[Federal Register Volume 68, Number 66 (Monday, April 7, 2003)]
[Notices]
[Pages 16849-16850]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 03-8387]



[[Page 16849]]

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SECURITIES AND EXCHANGE COMMISSION

[Release No. 34-47599; File No. SR-OCC-2002-04]


Self-Regulatory Organizations; The Options Clearing Corporation; 
Order Granting Approval of a Proposed Rule Change Relating to Money 
Market Funds as Margin Collateral

March 31, 2003.

I. Introduction

    On January 29, 2002, The Options Clearing Corporation (``OCC'') 
filed with the Securities and Exchange Commission (``Commission'') 
proposed rule change SR-OCC-2002-04 pursuant to section 19(b)(1) of the 
Securities Exchange Act of 1934 (``Act'').\1\ Notice of the proposal 
was published in the Federal Register on January 16, 2003.\2\ No 
comment letters were received. For the reasons discussed below, the 
Commission is granting approval of the proposed rule change.
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    \1\ 15 U.S.C. 78s(b)(1).
    \2\ Securities Exchange Act Release No. 47146 (January 9, 2003), 
68 FR 2385.
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II. Description

    The change to OCC's rule 604 expands the permissible forms of 
margin collateral to include shares in money market funds. The rule 
change also reorganizes the rule and makes certain nonsubstantive 
format changes.
    Rule 604 specifies the forms of collateral that may be deposited as 
margin. Permitted forms of margin collateral include cash, government 
securities, letters of credit, and certain equity and debt 
securities.\3\ OCC regularly reviews these forms of collateral for 
suitability with the intent of addressing clearing members' desire to 
use a diverse combination of readily available and cost-effective forms 
of collateral while ensuring that collateral is limited to instruments 
that are relatively stable in value and are easily converted to cash. 
OCC believes that shares in certain money market funds meet these 
criteria and that it is appropriate for OCC to expand its categories of 
acceptable collateral to include such instruments.
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    \3\ Pursuant to a rule filing approved by the Commission last 
year, OCC clearing members are allowed to deposit as margin debt 
securities issued by Congressionally chartered corporations that 
OCC's membership/margin committee has approved. Securities Exchange 
Act Release No. 45745 (April 12, 2002), 67 FR 19467 (April 19, 2002) 
(File No. SR-OCC-2001-04).
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    OCC believes that the professional asset management, liquidity, and 
stable principal value typically associated with money market funds 
make shares in such funds an attractive collateral alternative for all 
OCC clearing accounts. As a result of recent amendments to the 
regulations of the Commodity Futures Trading Commission (``CFTC''), 
clearing members that are registered as futures commission merchants 
are now permitted to invest customer funds of their futures customers 
in money market fund shares.\4\ Accordingly, clearing members want to 
be able to pledge shares in such funds as margin for their ``non-
proprietary'' cross-margining accounts. OCC believes that such deposits 
are appropriate collateral not only for cross-margining accounts but 
for all accounts.
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    \4\ In December 2000, the CFTC amended its Regulation 1.25 to 
expand the range of instruments in which FCMs and clearing 
organizations may invest customer segregated funds to include highly 
liquid instruments such as money market mutual funds. Rules Relating 
to Intermediaries of Commodity Interest Transactions, 65 FR 77993 
(December 13, 2000).
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Requirements for Eligibility of Funds

    OCC will define acceptable money market funds as those meeting the 
criteria of SEC rule 2a-7,\5\ ``Money Market Funds,'' under the 
Investment Company Act of 1940 (``ICA''),\6\ subject to certain 
additional criteria. The ICA sets the standards by which mutual funds 
and other investment vehicles operate, and rule 2a-7 thereunder 
requires a qualifying money market fund to meet certain portfolio 
maturity, quality, and diversification criteria. Instruments that may 
qualify as permitted investments for money market funds typically 
include U.S. Treasury securities, repurchase agreements, Federal agency 
securities, commercial paper, certificates of deposit, time deposits, 
corporate notes, asset-backed securities, and municipal securities. To 
minimize credit risk, OCC will accept only money market funds that 
limit their investments to ``first tier securities'' as defined in rule 
2a-7 under the ICA.\7\ Although certain types of instruments that 
qualify as first tier securities would not qualify to be pledged 
directly as margin collateral under rule 604,\8\ OCC believes that the 
rating requirements and maturity prerequisites combined with inherent 
diversification of the funds provides sufficient protection to warrant 
acceptance of shares of money market funds containing such instruments.
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    \5\ 17 CFR 270.2a-7.
    \6\ 15 U.S.C. 80a et seq.
    \7\ In general, a first tier security is a security with a 
remaining maturity of 397 calendar days or less that: (i) Has 
received a short-term rating from at least two nationally recognized 
statistical rating organizations in the highest short-term rating 
category for debt obligations; (ii) is unrated but is deemed to be 
of comparable quality to securities identified in (i) as determined 
by the fund's board of directors; (iii) is issued by a registered 
investment company that is itself a money market fund; or (iv) is a 
government security. 17 CFR 270.2a-7(a)(12).
    \8\ For example, OCC does not currently accept commercial paper, 
certificates of deposit, time deposits, corporate notes, asset-
backed securities, or municipal securities.
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    To ensure a diverse group of fund investors so that the actions of 
any one shareholder (e.g., redeeming a large interest in a fund) do not 
materially disrupt the ability of the fund to redeem shares in an 
orderly manner, rule 604(b)(3) will prohibit a clearing member from 
depositing as margin collateral any money market fund where a 
registered holder of the money market fund has an interest of 10% or 
more in the money market fund.
    In order for a fund's shares to be acceptable as margin collateral, 
the fund (and/or its sponsor, transfer agent, or other agent as 
appropriate) will be required to represent to OCC that it meets the 
foregoing requirements and to agree that it will continue to do so. In 
addition, OCC will require the fund to make certain other agreements 
intended to further ensure OCC's ability to convert fund shares 
promptly to cash if necessary.

