Self-Regulatory Organizations; New York Stock Exchange, Inc; Notice of Filing of Proposed Rule Change to Rule 431 (“Margin Requirements”) and Rule 726 (“Delivery of Options Disclosure Document and Prospectus”) To Expand the Products Eligible for Customer Portfolio Margining and Cross-Margining, 3586-3595 [E6-668]
Download as PDF
<![CDATA[
3586
Federal Register / Vol. 71, No. 14 / Monday, January 23, 2006 / Notices
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 also will be
available for inspection and copying at
the principal offices of NASD. All
comments received will be posted
without change; the Commission does
not edit personal identifying
information from submissions. You
should submit only information that
you wish to make available publicly. All
submissions should refer to File
Number SR–NASD–2005–144 and
should be submitted on or before
February 13, 2006.
For the Commission, by the Division of
Market Regulation, pursuant to delegated
authority.6
Nancy M. Morris,
Secretary.
[FR Doc. E6–663 Filed 1–20–06; 8:45 am]
[Release No. 34–53126; File No. SR–NYSE–
2005–93]
Self-Regulatory Organizations; New
York Stock Exchange, Inc; Notice of
Filing of Proposed Rule Change to
Rule 431 (‘‘Margin Requirements’’) and
Rule 726 (‘‘Delivery of Options
Disclosure Document and
Prospectus’’) To Expand the Products
Eligible for Customer Portfolio
Margining and Cross-Margining
erjones on PROD1PC61 with NOTICES
January 13, 2006.
Pursuant to Section 19(b)(1) of the
Securities Exchange Act of 1934 (the
‘‘Exchange Act’’),1 and Rule 19b–4
thereunder,2 notice is hereby given that
on December 29, 2005, the New York
Stock Exchange, Inc. (‘‘NYSE’’ or the
‘‘Exchange’’) filed with the Securities
and Exchange Commission (the
‘‘Commission’’) the proposed rule
change as described in Items I, II, and
III below, which Items have been
prepared by the Exchange. The
Commission is publishing this notice to
CFR 200.30–3(a)(12).
U.S.C. 78s(b)(1).
2 17 CFR 240.19b–4.
VerDate Aug<31>2005
13:01 Jan 20, 2006
Jkt 208001
The NYSE is filing with the
Commission proposed amendments to
NYSE Rule 431 (‘‘Margin
Requirements’’) that would expand the
scope of products that are eligible for
treatment as part of the Commission’s
approved Portfolio Margin Pilot
Program (the ‘‘Pilot’’).3 Amendments to
Rule 726 (‘‘Options Disclosure
Document’’) also are proposed to
include the Commission approved
products on the disclosure document
required to be furnished to customers
pursuant to this rule. The text of the
proposed rule change is below.
Additions are in italics. Deletions are in
brackets.
*
*
*
*
*
Margin Requirements
Portfolio Margin and Cross-Margin [for
Index Options]
SECURITIES AND EXCHANGE
COMMISSION
1 15
I. Self-Regulatory Organization’s
Statement of the Terms of Substance of
the Proposed Rule Change
Rule 431. (a) through (f) unchanged.
BILLING CODE 8010–01–P
6 17
solicit comments on the proposed rule
change from interested persons.
(g) As an alternative to the [‘‘strategy’’
based] ‘‘strategy-based’’ margin
requirements set forth in sections
[paragraphs] (a) through (f) of this Rule,
member organizations may elect to
apply the portfolio margin requirements
set forth in this section (g) to [margin
for] (1) listed, broad-based U.S. index
options, index warrants and underlying
instruments and (2) listed security
futures contracts 4 and listed single
stock options, (See section (g)(6)(C)(1)).
[(as defined below) in accordance with
the portfolio margin requirements set
forth in this Rule.]
In addition, member organizations,
provided they are a Futures Commission
Merchant (‘‘FCM’’) and are either a
clearing member of a futures clearing
organization or have an affiliate that is
a clearing member of a futures clearing
organization, are permitted under this
3 See Securities Exchange Act Release No. 52031
(July 14, 2005), 70 FR 42130 (July 21, 2005), (SR–
NYSE–2002–19). On July 14, 2005, the Commission
approved on a Pilot Basis expiring July 31, 2007,
amendments to Exchange Rule 431 to permit the
use of a prescribed risk-based margin requirement
(‘‘portfolio margin’’) for certain specified products
as an alternative to the strategy based margin
requirements currently required in section (a)
through (f) of the Rule. Amendments to Rule 726
were also approved to require disclosure to, and
written acknowledgement from, customers in
connection with the use of portfolio margin. See
NYSE Information Memo 05–56, dated August 18,
2005 for additional information.
4 For purposes of this section of the Rule, the term
‘‘security future’’ utilizes the definition at section
3(a)(55) of the Exchange Act, excluding narrowbased security indices.
PO 00000
Frm 00133
Fmt 4703
Sfmt 4703
section (g) to combine an eligible
participant’s [a customer’s] related
instruments [(] as defined in section
(g)(2)(C), [below) and] with listed, broadbased U.S. index options, index
warrants and underlying instruments
and compute a margin requirement for
such combined products [(‘‘cross
margin’’)] on a portfolio margin
basis[.](‘‘cross-margin’’). Member
organizations must confine cross-margin
positions to a portfolio margin account
dedicated exclusively to crossmargining.
The portfolio margin and crossmargining provisions of this Rule shall
not apply to Individual Retirement
Accounts (‘‘IRAs’’).
(1) Member organizations must [will
be expected to] monitor the risk of
portfolio margin accounts and maintain
a written risk analysis methodology for
assessing the potential risk to the
member organization’s capital over a
specified range of possible market
movements of positions maintained in
such accounts. The risk analysis
methodology shall specify the
computations to be made, the frequency
of computations, the records to be
reviewed and maintained, and the
person(s) [position(s)] within the
organization responsible for the risk
function. This risk analysis
methodology shall be made available to
the Exchange upon request. In
performing the risk analysis of portfolio
margin accounts required by this Rule,
each member organization shall include
the following in the written risk analysis
methodology:
(A) Procedures and guidelines for the
determination, review and approval of
credit limits to each eligible participant,
[customer,] and across all eligible
participants, [customers,] utilizing a
portfolio margin account.
(B) Procedures and guidelines for
monitoring credit risk exposure to the
member organization, including intraday credit risk, related to portfolio
margin accounts.
