[Federal Register Volume 70, Number 139 (Thursday, July 21, 2005)]
[Notices]
[Pages 42118-42122]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: E5-3870]
-----------------------------------------------------------------------
SECURITIES AND EXCHANGE COMMISSION
[Release No. 34-52032; File No. SR-CBOE-2002-03]
Self-Regulatory Organizations; Chicago Board Options Exchange,
Incorporated; Order Approving a Proposed Rule Change and Amendment Nos.
1 and 2 Thereto Relating to Customer Portfolio and Cross-Margining
Requirements
July 14, 2005.
I. Introduction
On January 15, 2002, the Chicago Board Options Exchange,
Incorporated (``CBOE'' or ``Exchange'') filed with the Securities and
Exchange Commission (``Commission''), pursuant to Section 19(b)(1) of
the Securities Exchange Act of 1934 (``Act'') \1\ and Rule 19b- 4\2\
thereunder, a proposed rule change seeking to amend its rules, for
certain customer accounts, to allow member organizations to margin
listed, broad-based, market index options, index warrants, futures,
futures options and related exchange-traded funds according to a
portfolio margin methodology. The CBOE seeks to introduce the proposed
rule as a two-year pilot program that would be made available to member
organizations on a voluntary basis.
---------------------------------------------------------------------------
\1\ 15 U.S.C. 78s(b)(1).
\2\ 17 CFR 240.19b-4.
---------------------------------------------------------------------------
The proposed rule change was published in the Federal Register on
March 29, 2002.\3\ The Commission received two comment letters in
response to the March 29, 2002 Federal Register notice.\4\ On April 2,
2004, the Exchange filed Amendment No. 1 to the proposed rule
change.\5\ The proposed rule change and Amendment No. 1 were published
in the Federal Register on December 27, 2004.\6\ The Commission
received eleven comment letters in response to the December 27, 2004
Federal Register notice.\7\
---------------------------------------------------------------------------
\3\ See Securities Exchange Act Release No. 45630 (March 22,
2002), 67 FR 15263 (March 29, 2002).
\4\ See letter from Carl E. Vander Wilt, Federal Reserve Bank of
Chicago, to Jonathan G. Katz, Secretary, Commission, dated July 18,
2002 (``Vander Wilt Letter''); and e-mail from Mike Ianni, Private
Investor to [email protected], dated November 7, 2002 (``Ianni
E-mail'').
\5\ See letter from Richard Lewandowski, Vice President,
Division of Regulatory Services, CBOE, to Michael A. Macchiaroli,
Associate Director, Division of Market Regulation (``Division''),
Commission, dated April 1, 2004 (``Amendment No. 1''). The CBOE
proposed Amendment No. 1 to make corrections or clarifications to
the proposed rule, or to reconcile differences between the proposed
rule and a parallel filing by the NYSE. See Securities Exchange Act
Release No. 46576 (October 1, 2002), 67 FR 62843 (October 8, 2002)
(File No. SR-NYSE-2002-19).
\6\ See Securities Exchange Act Release No. 50886 (December 20,
2004), 69 FR 77275 (December 27, 2004); see also Securities Exchange
Act Release No. 50885 (December 20, 2004), 69 FR 77287 (December 27,
2004).
\7\ See letter from Anthony J. Saliba, President, LiquidPoint,
LLC, to Jonathan G. Katz, Secretary, Commission, dated January 21,
2005 (``Saliba Letter''); letter from Barbara Wierzynski, Executive
Vice President and General Counsel, Futures Industry Association
(``FIA''), and Gerard J. Quinn, Vice President and Associate General
Counsel, Securities Industry Association (``SIA''), to Jonathan G.
Katz, Secretary, Commission, dated January 14, 2005 (``Wierzynski/
Quinn Letter''); letter from Craig S. Donohue, Chief Executive
Officer, Chicago Mercantile Exchange, to Jonathan G. Katz,
Secretary, Commission, dated January 18, 2005 (``Donohue Letter'');
letter from Robert C. Sheehan, Chairman, Electronic Brokerages
Systems, LLC, to Jonathan G. Katz, Secretary, Commission, dated
January 19, 2005 (``Sheehan Letter''); letter from William O.
Melvin, Jr., President, Acorn Derivatives Management, to Jonathan G.