Redemption

    While the ICA generally prohibits mutual funds from suspending the 
right of redemption, the ICA does allow funds to postpone the payment 
of redemption proceeds for up to seven days after the tender of fund 
shares to the fund or its agent. The ICA also allows for the suspension 
or postponement of redemption in certain emergency situations. In 
addition, while the intent of a money market fund is to redeem shares 
in cash, most issuers retain the right to redeem their shares in kind 
where the redeeming shareholder would receive portfolio securities 
rather than cash. Any such action would introduce liquidation risk as 
well as additional costs associated with the sale of such securities.
    Rule 604(b)(3)(i)(H) will require any fund accepted as margin 
collateral to waive its rights under the ICA to delay redemption or to 
redeem in kind. The fund will instead have to agree to redeem fund 
shares in cash no later than the business day following a redemption 
request by OCC with limited exceptions for unscheduled closings of 
Federal Reserve Banks or the New York Stock Exchange. These waivers of 
redemption restrictions along with the next day

[[Page 16850]]

payment requirement have been established to maintain adequate 
liquidity of margin collateral and are also intended to be consistent 
with the redemption conditions contained in CFTC rule 1.25.\9\
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    \9\ CFTC Regulation 1.25(c)(5), 65 FR 77993, 78010, 78011 (Dec. 
13, 2000); see also, 65 FR 82270 (Dec. 28, 2000). CFTC Interpretive 
Letter No. 01-31 (April 2, 2001) (Funds will be deemed in compliance 
with Regulation 1.25(c)(5) even though they provide for delayed 
redemption in specified emergency situations).
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Valuation

    OCC will require funds to perform a net asset value computation at 
least once per day with the dissemination of such computation to be 
made available to OCC no later than 9 a.m. central time the following 
day. Given the diversified nature of eligible fund investments as well 
as the investment duration limitations, a daily computation of net 
asset value appears reasonable. Nevertheless, OCC will apply a 2% 
haircut on the current market value of fund shares. The 2% haircut was 
selected for consistency with the treatment of similar assets under the 
net capital rule.\10\
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    \10\ 17 CFR 240.15c3-1(c)(2)(vi)(D)(1).
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OCC's Security Interest

    As in the case of other securities held as collateral, OCC will 
require that clearing members give OCC a first priority perfected 
security interest in deposited fund shares. Because shares in money 
market funds are typically not issued in certificated form, ownership 
is established by registration of the securities on the books of the 
fund or its transfer agent. OCC can ordinarily obtain a perfected 
security interest in fund shares registered in the name of a clearing 
member by execution of the fund's standard three-party agreement among 
OCC, the clearing member, and the fund or its transfer agent.
    In addition, to preclude a situation whereby a clearing member 
secures its obligations to OCC with collateral managed and within the 
control of that clearing member or a related party, an association 
restriction is included in rule 604(b)(3)(iii). This restriction is 
consistent with OCC rules regarding the deposit of government 
securities, debt or equity issues, or letters of credit as margin 
collateral.\11\ This standard may be waived if the issuing institution 
can demonstrate that an acceptable arrangement has been made for the 
control of underlying portfolio investments and for the processing of 
OCC redemption requests by a third party.
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    \11\ OCC rule 604, Interpretation and Policies .07 and .10.
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    OCC is also moving the provisions which require compliance with the 
Commission's rule 15c3-3 when applicable, formerly set forth in rule 
604(d)(2), have been moved so that these provisions apply not only to 
equity and debt securities but to all securities deposited as margin 
under rule 604(b). A sentence has been added to these provisions to 
require compliance with the CFTC's customer protection regime when 
securities are deposited with respect to futures accounts.
    OCC believes that the proposed rule change is consistent with the 
requirements of section 17A of the Securities Exchange Act of 1934, as 
amended, because it enhances the efficiency of the clearing system 
while still allowing OCC to safeguard securities and funds by 
permitting clearing members to collateralize their obligations to OCC 
with an additional form of highly liquid, stable value assets.

III. Discussion

    The Commission finds that the proposed rule change is consistent 
with the requirements of the Act and the rules and regulations 
thereunder and particularly with the requirements of section 
17A(b)(3)(F).\12\ Section 17A(b)(3)(F) requires that the rules of a 
clearing agency be designed to assure the safeguarding of securities 
and funds which are in the custody or control of the clearing agency or 
for which it is responsible. The Commission believes that OCC's rule 
change meets this requirement because while OCC clearing members will 
be able to deposit money market funds as margin collateral, OCC has 
established procedures with respect to the deposits of money market 
funds as margin collateral that should ensure that OCC will be able to 
safeguard the securities and funds that are within its custody or 
control or for which it is responsible.
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    \12\ 15 U.S.C. 78q-1(b)(3)(F).
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IV. Conclusion

    On the basis of the foregoing, the Commission finds that the 
proposed rule change is consistent with the requirements of the Act and 
in particular section 17A of the Act and the rules and regulations 
thereunder.
    It is therefore ordered, pursuant to section 19(b)(2) of the Act, 
that the proposed rule change (File No. SR-OCC-2002-04) be and hereby 
is approved.

    For the Commission by the Division of Market Regulation, 
pursuant to delegated authority.\13\
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    \13\ 17 CFR 200.30-3(a)(12).
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Margaret H. McFarland,
Deputy Secretary.
[FR Doc. 03-8387 Filed 4-4-03; 8:45 am]
BILLING CODE 8010-01-P