(C) Procedures and guidelines for the
use of stress testing of portfolio margin
accounts in order to monitor market risk
exposure from individual accounts and
in the aggregate.
(D) Procedures providing for the
regular review and testing of these risk
analysis procedures by an independent
unit such as internal audit or other
comparable group.
(2) Definitions.—For purposes of this
section [paragraph] (g), the following
terms shall have the meanings specified
below:
(A) The term ‘‘listed option’’ [shall]
means any option traded on a registered
national securities exchange or
E:\FR\FM\23JAN1.SGM
23JAN1
erjones on PROD1PC61 with NOTICES
Federal Register / Vol. 71, No. 14 / Monday, January 23, 2006 / Notices
automated facility of a registered
national securities association.
(B) [(F)] The term ‘‘underlying
instrument’’ means long and short
positions in an exchange traded fund or
other fund product registered under the
Investment Company Act of 1940, that
holds the same securities, and in the
same proportion, as contained in a
broad-based index on which options are
listed. The term ‘‘underlying
instrument’’ shall not be deemed to
include[,] futures contracts, options on
futures contracts, underlying stock
baskets, or unlisted instruments.
(C) [(E]) The term ‘‘related
instrument’’ within an option class or
product group means futures contracts
and options on futures contracts
covering the same underlying
instrument.
(D) [(B)] The term ‘‘options class’’
refers to all options contracts covering
the same underlying instrument.
(E) [(C)] The term ‘‘portfolio’’ means
any eligible product, as defined in
section (g)(6)(C)(1), [options of the same
options class] grouped with their
underlying instruments and related
instruments.
(F) [(D)] The term ‘‘option series’’
relates to listed options and means all
option contracts of the same type (either
a call or a put) and exercise style,
covering the same underlying
instrument with the same exercise price,
expiration date, and number of
underlying units.
(G) The term ‘‘product group’’ means
two or more portfolios of the same type
(see table in section [sub-paragraph]
(g)(2) [(H)] (I) below) for which it has
been determined by Rule 15c3–1a under
the Securities Exchange Act of 1934 that
a percentage of offsetting profits may be
applied to losses at the same valuation
point.
(H) For purposes of portfolio margin
and cross-margin the term ‘‘equity’’, as
defined in section (a)(4) of this Rule,
includes the market value of any long or
short option positions held in an eligible
participant’s account.
(I) [(H)] The term ‘‘theoretical gains
and losses’’ means the gain and loss in
the value of individual eligible products
[option series] and related instruments
at 10 equidistant intervals (valuation
points) ranging from an assumed
movement (both up and down) in the
current market value of the underlying
instrument. The magnitude of the
VerDate Aug<31>2005
13:01 Jan 20, 2006
Jkt 208001
3587
futures contracts and listed single stock
options, the five million dollar equity
requirement shall be waived.
Up/down
(5) Opening of Accounts.
market
(A) Member organizations must notify
Portfolio type
move (high
& low valu- and receive approval from the Exchange
ation points) prior to establishing a portfolio margin
or cross-margin methodology for eligible
Listed Security Futures Conparticipants.
tract and Listed Single Stock
(B) [(A)] Only eligible participants
Option ....................................
+/¥15%
[customers] that have been approved for
Non-High Capitalization, Broadoptions transactions and approved to
based U.S. Market Index Option ........................................
+/¥10% engage in uncovered short option
contracts pursuant to Exchange Rule
High Capitalization, Broad721, are permitted to utilize a portfolio
based U.S. Market Index Option ........................................
+6%/¥8% margin account.
(C) [(B)] On or before the date of the
(3) Approved Theoretical Pricing
initial transaction in a portfolio margin
Models.—Theoretical pricing models
account, a member organization shall:
must be approved by a Designated
(1) [(i)] furnish the eligible participant
Examining Authority and reviewed by
[customer] with a special written
the Securities and Exchange
disclosure statement describing the
Commission (‘‘The Commission’’) in
nature and risks of portfolio margining
order to qualify. Currently, the
and cross-margining which includes an
theoretical model utilized by [The] the
acknowledgement for all portfolio
Options Clearing Corporation (‘‘[The]
margin account owners to sign, and an
OCC’’)[,] is the only model qualified
additional acknowledgement for owners
pursuant to [The] the Commission’s Net that also engage in cross-margining to
Capital Rule. All member organizations
sign, attesting that they have read and
[participating in the pilot program] shall understood the disclosure statement,
obtain their theoretical values from
and agree to the terms under which a
[The] the OCC.
portfolio margin account and the cross(4) Eligible Participants.—The
margin account respectively, are
application of the portfolio margin
provided (see Exchange Rule 726 (d)),
provisions of this section [paragraph]
and (2) [(ii)] obtain the signed
(g), including cross-margining, is
acknowledgement(s) noted above from
limited to the following:
the eligible participant [customer] (both
(A) any broker or dealer registered
of which are required for crosspursuant to Section 15 of the Securities
margining eligible participants
Exchange Act of 1934;
[customers]) and record the date of
(B) any member of a national futures
receipt.
exchange to the extent that listed index
(6) Establishing Account and Eligible
options hedge the member’s index
Positions.
futures; and
(A) [(1)] Portfolio Margin Account.
(C) any other person or entity not
For purposes of applying the portfolio
included in sections (g)(4)(A) and
margin requirements [provided]
[through] (g)(4)(B) above that has or
prescribed in this [paragraph] section
establishes, and maintains, equity of at
(g), member organizations are to
least five [5] million dollars. For
establish and utilize a specific securities
purposes of this equity requirement, all
margin account, or sub-account of a
securities and futures accounts carried
margin account, clearly identified as a
by the member organization for the
portfolio margin account that is separate
same eligible participant [customer]
from any other securities account
may be combined provided ownership
carried for an eligible participant [a
across the accounts is identical. A
customer].
guarantee pursuant to section
(B) [(2)] Cross-Margin Account. For
[paragraph] (f)(4) of this Rule is not
purposes of combining related
permitted for purposes of the minimum
instruments [and] with listed, broadequity requirement. For those accounts
based U.S. index options, index
that are solely limited to listed security
warrants, and underlying instruments,
and applying the portfolio margin
5 In accordance with section [sub-paragraph]
requirements, member[s] organizations
(b)(1)(i)(B) of Rule 15c3–1a (Appendix A to Rule
15c3–1) under the Securities Exchange Act of 1934,
are to establish [and utilize a portfolio
17 CFR 240.15c3–1a(b)(1)(i)(B).
margin account, clearly identified as] a
6 See footnote above.
cross-margin account[,] that is separate
7 For purposes of this Rule, the term ‘‘related
from any other securities account or
instruments,’’ within an option class or product
portfolio margin account carried for an
means futures contracts and options on futures
contracts covering the same underlying instrument.
