures adopted 
by the Commission and the CFTC. In particular, the Commission notes 
that, consistent with Rule 403 under the Act, NQLX's proposed rule 
provides for a minimum margin level of 20% of current market value for 
all positions in security futures. The Commission believes that 20% is 
the minimum margin level necessary to satisfy the requirements of 
section 7(c)(2)(B) of the Act. Rule 403 under the Act \19\ also 
provides that a national securities exchange may set margin levels 
lower than 20% of the current market value of the security future for 
an offsetting position involving security futures and related 
positions, provided that an exchange's margin levels for offsetting 
positions meet the criteria set forth in section 7(c)(2)(B) of the Act. 
The offsets proposed by NQLX are consistent with the strategy-based 
offsets permitted for comparable offset positions involving exchange-
traded options and therefore consistent with section 7(c)(2)(B) of the 
Act.
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    \19\ 17 CFR 240.403(b)(2).
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    Finally, the Commission believes that the standards proposed by 
NQLX for Security Futures Dealers are consistent with the Act, and Rule 
400(c)(2)(v) thereunder.\20\ Specifically, the Commissions' margin 
rules do not apply to a member of a national securities exchange that 
is registered with such exchange as a ``security futures dealer'' 
pursuant to exchange rules that must meet several criteria, including a 
requirement that a security futures dealer be required ``to hold itself 
out as being willing to buy and sell security futures for its own 
account on a regular or continuous basis.'' The Commission believes 
that the affirmative obligations required by NQLX Rule 403(e) satisfy 
this requirement.
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    \20\ 17 CFR 200.400(c)(2)(v).
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IV. Accelerated Approval of Amendment No. 1

    The Commission finds good cause to approve Amendment No. 1 to the 
proposed rule change prior to the thirtieth day after the date of 
publication of notice in the Federal Register. In response to the 
commenters concerns, Amendment No. 1 adds two subsections to require 
Security Futures Dealers to satisfy their market making obligations in 
a meaningful number of contracts. Specifically, new paragraph 
(e)(1)(iv) of Rule 403 requires a Security Futures Dealer to fulfill 
its market making activities in one or more security futures contacts 
representing at least 20 percent of the total volume in all security 
futures contracts traded on NQLX for the preceding calendar quarter. 
Similarly, new paragraph (e)(2)(iii) of Rule 403 requires 75% of a 
Security Futures Dealer's total trading to be in security futures 
contacts in which it fulfills its market making obligations.
    Because the amendments are responsive to commenters concerns and 
further clarify the minimum requirements imposed on market makers 
designated as Security Futures Dealers, the Commission believes that 
there is good cause, consistent with Section 19(b) of the Act, to 
approve Amendment No. 1 to the proposed rule change, on an accelerated 
basis.

V. Solicitation of Comments

    Interested persons are invited to submit written data, views and 
arguments concerning the foregoing, including whether Amendment No. 1 
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 Exchange. All 
submissions should refer to File No. SR-NQLX-2002-01 and should be 
submitted by December 3, 2002.

[[Page 68713]]

VI. Conclusion

    It is therefore ordered, pursuant to section 19(b)(2) of the 
Act,\21\ that the proposed rule change (SR-NQLX-2002-01), as amended, 
is approved.
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    \21\ 15 U.S.C. 78s(b)(2).

    For the Commission, by the Division of Market Regulation, 
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pursuant to delegated authority.\22\

    \22\ 17 CFR 200.30-3(a)(12).
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Margaret H. McFarland,
Deputy Secretary.
[FR Doc. 02-28606 Filed 11-8-02; 8:45 am]
BILLING CODE 8010-01-P