Katz, Secretary, Commission, dated January 19, 2005 (``Melvin
Letter''); letter from Margaret Wiermanski, Chief Operating &
Compliance Officer, Chicago Trading Company, to Jonathan G. Katz,
Secretary, Commission, dated January 20, 2005 (``Wiermanski
Letter''); e-mail from Jeffrey T. Kaufmann, Lakeshore Securities,
L.P., to Jonathan G. Katz, Secretary, Commission, dated January 24,
2005 (``Kaufmann Letter''); letter from J. Todd Weingart, Director
of Floor Operations, Mann Securities, to Jonathan G. Katz,
Secretary, Commission, dated January 25, 2005 (``Weingart Letter'');
letter from Charles Greiner III, LDB Consulting, Inc., to Jonathan
G. Katz, Secretary, Commission, dated January 26, 2005 (``Greiner
Letter''); letter from Jack L. Hansen, Chief Investment Officer and
Principal, The Clifton Group, to Jonathan G. Katz, Secretary,
Commission, dated February 1, 2005 (``Hansen Letter''); and letter
from Barbara Wierzynski, Executive Vice President and General
Counsel, Futures Industry Association, and Ira D. Hammerman, Senior
Vice President and General Counsel, Securities Industry Association,
to Jonathan G. Katz, Secretary, Commission, dated March 4, 2005
(``Wierzynski/Hammerman Letter'').
---------------------------------------------------------------------------
On April 15, 2005, the Exchange filed Amendment No. 2 \8\ to the
proposed rule change. The proposed rule change and Amendment Nos. 1 and
2 were published in the Federal Register on May 3, 2005.\9\ The
Commission received one comment in response to the May 3, 2005 Federal
Register notice.\10\
---------------------------------------------------------------------------
\8\ See Partial Amendment No. 2 (``Amendment No. 2''). The
Exchange submitted this partial amendment, pursuant to the request
of Commission staff, to remove the paragraph under which any
affiliate of a self-clearing member organization could participate
in portfolio margining, without being subject to the $5 million
equity requirement.
\9\ See Securities Exchange Act Release No. 34-51614 (April 26,
2005), 70 FR 22935 (May 3, 2005); see also Securities Exchange Act
Release No. 34-51615 (April 26, 2005), 70 FR 22953 (May 3, 2005).
\10\ See letter from William H. Navin, Executive Vice President,
General Counsel, and Secretary, The Options Clearing Corporation, to
Jonathan G. Katz, Secretary, Commission, dated May 27, 2005 (``Navin
Letter'').
---------------------------------------------------------------------------
The comment letters and the Exchange's responses to the comments
\11\ are summarized below.
[[Page 42119]]
This Order approves the proposed rule, as amended.\12\
---------------------------------------------------------------------------
\11\ See letter from Timothy H. Thompson, Senior Vice President,
Chief Regulatory Officer, Regulatory Services Division, CBOE, to
Michael A. Macchiaroli, Associate Director, Division of Market
Regulation, Commission, dated May 2, 2005 (``CBOE Response''). The
Commission received the CBOE Response on June 1, 2005; see also
letter from Timothy H. Thompson, Senior Vice President, Chief
Regulatory Officer, Regulatory Services Division, CBOE, to Michael
A. Macchiaroli, Associate Director, Division of Market Regulation,
Commission, dated June 29, 2005.
\12\ By separate orders, the Commission also is approving a
parallel rule filing by the NYSE [SR-NYSE-2002-19], and a related
rule filing by the Options Clearing Corporation (``OCC'') [SR-OCC-
2003-04]. See Securities Exchange Act Release No. 52031 (July 14,
2005) and Securities Exchange Act Release No. 52030 (July 14, 2005).
In addition, the staff of the Division of Market Regulation is
issuing certain no-action relief related to the OCC's rule filing.
See letter from Bonnie Gauch, Attorney, Division of Market
Regulation, Commission, to William H. Navin, General Counsel, OCC,
dated July 14, 2005.