eligible participant. [a customer.]
valuation point range shall be as
follows: 5 6
PO 00000
Frm 00134
Fmt 4703
Sfmt 4703
E:\FR\FM\23JAN1.SGM
23JAN1
erjones on PROD1PC61 with NOTICES
3588
Federal Register / Vol. 71, No. 14 / Monday, January 23, 2006 / Notices
A margin deficit in either the portfolio
margin account or the cross-margin
account of an eligible participant [a
customer] may not be considered as
satisfied by excess equity in the other
account. Funds and/or securities must
be transferred to the deficient account
and a written record created and
maintained.
(C) [(A)] Portfolio Margin Account—
Eligible [Positions] Products
(1) For eligible participants as
described in sections (g)(4)(A) through
(g)(4)(C), [(i) A] a transaction in, or
transfer of, [a listed, broad-based U.S.
index option or index warrant] an
eligible product may be effected in the
portfolio margin account. Eligible
products under this section consist of:
(i) a listed, broad-based U.S. index
option or index warrant and underlying
instrument.
(ii) a listed security futures contract or
listed single stock option.
(2) [(ii)] A transaction in, or transfer
of, an underlying instrument may be
effected in the portfolio margin account
provided a position in an offsetting
listed, broad-based U.S. index option or
index warrant is in the account or is
established in the account on the same
day.
(3) A transaction in, or transfer of, a
listed security futures contract or listed
single stock option may also be effected
in the portfolio margin account.
(4) Any long position or any short
position in any eligible product that is
no longer part of a hedge strategy must
be transferred from the portfolio margin
account to the appropriate securities
account within ten business days,
subject to any applicable margin
requirement, unless the position
becomes part of a hedge strategy again.
Member organizations must monitor
portfolio margin accounts for possible
abuse of this provision.
[(iii) If, in the portfolio margin
account, the listed, broad-based U.S.
index option or index warrant position
offsetting an underlying instrument
position ceases to exist and is not
replaced within ten business days, the
underlying instrument position must be
transferred to a regular margin account,
subject to initial Regulation T and
margined according to the other
provisions of this Rule. Member
organizations will be expected to
monitor portfolio margin accounts for
possible abuse of this provision.
(iv) In the event that fully paid for
long options and/or index warrants are
the only positions contained within a
portfolio margin account, such long
positions must be transferred to a
securities account other than a portfolio
margin account or cross-margin account
VerDate Aug<31>2005
13:01 Jan 20, 2006
Jkt 208001
within 10 business days, subject to the
margin required, unless the status of the
account changes such that it is no longer
composed solely of fully paid for long
options and/or index warrants.]
(D)[(B)] Cross-Margin Account—
Eligible [Positions] Products
(1) For eligible participants, as
described in sections (g)(4)(A) through
(g)(4)(C), a transaction in, or transfer of,
an eligible product may be effected in
the cross-margin account.
(2) [(i)] A transaction in, or transfer of,
a related instrument may be effected in
the cross-margin account provided a
position in an offsetting eligible product
[listed, U.S. broad-based index option,
index warrant or underlying instrument]
is in the account or is established in the
account on the same day.
(3) Any long position or any short
position in any eligible product that is
no longer part of a hedge strategy must
be transferred from the cross-margin
account to the appropriate securities
account or futures account within ten
business days, subject to any applicable
margin requirement, unless the position
becomes part of a hedge strategy again.
Member organizations must monitor
cross-margin accounts for possible
abuse of this provision.
[(ii) If the listed, U.S. broad-based
index option, index warrant or
underlying instrument position
offsetting a related instrument ceases to
exist and is not replaced within ten
business days, the related instrument
position must be transferred to a futures
account and margined accordingly.
Member organizations will be expected
to monitor cross-margin accounts for
possible abuse of this provision.
(iii) In the event that fully paid for
long options and/or index warrants
(securities) are the only positions
contained within a cross-margin
account, such long positions must be
transferred to a securities account other
than a portfolio margin account or cross
margin account within 10 business
days, subject to the margin required,
unless the status of the account changes
such that it is no longer composed
solely of fully paid for long options and/
or index warrants.]
(7) Initial and Maintenance Margin
Required.—The amount of margin
required under this section [paragraph]
(g) for each portfolio shall be the greater
of:
(A) the amount for any of the 10
equidistant valuation points
representing the largest theoretical loss
as calculated pursuant to section
[paragraph] (g)(8) below, or
(B) $.375 for each contract [listed
index option] and related instrument
multiplied by the contract’s or
PO 00000
Frm 00135
Fmt 4703
Sfmt 4703
instrument’s multiplier, not to exceed
the market value in the case of long
positions in eligible products. [listed
options and options on futures
contracts.]
(C) Account guarantees pursuant to
section [paragraph] (f)(4) of this Rule are
not permitted for purposes of meeting
initial and maintenance margin
requirements.
(8) Method of Calculation.
(A) Long and short contracts,
[positions in listed options,] including
underlying instruments and related
instruments, are to be grouped [by
option class; each option class group
being] as a ‘‘portfolio.’’[.] Each portfolio
is categorized as one of the portfolio
types specified in section [subparagraph] (g)(2)(I) [(H)] above.
(B) For each portfolio, theoretical
gains and losses are calculated for each
position as specified in section [subparagraph] (g)(2)(I) [(H)] above. For
purposes of determining the theoretical
gains and losses at each valuation point,
member organizations shall obtain and
utilize the theoretical values of eligible
products as described in this section [a
listed index option, underlying
instrument or related instrument]
rendered by an approved [a] theoretical
pricing model. [that, in accordance with
sub-paragraph (b)(1)(i)(B) of Rule 15c3–
1a under the Securities Exchange Act of
1934, qualifies for purposes of
determining the amount to be deducted
in computing net capital under a
portfolio based methodology.]
(C) Offsets. Within each portfolio,
theoretical gains and losses may be
netted fully at each valuation point.