---------------------------------------------------------------------------
II. Description
a. Summary of Proposed Rule Change
The CBOE has proposed to amend its rules, for certain customer
accounts, to allow member organizations to margin listed broad-based
securities index options, warrants, futures, futures options and
related exchange-traded funds according to a portfolio margin
methodology. The CBOE seeks to introduce the proposed rule as a two-
year pilot program that would be made available to member organizations
on a voluntary basis.
b. Overview--Portfolio Margin Computation
(1) Portfolio Margin
Portfolio margining is a methodology for calculating a customer's
margin requirement by ``shocking'' a portfolio of financial instruments
at different equidistant points along a range representing a potential
percentage increase and decrease in the value of the instrument or
underlying instrument in the case of a derivative product. For example,
the calculation points could be spread equidistantly along a range
bounded on one end by a 10% increase in market value of the instrument
and at the other end by a 10% decrease in market value. Gains and
losses for each instrument in the portfolio are netted at each
calculation point along the range to derive a potential portfolio-wide
gain or loss for the point. The margin requirement is the amount of the
greatest portfolio-wide loss among the calculation points.
Under the Exchange's proposed rule, a portfolio would consist of,
and be limited to, financial instruments in the customer's account
within a given broad-based US securities index class (e.g., the S&P 500
or S&P 100).\13\ The gain or loss on each position in the portfolio
would be calculated at each of 10 equidistant points (``valuation
points'') set at and between the upper and lower market range points.
The range for non-high capitalization indices would be between a market
increase of 10% and a decrease of 10%. High capitalization indices
would have a range of between a market increase of 6% and a decrease of
8%.\14\ A theoretical options pricing model would be used to derive
position values at each valuation point for the purpose of determining
the gain or loss. The amount of margin (initial and maintenance)
required with respect to a given portfolio would be the larger of: (1)
The greatest loss amount among the valuation point calculations; or (2)
the sum of $.375 for each option and future in the portfolio multiplied
by the contract's or instrument's multiplier. The latter computation
establishes a minimum margin requirement to ensure that a certain level
of margin is required from the customer. The margin for all other
portfolios of broad based US securities index instruments within an
account would be calculated in a similar manner.
---------------------------------------------------------------------------
\13\ A``portfolio'' is defined in the rule as ``options of the
same options class grouped with their underlying instruments and
related instruments.''
\14\ These are the same ranges applied to options market makers
under Appendix A to Rule 15c3-1 (17 CFR 240.15c3-1a), which permits
a broker-dealer when computing net capital to calculate securities
haircuts on options and related positions using a portfolio margin
methodology. See 17 CFR 240.15c3-1a(b)(1)(iv)(A); Letter from
Michael Macchiaroli, Associate Director, Division of Market
Regulation, Commission, to Richard Lewandowski, Vice President,
Regulatory Division, The Chicago Board Options Exchange, Inc. (Jan.
13, 2000).
---------------------------------------------------------------------------
Certain portfolios would be allowed offsets such that, at the same
valuation point, for example, 90% of a gain in one portfolio may reduce
or offset a loss in another portfolio.\15\ The amount of offset allowed
between portfolios would be the same as permitted under Rule 15c3-1a
for computing a broker-dealer's net capital.\16\
---------------------------------------------------------------------------
\15\ These offsets would be allowed between portfolios within
the High Capitalization, Broad Based Index Option product group and
the Non-High Capitalization, Broad Based Index product group.
\16\ 17 CFR 240.15c3-1a.16
---------------------------------------------------------------------------
Under the Exchange's proposed rule, the theoretical prices used for
computing profits and losses must be generated by a theoretical pricing
model that meets the requirements in Rule 15c3-1a.\17\ These
requirements include, among other things, that the model be non-
proprietary, approved by a Designated Examining Authority (``DEA'') and
available on the same terms to all broker-dealers.\18\ Currently, the
only model that qualifies under Rule 15c3-1a is the OCC's Theoretical
Intermarket Margining System (``TIMS'').
---------------------------------------------------------------------------
\17\ See 17 CFR 240.15c3-1a(b)(1)(i)(B).
\18\ Id.
---------------------------------------------------------------------------
(2) Cross-Margining
The Exchange's proposed rule permits futures and futures options on
broad-based US securities indices to be included in the portfolios.
Consequently, futures and futures options would be permitted offsets to
the securities positions in a given portfolio. Operationally, these
offsets would be achieved through cross-margin agreements between the
OCC and the futures clearing organizations holding the customer's
futures positions. Cross-margining would operate similar to the cross-
margin program that the Commission and the Commodity Futures Trading
Commission (``CFTC'') approved for listed options market-makers and
proprietary accounts of clearing member organizations.\19\ For
determining theoretical gains and losses, and resultant margin
requirements, the same portfolio margin computation program will be
applied to portfolio margin accounts that include futures. Under the
proposed rule, a separate cross-margin account must be established for
a customer.
---------------------------------------------------------------------------
\19\ See Securities Exchange Act Release 26153 (Oct. 3, 1988),
53 FR 39567 (Oct. 7, 1988).
---------------------------------------------------------------------------
c. Margin Deficiency
Under the Exchange's proposed rule, account equity would be
calculated and maintained separately for each portfolio margin account
and a margin call would need to be met by the customer within one
business day (T+1), regardless of whether the deficiency is caused by
the addition of new positions, the effect of an unfavorable market
movement, or a combination of both. The portfolio margin methodology,
therefore, would establish both the customer's initial and maintenance
margin requirement.
d. $5.0 Million Equity Requirement
The Exchange's proposed rule would require a customer (other than a
broker-dealer or a member of a national futures exchange) to maintain a
minimum account equity of not less than $5.0 million. This requirement
can be met by combining all securities and futures accounts owned by
the customer and carried by the broker-dealer (as broker-dealer and
futures commission merchant), provided ownership is identical across
all combined accounts. The proposed rule would require that, in the
event account equity falls below the $5 million minimum, additional
[[Page 42120]]
equity must be deposited within three business days (T+3).
e. Net Capital
The Exchange's proposed rule would provide that the gross customer
portfolio margin requirements of a broker-dealer may at no time exceed
1,000 percent of the broker-dealer's net capital (a 10:1 ratio), as
computed under Rule 15c3-1.\20\ This requirement is intended to place a
ceiling on the amount of portfolio margin a broker-dealer can extend to
its customers.
---------------------------------------------------------------------------
\20\ 17 CFR 240.15c3-1.
---------------------------------------------------------------------------
f. Internal Risk Monitoring Procedures
The Exchange's proposed rule would require a broker-dealer that
carries portfolio margin accounts to establish and maintain written
procedures for assessing and monitoring the potential risks to capital
arising from portfolio margining.
g. Margin at the Clearing House Level
The OCC will compute clearing house margin for the broker-dealer
using the same portfolio margin methodology applied at the customer
level. The OCC will continue to require full payment for all customer
long option positions. These positions, however, would be subject to
the OCC's lien. This would permit the long options positions to offset
short positions in the customer's portfolio margin account. In
conjunction with the Exchange's rule proposal, the OCC proposed
amending OCC Rule 611 and establishing a new type of omnibus account to
be carried at the OCC and known as the ``customer's lien account.''
\21\ In order to unsegregate the long option positions, the Commission
staff would have to grant certain relief from some requirements of
Commission Rules 8c-1, 15c2-1, and 15c3-3.\22\ The OCC requested such
relief on behalf of its members.\23\
---------------------------------------------------------------------------
\21\ See SR-OCC-2003-04, Securities Exchange Act Release No.
51330 (March 8, 2005). As noted above, the Commission is approving
the OCC's rule filing. See Securities Exchange Act Release No. 52030
(July 14, 2005).
\22\ 17 CFR 240.8c-1, 17 CFR 240.15c2-1 and 17 CFR 240.15c3-3,
respectively.
\23\ See Letter from William H. Navin, Executive Vice President,
General Counsel, and Secretary, The Options Clearing Corporation, to
Michael A. Macchiaroli, Associate Director, Division of Market
Regulation, Commission, dated January 13, 2005. As noted above, the
staff of the Division of Market Regulation is issuing a no-action
letter providing such relief. See letter from Bonnie Gauch,
Attorney, Division of Market Regulation, Commission, to William H.
Navin, General Counsel, OCC, dated July 14, 2005.
---------------------------------------------------------------------------
h. Risk Disclosure Statement and Acknowledgement
The Exchange's proposed rule would require a broker-dealer to
provide a portfolio margin customer with a written risk disclosure
statement at or prior to the initial opening of a portfolio margin
account. This disclosure statement would highlight the risks and
describe the operation of a portfolio margin account. The disclosure
statement would be divided into two sections, one dealing with
portfolio margining and the other with cross-margining. The disclosure
statement would note that additional leverage is possible in an account
margined on a portfolio basis in relation to existing margin
requirements. The disclosure statement also would describe, among other
things, eligibility requirements for opening a portfolio margin
account, the instruments that are allowed in the account, and when
deposits to meet margin and minimum equity requirements are due.