Offsets between portfolios within
eligible product groups, as described in
section (g)(2)(I), [the High
Capitalization, Broad-based Index
Option product group and the Non-High
Capitalization, Broad-based Index
Option product group] may then be
applied as permitted by Rule 15c3–1a
under the Securities Exchange Act of
1934.
(D) After applying the [Offsets] offsets
above, the sum of the greatest loss from
each portfolio is computed to arrive at
the total margin required for the account
(subject to the per contract minimum).
(9) Portfolio Margin Minimum Equity
Call [Equity Deficiency .—]
(A) If, at any time, the equity in the
portfolio margin or cross-margin
account of an eligible participant, as
described in section (g)(4)(C), declines
below the [5] five million dollar
minimum equity required, [under subparagraph (4)(D) of this paragraph (g)]
and is not restored to at least [5] five
million dollars within three [(3)]
business days (T+3) by a deposit of
E:\FR\FM\23JAN1.SGM
23JAN1
erjones on PROD1PC61 with NOTICES
Federal Register / Vol. 71, No. 14 / Monday, January 23, 2006 / Notices
funds and/or securities, [;] member
organizations are prohibited from
accepting opening orders starting on
T+4, except that opening orders entered
for the purpose of hedging existing
positions may be accepted if the result
would be to lower margin requirements.
This prohibition shall remain in effect
until equity of five [5] million dollars is
established. For those accounts that are
solely limited to security futures
contracts and single stock options, the
five million dollar equity requirement
shall be waived.
(B) Member organizations will not be
permitted to deduct any portfolio
margin minimum equity call amount
from Net Capital in lieu of collecting the
minimum equity required.
(10) [(11)] Portfolio Margin
Maintenance Call [Additional Margin.
—]
(A) If at any time, the equity in the
[any] portfolio margin or cross-margin
account of an eligible participant, as
described in sections (g)(4)(A) through
(g)(4)(C), is less than the margin
required, the eligible participant
[customer] may deposit additional
margin or establish a hedge to meet the
margin requirement within [one] three
business days [(T+1)] (T+3). During the
three business day period, member
organizations are prohibited from
accepting opening orders, except that
opening orders entered for the purpose
of hedging existing positions may be
accepted if the result would be to lower
margin requirements. In the event an
eligible participant [a customer] fails to
hedge existing positions or deposit
additional margin within [one] three
business days, the member organization
must liquidate positions in an amount
sufficient to, at a minimum, lower the
total margin required to an amount less
than or equal to the account equity.
[Paragraph (f)(7) of this Rule—Practice
of Meeting Regulation T Margin Calls by
Liquidation Prohibited shall not apply
to portfolio margin accounts. However,
member organizations will be expected
to monitor portfolio margin and crossmargin accounts for possible abuse of
this provision.]
(B) If the portfolio margin
maintenance call is not met by the close
of business T+1, member organizations
will be required to deduct from Net
Capital the amount of the call until such
time the call is satisfied.
(C) Member organizations will not be
permitted to deduct any portfolio
margin maintenance call amount from
Net Capital in lieu of collecting the
margin required.
(11) [(10)] Determination of Value for
Margin Purposes.—For the purposes of
this section [paragraph] (g), all eligible
VerDate Aug<31>2005
13:01 Jan 20, 2006
Jkt 208001
products [listed index options] and
related instrument positions shall be
valued at current market prices.
Account equity for the purposes of this
section [paragraph] (g) shall be
calculated separately for each portfolio
margin or cross-margin account. [by
adding the current market value of all
long positions, subtracting the current
market value of all short positions, and
adding the credit (or subtracting the
debit) balance in the account.]
(12) Net Capital Treatment of Portfolio
Margin and Cross-Margin Accounts.
(A) No member organization that
requires margin in any eligible
participant [customer] account pursuant
to section [paragraph] (g) of this Rule
shall permit [gross] the aggregate
eligible participant [customer] portfolio
margin and cross-margin initial and
maintenance requirements to exceed
[1,000 percent] ten times [of] its net
capital for any period exceeding three
business days. The member organization
shall, beginning on the fourth business
day, cease opening new portfolio margin
and cross-margin accounts until
compliance is achieved.
(B) If, at any time, a member
organization’s [gross] aggregate eligible
participant [customer] portfolio margin
and cross-margin requirements exceed
[1,000 percent] ten times [of] its net
capital, the member organization shall
immediately transmit telegraphic or
facsimile notice of such deficiency to
the principal office of the Securities and
Exchange Commission in Washington,
DC, [450 Fifth Street, NW., Washington,
DC 20549; to] the district or regional
office of the Securities and Exchange
Commission for the district or region in
which the member organization
maintains its principal place of
business; and to the New York Stock
Exchange. [its Designated Examining
Authority.]
(13) Day Trading Requirements.—The
requirements of section [sub-paragraph]
(f)(8)(B) of this Rule—Day-Trading shall
not apply to portfolio margin accounts
or [including] cross-margin accounts.
(14) Cross-Margin Accounts—
Requirements to Liquidate
(A) A member is required
immediately either to liquidate, or
transfer to another broker-dealer eligible
to carry cross-margin accounts, all
eligible participant [customer] crossmargin accounts that contain positions
eligible for cross-margining [in futures
and/or options on futures] if the
member is:
(1) [(i)] insolvent as defined in section
101 of title 11 of the United States Code,
or is unable to meet its obligations as
they mature;
PO 00000
Frm 00136
Fmt 4703
Sfmt 4703
3589
(2) [(ii)] the subject of a proceeding
pending in any court or before any
agency of the United States or any State
in which a receiver, trustee, or
liquidator for such debtor has been
appointed;
(3) [(iii)] not in compliance with
applicable requirements under the
Securities Exchange Act of 1934 or rules
of the Securities and Exchange
Commission or any self-regulatory
organization with respect to financial
responsibility or hypothecation of
eligible participant’s [customer’s]
securities; or
(4) [(iv)] unable to make such
computations as may be necessary to
establish compliance with such
financial responsibility or
hypothecation rules.
(B) Nothing in this section [paragraph]
(14) shall be construed as limiting or
restricting in any way the exercise of
any right of a registered clearing agency
to liquidate or cause the liquidation of
positions in accordance with its by-laws
and rules.
*
*
*
*
*
Delivery of Options Disclosure
Document and Prospectus
Rule 726 (a) through (c) unchanged.