Further, there would be a summary list of the special risks of a
portfolio margin account, including the increased leverage, time frame
for meeting margin calls, potential for involuntary liquidation if
margin is not received, inability to calculate future margin
requirements because of the data and calculations required, and the OCC
lien on long option positions. The risks and operation of the cross-
margin account are outlined in a separate section of the disclosure
statement.
Further, at or prior to the time a portfolio margin account is
initially opened, the broker-dealer would be required to obtain a
signed acknowledgement concerning portfolio margining from the
customer. A separate acknowledgement would be required for cross-
margining. The acknowledgements would contain statements to the effect
that the customer has read the disclosure statement and is aware of the
fact that long option positions in a portfolio margin account are not
subject to the segregation requirements under the Commission's customer
protection rules, and would be subject to a lien by the OCC.
An additional acknowledgement form would be required for a cross-
margin account. It would contain similar statements as well as
statement to the effect that the customer is aware that futures
positions are being carried in a securities account, which would make
them subject to the Commission's customer protection rules, and
Securities Investor Protection Act of 1970 (``SIPA'') \24\ in the event
the broker-dealer becomes financially insolvent. The Exchange would
prescribe the format of the written disclosure statements and
acknowledgements, which would allow a broker-dealer to develop its own
format, provided the acknowledgement contains substantially similar
information and is approved by the Exchange in advance.
---------------------------------------------------------------------------
\24\ 24 5 U.S.C. 78aaa et seq.
---------------------------------------------------------------------------
i. Rationale for Portfolio Margin
Theoretical options pricing models have become widely utilized
since Fischer Black and Myron Scholes first introduced a formula for
calculating the value of a European style option in 1973.\25\ Other
formulas, such as the Cox-Ross-Rubinstein model have since been
developed. Option pricing formulas are now used routinely by option
market participants to analyze and manage risk. In addition, as noted,
a portfolio margin methodology has been used by broker-dealers since
1994 to calculate haircuts on option positions for net capital
purposes.\26\
---------------------------------------------------------------------------
\25\ See Securities Exchange Act Release No. 34-38248 (Feb. 6,
1997), 62 FR 6474 (Feb. 12, 1997) (discussing the development of the
options pricing approach to capital); see also Securities Exchange
Act Release No. 33761 (March 15, 1994), 59 FR 13275 (March 21,
1994).
\26\ See letter from Brandon Becker, Director, Division,
Commission, to Mary Bender, First Vice President, Division of
Regulatory Services, CBOE, and Timothy Hinkes, Vice President, OCC,
dated March 15, 1994; see also ``Net Capital Rule,'' Securities
Exchange Act Release No. 38248 (February 6, 1997), 62 FR 6474
(February 12, 1997).
---------------------------------------------------------------------------
The Board of Governors of the Federal Reserve System (the ``Federal
Reserve Board'' or ``FRB'') in its amendments to Regulation T in 1998
permitted SROs to implement portfolio margin rules, provided they are
approved by the Commission.\27\
---------------------------------------------------------------------------
\27\ See Federal Reserve System, ``Securities Credit
Transactions; Borrowing by Brokers and Dealers''; Regulations G, T,
U and X; Docket Nos. R-0905, R-0923 and R-0944, 63 FR 2806 (January
16, 1998). More recently, the FRB encouraged the development of a
portfolio margin approach in a letter to the Commission and the CFTC
delegating authority to the agencies to jointly prescribe margin
regulations for security futures products. See letter from the FRB
to James E. Newsome, Acting Chairman, CFTC, and Laura S. Unger,
Acting Chairman, Commission, dated March 6, 2001.
---------------------------------------------------------------------------
Portfolio margining brings a more risk sensitive approach to
establishing margin requirements. For example, in a diverse portfolio
some positions may appreciate and others depreciate in response to a
given change in market prices. The portfolio margin methodology
recognizes offsetting potential changes among the full portfolio of
related instruments. This links the margin required to the risk of the
entire portfolio as opposed to the individual positions on a position-
by-position basis.
Professional investors frequently hedge listed index options with
futures positions. Cross-margining would better
[[Page 42121]]
align their margin requirements with the actual risks of these hedged
positions. This could reduce the risk of forced liquidations.
Currently, an option (securities) account and futures account of the
same customer are viewed as separate and unrelated. Moreover, an option
account currently must be liquidated if the risk in the positions has
increased dramatically or margin calls cannot be met, even if gains in
the customer's futures account offset the losses in the options
account. If the accounts are combined (i.e., cross-margined),
unnecessary liquidation may be avoided. This could lessen the severity
of a period of high volatility in the market by reducing the number of
liquidations.
III. Summary of Comments Received and CBOE Response
The Commission received a total of fourteen comment letters to the
proposed rule.\28\ The comments, in general, were supportive. One
commenter stated that ``portfolio margining would enable CBOE to more
accurately reflect the risk exposure of options and related positions-
potentially reducing the trading costs of market participants and
increasing the liquidity and efficiency of the market.'' \29\ Some
commenters, however, recommended changes to specific provisions of the
proposed rule change.
---------------------------------------------------------------------------
\28\ See supra notes 4, 7 and 10.
\29\ See Vander Wilt Letter.
---------------------------------------------------------------------------
Seven of the comment letters specifically objected to the $5.0
million equity requirement.\30\ Three commenters noted that the
requirement blocks certain large institutions from participating in
portfolio margining because these institutions hold assets at a
custodian bank and, consequently, would not hold $5.0 million in an
account with a broker-dealer.\31\ Five commenters raised the issue that
securities index options will be at a disadvantage compared with
economically similar CFTC regulated index futures, because futures
accounts have no minimum equity requirement.\32\
---------------------------------------------------------------------------
\30\ See Ianni Letter; Weingart Letter; Wiermanski Letter;
Hansen Letter; Greiner Letter; Saliba Letter; and Melvin Letter.
\31\ See Weingart Letter; Wiermanski Letter; and Melvin Letter.
\32\ See Weingart Letter, Wiermanski Letter; Hansen Letter;
Saliba Letter; and Sheehan Letter.
---------------------------------------------------------------------------
The Exchange believes that the comments directed at the $5.0
million equity requirements have merit, particularly with respect to
certain types of accounts that must hold assets at a custodial
bank.\33\ The Exchange, however, stated that these comments should not
delay implementation of the proposed rule change and noted that it
intends to file a proposed rule amendment that would offer alternative
methods for meeting the minimum equity requirement after the industry
becomes acclimated to the portfolio margin methodology and its
operational aspects.
---------------------------------------------------------------------------
\33\ See CBOE Response.
---------------------------------------------------------------------------
Several commenters stated that other products should be eligible
for portfolio margining,\34\ such as equities,\35\ as well as OCC-
cleared equity derivatives.\36\ One commenter stated that other risk-
based algorithms, such as SPAN,\37\ that are recognized by other
clearing organizations should be permitted for calculating the
portfolio margin requirement, in addition to the OCC's TIMS.\38\
---------------------------------------------------------------------------
\34\ See Wiermanski Letter; Saliba Letter; and Donohue Letter.
\35\ See Saliba Letter.
\36\ See Sheehan Letter.
\37\ SPAN is the Chicago Mercantile Exchange's Standard
Portfolio Analysis System, which is used by many futures exchanges
to calculate margin.
\38\ See Donohue Letter.
---------------------------------------------------------------------------
In addition, one commenter stated that the Securities Investor
Protection Corporation (``SIPC'') would need to amend its rules in
order to provide SIPA protection to futures and options on futures in a
securities account.\39\ The Exchange disagrees and notes that the
proposed rule change was amended, at the request of Commission staff,
to require the immediate transfer to another broker-dealer or the
liquidation of a cross-margin account in the event that a broker-dealer
becomes insolvent. In addition, the Exchange believes that amendments
to Commission Rule 15c3-3 could provide customers holding both
securities and futures with protection under SIPA.
---------------------------------------------------------------------------
\39\ See Wierzynski/Hammerman Letter.