Portfolio Margining and CrossMargining Disclosure Statement and
Acknowledgement
(d) The special written disclosure
statement describing the nature and
risks of portfolio margining and crossmargining, and acknowledgement for an
eligible participant [customer] signature,
required by Rule 431(g)(5)(B) shall be in
a format prescribed by the Exchange or
in a format developed by the member
organization, provided it contains
substantially similar information as in
the prescribed Exchange format and has
received the prior written approval of
the Exchange.
Sample Portfolio Margining and CrossMargining Risk Disclosure Statement To
Satisfy Requirements of Exchange Rule
431(g)
Overview of Portfolio Margining
1. 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
‘‘product group’’ as determined by an
options pricing model using multiple
pricing scenarios. These pricing
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. Portfolio margining is currently
E:\FR\FM\23JAN1.SGM
23JAN1
3590
Federal Register / Vol. 71, No. 14 / Monday, January 23, 2006 / Notices
limited to product classes and groups of
index products relating to listed, broadbased market indexes, listed security
futures contracts and listed single stock
options.
2. The goal of portfolio margining is
to set levels of margin that more
precisely reflects actual net risk. The
eligible participant [customer] benefits
from portfolio margining in that margin
requirements calculated on net risk are
generally lower than alternative
‘‘position’’ or ‘‘strategy’’ based
methodologies for determining margin
requirements. Lower margin
requirements allow the customer more
leverage in an account.
Customers Eligible for Portfolio
Margining
3. To be eligible for portfolio
margining, customers (other than
broker-dealers) must meet the basic
standards for having an options account
that is approved for uncovered writing
and must have and maintain at all times
account net equity of not less than [$5]
five million dollars, aggregated across
all accounts under identical ownership
at the clearing broker. [The] This
identical ownership requirement
excludes accounts held by the same
customer in different capacities (e.g., as
a trustee and as an individual) and
accounts where ownership is
overlapping but not identical (e.g.,
individual accounts and joint accounts).
For those accounts that are solely
limited to listed security futures
contracts and listed single stock options,
the five million dollar equity
requirement shall be waived.
erjones on PROD1PC61 with NOTICES
Positions Eligible for a Portfolio Margin
Account
4. All positions in listed security
futures contracts, listed single stock
options, listed, broad-based U.S. market
index options [and] or index warrants,
[listed on a national securities exchange,
and] exchange traded funds and other
products registered under the
Investment Company Act of 1940 that
are managed to track the same index
that underlies permitted index options,
are eligible for a portfolio margin
account.
Special Rules for Portfolio Margin
Accounts
5. A portfolio margin account may be
either a separate account or a subaccount of a customer’s standard
[regular] margin account. In the case of
a sub-account, equity in the standard
[regular] account will be available to
satisfy any margin requirement in the
portfolio margin sub-account without
transfer to the sub-account.
VerDate Aug<31>2005
13:01 Jan 20, 2006
Jkt 208001
6. A portfolio margin account or subaccount will be subject to a minimum
margin requirement of $.375 multiplied
by the contract’s [index] multiplier for
every contract [option contract or index
warrant] carried long or short in the
account. No minimum margin is
required in the case of eligible exchange
traded funds or other eligible fund
products.
7. Margin calls in the portfolio margin
account or sub-account, regardless of
whether due to new commitments or the
effect of adverse market [moves]
movements on existing positions, must
be met within [one] three business days.
Any shortfall in aggregate net equity
across accounts must be met within
three business days. Failure to meet a
portfolio margin maintenance call when
due will result in immediate liquidation
of positions to the extent necessary to
reduce the margin requirement. Failure
to meet [an] a minimum equity call
prior to the end of the third business
day will result in a prohibition on
entering any opening orders, with the
exception of opening orders that hedge
existing positions, beginning on the
fourth business day and continuing
until such time as the minimum equity
requirement is satisfied.
8. A position in an exchange traded
index fund or other eligible fund
product may not be established in a
portfolio margin account unless there
exists, or there is established on the
same day, an offsetting position in
securities options, or other eligible
securities. The position(s) [Exchange
traded index funds and/or other eligible
funds] will be transferred out of the
portfolio margin account and into a
standard [regular] securities account
subject to any applicable margin
requirement [initial Regulation T and
NYSE Rule 431 margin] if the offsetting
securities options, other eligible
securities and/or related instruments no
longer remain in the account for ten
business days.
9. When a broker-dealer carries a
standard [regular] cash account or
margin account for a customer, the
broker-dealer is limited by rules of the
Securities and Exchange Commission
and of The Options Clearing
Corporation (‘‘OCC’’) to the extent to
which the broker-dealer may permit
OCC to have a lien against long option
positions in those accounts. In contrast,
OCC will have a lien against all long
option positions that are carried by a
broker-dealer in a portfolio margin
account, and this could, under certain
circumstances, result in greater losses to
a customer having long option positions
in such an account in the event of the
insolvency of the customer’s broker.
PO 00000
Frm 00137
Fmt 4703
Sfmt 4703
Accordingly, to the extent that a
customer does not borrow against long
option positions in a portfolio margin
account or have margin requirements in
the account against which the long
option can be credited, there is no
advantage to carrying the long options
in a portfolio margin account and the
customer should consider carrying them
in an account other than a portfolio
margin account.
Special Risks of Portfolio Margin
Accounts
10. Portfolio margining generally
permits greater leverage in an account,
and greater leverage creates greater
losses in the event of adverse market
movements.
11. Because the time limit for meeting
margin calls is shorter than in a
standard [regular] margin account, there
is increased risk that a customer’s
portfolio margin account will be
liquidated involuntarily, possibly
causing losses to the customer.
12. Because portfolio margin
requirements are determined using
sophisticated mathematical calculations
and theoretical values that must be
calculated from market data, it may be
more difficult for customers to predict
the size of future margin calls in a
portfolio margin account. This is
particularly true in the case of
customers who do not have access to
specialized software necessary to make
such calculations or who do not receive
theoretical values calculated and
distributed periodically by The Options
Clearing Corporation.
13. For the reasons noted above, a
customer that carries long options
positions in a portfolio margin account
could, under certain circumstances, be
less likely to recover the full value of
those positions in the event of the
insolvency of the carrying broker.
14. Trading of securities index
products in a portfolio margin account
is generally subject to all the risks of
trading those same products in a
standard [regular] securities margin
account. Customers should be
thoroughly familiar with the risk
disclosure materials applicable to those
products, including the booklet entitled
‘‘Characteristics and Risks of
Standardized Options’’.