---------------------------------------------------------------------------
One commenter, the OCC, strongly urged the Commission to move
forward promptly with the approval of the proposed rule changes, and
contended that additional regulatory actions are necessary in order to
implement the proposed pilot programs.\40\ These other regulatory
actions include: Commission approval of SR-OCC-2003-04; a Commission
``no-action'' letter in connection with SR-OCC-2003-04; an exemptive
order from the CFTC; and amendments to Commission Rule 15c3-3. The
Exchange agrees with the OCC that approval of the OCC rule filing and
issuance of the ``no-action'' letter are necessary to enable portfolio
margining, including cross-margining, to be utilized.\41\ The Exchange
also urged the Commission to complete all regulatory actions necessary
to enable portfolio margining along with the cross-margin component.
---------------------------------------------------------------------------
\40\ See Navin Letter.
\41\ See supra notes 21 and 23.
---------------------------------------------------------------------------
IV. Discussion and Commission Findings
After careful review, the Commission finds that the proposed rule
change, as amended, is consistent with the requirements of the Act and
the rules and regulations thereunder applicable to a national
securities exchange.\42\ In particular, the Commission believes that
the proposed rule change is consistent with Section 6(b)(5) of the Act
\43\ in particular, in that it is designed to perfect the mechanism of
a free and open market and to protect investors and the public
interest. The Commission notes that the proposed portfolio margin rule
change is intended to promote greater reasonableness, accuracy and
efficiency with respect to Exchange margin requirements for complex
listed securities index option strategies. The Commission further notes
that the cross-margining capability with related index futures
positions in eligible accounts may alleviate excessive margin calls,
improve cash flows and liquidity, and reduce volatility. Moreover, the
Commission notes that approving the proposed rule change would be
consistent with the FRB's 1998 amendments to Regulation T, which sought
to advance the use of portfolio margining.
---------------------------------------------------------------------------
\42\ In approving this proposed rule change, the Commission
notes that it has considered the proposed rule's impact on
efficiency, competition, and capital formation. 15 U.S.C. 78c(f).
\43\ 15 U.S.C. 78f(b)(5).
---------------------------------------------------------------------------
Under the proposed rule changes, the Commission notes that a
broker-dealer choosing to offer portfolio margining to its customers
must employ a methodology that has been approved by the Commission for
use in calculating haircuts under Rule 15c3-1a. As stated above,
currently, TIMS is the only approved methodology. While some commenters
recommended expanding the choice of models, the Commission believes
that requiring a broker-dealer to use a model that qualifies for
calculating haircuts under Commission Rule 15c3-1a maintains a
consistency with the Commission's net capital rule and across potential
portfolio margin pricing models. As a result, portfolio margin
requirements would vary less from firm to firm. The Commission notes,
however, that like Rule 15c3-1a, the proposed rule permits the use of
another theoretical pricing model, should one be developed in the
future.\44\
---------------------------------------------------------------------------
\44\ See also Securities Exchange Act Release No. 34-38248
(February 6, 1997), 62 FR 6474 (February 12, 1997) (discussing in
Part II.A. the use of TIMS versus other pricing models).
---------------------------------------------------------------------------
[[Page 42122]]
The Commission notes the objections of certain commenters to the $5
million minimum equity requirement. The Commission believes that the
requirement circumscribes the number of accounts able to participate
and adds safety in that such accounts are more likely to be of
significant financial means and investment sophistication.
Finally, the Commission notes that several commenters recommended
expanding the products eligible for portfolio margining. The Exchange's
proposed rule limits the instruments eligible for portfolio margining
to listed products based on broad-based US securities indices, which
tend to be less volatile than narrow-based indices and non-index
equities. The Commission believes this limitation is appropriate for
the pilot program, which should serve as a first step toward the
possible expansion of portfolio margining to other classes of
securities.
V.Conclusion
It is therefore ordered, pursuant to Section 19(b)(2) of the
Act,\45\ that the proposed rule change (File No. SR-CBOE-2002-03), as
amended, is approved on a pilot basis to expire on July 31, 2007.
---------------------------------------------------------------------------
\45\ 15 U.S.C. 78s(b)(2).
For the Commission, by the Division of Market Regulation,
pursuant to delegated authority.\46\
---------------------------------------------------------------------------
\46\ 17 CFR 200.30-3(a)(12).
---------------------------------------------------------------------------
J. Lynn Taylor,
Assistant Secretary.
[FR Doc. E5-3870 Filed 7-20-05; 8:45 am]
BILLING CODE 8010-01-P