15. Customers should consult with
their tax advisers to be certain that they
are familiar with the tax treatment of
transactions in securities options
[index] and futures products.
16. The descriptions in this disclosure
statement relating to eligibility
requirements for portfolio margin
accounts, and minimum equity and
margin requirements for those accounts,
E:\FR\FM\23JAN1.SGM
23JAN1
Federal Register / Vol. 71, No. 14 / Monday, January 23, 2006 / Notices
are minimums imposed under Exchange
rules. Time frames within which margin
and equity calls must be met are
maximums imposed under Exchange
rules. Broker-dealers may impose their
own more stringent requirements.
Overview Of Cross-Margining
17. In a cross-margin account, [With
cross-margining,] index futures, [and]
options on index futures are combined
with offsetting positions in securities
index options and underlying
instruments, for the purpose of
computing a margin requirement based
on the net risk. This generally produces
lower margin requirements than if the
related instruments 7 and securities
products are viewed separately, thus
providing more leverage in the account.
18. Cross-margining must be effected
[done] in a portfolio margin account
type. A separate portfolio margin
account must be established exclusively
for cross-margining.
19. Cross-margining is achieved when
[When] index futures and options on
futures are combined with offsetting
positions in index options and
underlying instruments in a dedicated
account, and a portfolio margining
methodology is applied to them. [,
cross-margining is achieved.]
Customers Eligible for Cross-Margining
20. The eligibility requirements for
cross-margining are generally the same
as for portfolio margining. [,]
Accordingly, [and] any customer eligible
for portfolio margining is eligible for
cross-margining.
21. Members of futures exchanges on
which cross-margining eligible index
contracts are traded are also permitted
to carry positions in cross-margin
accounts without regard to the
minimum aggregate account equity.
erjones on PROD1PC61 with NOTICES
Positions Eligible for Cross-Margining
22. All securities products eligible for
portfolio margining are also eligible for
cross-margining.
23. All broad-based U.S. listed market
index futures and options on index
futures traded on a designated contract
market subject to the jurisdiction of the
Commodity Futures Trading
Commission (‘‘CFTC’’) are eligible for
cross-margining.
Special Rules for Cross-Margining
24. Cross-margining must be
conducted in a portfolio margin account
type. A separate portfolio margin
account must be established exclusively
7 For purposes of this Rule, the term ‘‘related
instruments,’’ within an option class or product
means futures contracts and options on futures
contracts covering the same underlying instrument.
VerDate Aug<31>2005
13:01 Jan 20, 2006
Jkt 208001
for cross-margining. A cross-margin
account is a securities account, and
must be maintained separately from all
other securities account.
25. Cross-margining is automatically
accomplished with the portfolio
margining methodology. Cross-margin
positions are subject to the same
minimum margin requirement for every
contract, including futures contracts.
26. Margin calls arising in a crossmargin account, and any shortfall in
aggregate net equity across accounts,
must be satisfied within the same
timeframe, and subject to the same
consequences, as in a portfolio margin
account.
27. A position in a futures product
may not be established in a cross-margin
account unless there exists, or there is
established on the same day, an
offsetting position in securities options
and/or other eligible securities. Related
instruments will be transferred out of
the cross-margin account and into a
futures account if, for more than ten
business days and for any reason, the
offsetting securities options and/or other
eligible securities no longer remain in
the account. If the transfer of related
instruments to a futures account causes
the futures account to be
undermargined, a margin call will be
issued or positions will be liquidated to
the extent necessary to eliminate the
deficit.
28. Customers participating in crossmargining will be required to sign an
agreement acknowledging that their
positions and property in the crossmargin account will be subject to the
customer protection provisions of Rule
15c3–3 under the Securities Exchange
Act of 1934 and the Securities Investor
Protection Act, and will not be subject
to the provisions of the Commodity
Exchange Act, including segregation of
funds.
29. According to the rules of the
exchanges, a broker-dealer is required to
immediately liquidate[,] or, if feasible,
transfer to another broker-dealer eligible
to carry cross-margin accounts, all
customer cross-margin accounts that
contain positions in futures and/or
options on futures in the event that the
carrying broker-dealer becomes
insolvent.
30. In signing the agreement referred
to in paragraph 28 above, a customer
also acknowledges that a cross-margin
account that contains positions in
futures and/or options on futures will be
immediately liquidated, or, if feasible,
transferred to another broker-dealer
eligible to carry cross-margin accounts,
in the event that the carrying brokerdealer becomes insolvent.
PO 00000
Frm 00138
Fmt 4703
Sfmt 4703
3591
Special Risks of Cross-Margining
31. Cross-margining must be
conducted in a portfolio margin account
type. Generally, cross-margining and the
portfolio margining methodology both
contribute to provide greater leverage
than a standard [regular] margin
account, and greater leverage creates
greater losses in the event of adverse
market movements.
32. Since cross-margining must be
conducted in a portfolio margin account
type, the time required for meeting
margin calls is shorter than in a
standard [regular] securities margin
account and may be shorter than the
time ordinarily required by a futures
commission merchant for meeting
margin calls in a futures account.
Consequently, there is increased risk
that a customer’s cross-margin positions
will be liquidated involuntarily, causing
possible loss to the customer.
33. As noted above, cross-margin
accounts are securities accounts and are
subject to the customer protections setforth in Rule 15c3–3 under the
Securities Exchange Act of 1934 and the
Securities Investor Protection Act.
Cross-margin positions are not subject to
the customer protection rules under the
segregation provisions of the
Commodity Exchange Act and the rules
of the CFTC adopted pursuant to the
Commodity Exchange Act.
34. Trading of index options and
futures contracts in a cross-margin
account is generally subject to all the
risks of trading those same products in
a futures account or a standard [regular]
securities margin account. Customers
should be thoroughly familiar with the
risk disclosure materials applicable to
those products, including the booklet
entitled Characteristics and Risks of
Standardized Options and the risk
disclosure document required by the
CFTC to be delivered to futures
customers. Because this disclosure
statement does not disclose the risks
and other significant aspects of trading
in futures and options, customers
should review those materials carefully
before trading in a cross-margin
account.
35. Customers should bear in mind
that the discrepancies in the cash flow
characteristics of futures and certain
options are still present even when
those products are carried together in a
cross-margin account. Both futures and
options contracts are generally marked
to the market at least once each business
day, but the marks may take place with
different frequency and at different
times within the day. When a futures
contract is marked to the market, the
gain or loss is immediately credited to
E:\FR\FM\23JAN1.SGM
23JAN1
3592
Federal Register / Vol. 71, No. 14 / Monday, January 23, 2006 / Notices
or debited from[, respectively,] the
customer’s account in cash. While an
increase in the value of a long option
contract may increase the equity in the
account, the gain is not realized until
the option is sold or exercised.
Accordingly, a customer may be
required to deposit cash in the account
in order to meet a variation payment on
a futures contract even though the
customer is in a hedged position and
has experienced a corresponding (but
yet unrealized) gain on a long option.
Alternatively, a customer who is in a
hedged position and would otherwise
be entitled to receive a variation
payment on a futures contract may find
that the cash is required to be held in
the account as margin collateral on an
offsetting option position.
36. Customers should consult with
their tax advisers to be certain that they
are familiar with the tax treatment of
transactions in index products,
including tax consequences of trading
strategies involving both futures and
option contracts.
37. The descriptions in this disclosure
statement relating to eligibility
requirements for cross-margining, and
minimum equity and margin
requirements for cross margin accounts,
are minimums imposed under Exchange
rules. Time frames within which margin
and equity calls must be met are
maximums imposed under Exchange
rules. The broker-dealer carrying a
customer’s portfolio margin account,
including any cross-margin account,
may impose [its own] more stringent
requirements.
*
*
*
*
*
erjones on PROD1PC61 with NOTICES
Sample Portfolio Margining and CrossMargining Acknowledgements
Acknowledgement for Customers
Utilizing a Portfolio Margin Account—
Cross-Margining And Non-CrossMargining—
Rule 15c3–3 under the Securities
Exchange Act of 1934 requires that a
broker or dealer promptly obtain and
maintain physical possession or control
of all fully-paid securities and excess
margin securities of a customer. Fullypaid securities are securities carried in
a cash account and margin equity
securities carried in a margin or special
account (other than a cash account) that
have been fully paid for. Excess margin
securities are a customer’s margin
securities having a market value in
excess of 140% of the total of the debit
balances in the customer’s non-cash
accounts. For the purposes of Rule
15c3–3, securities held subject to a lien
to secure obligations of the brokerdealer are not within the broker-dealer’s
VerDate Aug<31>2005
13:01 Jan 20, 2006
Jkt 208001
physical possession or control. The
Commission staff has taken the position
that all long option positions in a
customer’s portfolio[-]margining
account (including any cross-margin
account) may be subject to such a lien
by OCC and will not be deemed fullypaid or excess margin securities under
Rule 15c3–3.
The hypothecation rules under the
Securities Exchange Act of 1934 (Rules
8c–1 and 15c2–1)[,] prohibit brokerdealers from permitting the
hypothecation of customer securities in
a manner that allows those securities to
be subject to any lien or liens in an
amount that exceeds the customer’s
aggregate indebtedness. However, all
long option positions in a portfolio[]margining account (including any
cross-margining account) will be subject
to OCC’s lien, including any positions
that exceed the customer’s aggregate
indebtedness. The Commission staff has
taken a position that would [to] allow
customers to carry positions in
portfolio[-]margining accounts[,]
(including any cross-margining account)
even when those positions exceed the
customer’s aggregate indebtedness.
Accordingly, within a portfolio margin
account or cross-margin account, to the
extent that you have long option
positions that do not operate to offset
your aggregate indebtedness and thereby
reduce your margin requirement, you
receive no benefit from carrying those
positions in your portfolio[-]margin
account or cross-margin account and
incur the additional risk of OCC’s lien
on your long option position(s).
By signing below the customer affirms
that the customer has read and
understood the foregoing disclosure
statement and acknowledges and agrees
that long option positions in portfolio[]margining accounts, and crossmargining accounts, will be exempted
from certain customer protection rules
of the Securities and Exchange
Commission as described above and
will be subject to a lien by the options
clearing corporation without regard to
such rules.
Customer Name: llllllllll
By: llllllllllllllll
Date: llllllllllllllll
(Signature/title)
Acknowledgement for Customers
Engaged in Cross-Margining
As disclosed above, futures contracts
and other property carried in customer
accounts with Futures Commission
Merchants (‘‘FCM’’) are normally
subject to special protection afforded
under the customer segregation
provisions of the Commodity Exchange
PO 00000
Frm 00139
Fmt 4703
Sfmt 4703
Act (‘‘CEA’’) and the rules of the
Commodity Futures Trading
Commission adopted pursuant to the
CEA. These rules require that customer
funds be segregated from the accounts of
financial intermediaries and be
accounted for separately. However, they
do not provide for, and standard
[regular] futures accounts do not enjoy
the benefit of, insurance protecting
customer accounts against loss in the
event of the insolvency of the
intermediary carrying the accounts.
As discussed above, cross-margining
must be conducted in a portfolio margin
account, dedicated exclusively to crossmargining and cross-margin accounts
are not treated as a futures account with
an FCM. Instead, cross-margin accounts
are treated as securities accounts carried
with broker-dealers. As such, crossmargin accounts are covered by Rule
15c3–3 under the Securities Exchange
Act of 1934, which protects customer
accounts. Rule 15c3–3, among other
things, requires a broker-dealer to
maintain physical possession or control
of all fully-paid and excess margin
securities and maintain a special reserve
account for the benefit of their
customers. However, with regard to
cross-margin accounts, there is an
exception to the possession or control
requirement of Rule 15c3–3 that permits
The Options Clearing Corporation to
have a lien on long positions. This
exception is outlined in a separate
acknowledgement form that must be
signed prior to or concurrent with this
form. Additionally, the Securities
Investor Protection Corporation
(‘‘SIPC’’) insures customer accounts
against the financial insolvency of a
broker-dealer in the amount of up to
$500,000 to protect against the loss of
registered securities and cash
maintained in the account for
purchasing securities or as proceeds
from selling securities (although the
limit on cash claims is $100,000).
According to the rules of the exchanges,
a broker-dealer is required to
immediately liquidate[,] or, if feasible,
transfer to another broker-dealer eligible
to carry cross-margin accounts, all
customer cross-margin accounts that
contain positions in futures and/or
options on futures in the event that the
carrying broker-dealer becomes
insolvent.
By signing below the customer affirms
that the customer has read and
understood the foregoing disclosure
statement and acknowledges and agrees
that: (1) Positions and property in crossmargining accounts, will not be subject
to the customer protection rules under
the customer segregation provisions of
the Commodity Exchange Act and the
E:\FR\FM\23JAN1.SGM
23JAN1
Federal Register / Vol. 71, No. 14 / Monday, January 23, 2006 / Notices
rules of the Commodity Futures Trading
Commission adopted pursuant to the
CEA and (2) cross-margining accounts
that contain positions in futures and/or
options on futures will be immediately
liquidated, or if feasible, transferred to
another broker-dealer eligible to carry
cross-margin accounts in the event that
the carrying broker-dealer becomes
insolvent.
Customer Name: llllllllll
By: llllllllllllllll
Date: llllllllllllllll
(Signature/title)
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
Amendments to NYSE Rule 431
(‘‘Margin Requirements’’) are proposed
that would include security futures 8
and single stock options as products
eligible for treatment under portfolio
margin requirements as part of the
Portfolio Margin Pilot Program recently
approved by the Commission.
Amendments to Rule 726 (‘‘Delivery of
Options Disclosure Document and
Prospectus’’) also are proposed to
include the SEC approved products on
the disclosure document required to be
furnished to customers pursuant to this
rule.
erjones on PROD1PC61 with NOTICES
a. Background
Section 7(a) 9 of the Exchange Act of
1934 10 empowers the Board of
Governors of the Federal Reserve
System to prescribe the rules and
regulations regarding credit that may be
extended by broker-dealers on securities
(Regulation T) to their customers. NYSE
Rule 431 prescribes specific margin
8 For purposes of this filing term ‘‘security
futures’’ utilizes the definition at Section 3(a)(55) of
the Exchange Act, excluding narrow-based security
indices.
9 15 U.S.C. 78g.
10 15 U.S.C. 78a et seq.
VerDate Aug<31>2005
13:01 Jan 20, 2006
Jkt 208001
requirements that must be maintained
in all customer accounts, based on the
type of securities products held in such
accounts.
In April 1996, the Exchange
established a Rule 431 Committee (the
‘‘Committee’’) to assess the adequacy of
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 Committee
has endorsed the proposed amendments
discussed below.11
b. The Pilot
The Board of Governors of the Federal
Reserve System in its amendments to
Regulation T in 1998 permitted SROs to
implement portfolio margin rules,
subject to SEC approval.12 As noted
above, on July 14, 2005 the Commission
approved amendments to Exchange
Rules 431 and 726 to permit, on a two
year pilot basis, the use of a prescribed
risk-based methodology (‘‘Portfolio
Margin’’) 13 for certain products as an
alternative to the strategy or position
based margin requirements currently
required in Rule 431(a) through (f).
Exchange member organizations may
utilize portfolio margin for listed, broadbased U.S. index options and index
warrants, along with any underlying
instruments.14 These positions are to be
margined (either for initial or
11 The Committee is composed of several member
organizations, including Goldman, Sachs & Co.,
Morgan Stanley & Co., Inc., Merrill Lynch, Pierce,
Fenner and Smith, Inc., Bear Stearns Corp. and
Credit Suisse First Boston Corp. and several selfregulatory organizations, including: the NYSE, the
Chicago Board Options Exchange, the Options,
Clearing Corporation, the American Stock
Exchange, the Chicago Board of Trade, the Chicago
Mercantile Exchange, and the National Association
of Securities Dealers.
12 See Federal Reserve System, ‘‘Securities Credit
Transactions; Borrowing by Broker and Dealers;’’
Regulations G, T, U and X; Docket Nos. R–0905, R–
0923 and R–0944, 63 FR 2806 (January 16, 1998).
13 As a pre-condition to permitting portfolio
margining, member organization are required to
establish procedures and guidelines to monitor
credit risk to the member organization’s capital,
including intra-day credit risk and stress testing of
portfolio margin accounts. Further, member
organizations must establish procedures for regular
review and testing of these required risk analysis
procedures (see Rule 431(g)(1)).
14 For purposes of these amendments, the term
‘‘underlying instrument,’’ means long and short
positions in an exchange traded fund of other fund
product registered under the Investment Company
Act of 1940, that holds the same securities, and in
the same proportion, as contained in a broad-based
index on which options are listed. The term
‘‘underlying instrument’’ shall not be deemed to
include futures contracts, options on futures
contracts, underlying stock baskets, or unlisted
instruments.
PO 00000
Frm 00140
Fmt 4703
Sfmt 4703
3593
maintenance) in a separate portfolio
margin account dedicated exclusively
for such margin computation.
c. Strategy or Positioned-Based Margin
Requirements
Prior to the Pilot, member
organizations were subject, pursuant to
NYSE Rule 431, to strategy or
positioned-based margin requirements.
This methodology applied specific
margin percentage requirements as
prescribed in Rule 431 to each security
position and/or strategy, either long or
short, held in a customer’s account,
irrespective of the fact that all security
(e.g., options) prices do not change
equally (in percentage terms) with a
change in the price of the underlying
security. As discussed in more detail
below, when utilizing a portfolio margin
methodology, offsets are fully realized,
whereas under strategy or positionbased methodology, positions and or
groups of positions comprising a single
strategy are margined independently of
each other and offsets between them do
not efficiently impact the total margin
requirement.
d. Portfolio Margin Requirements
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.
The Pilot utilizes a Commission
approved theoretical options pricing
model using multiple pricing scenarios
to set or determine the risk level.15
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.
Generally, the purpose and benefit of
portfolio margining is to efficiently set
levels of margin that reflect historical
moves that more precisely reflects
actual net risk of all positions in the
account. A customer benefits from
portfolio margining in that margin
requirements calculated on net position
15 The theoretical options pricing model is used
to derive position values at each valuation point for
the purpose of determining the gain or loss. The
amount of initial and maintenance margin required
with respect to a portfolio would be the larger of:
(1) The greatest loss amount among the valuation
calculations; or (2) the sum of $.375 for each option
and security future in the portfolio multiplied by
the contract’s (e.g. 100 shares per contract) or
instrument’s multiplier. This computation
establishes a minimum margin requirement to
ensure that a certain level of margin is required
from a customer.
E:\FR\FM\23JAN1.SGM
23JAN1
3594
Federal Register / Vol. 71, No. 14 / Monday, January 23, 2006 / Notices
risk are generally lower than strategybased margin methodologies currently
in place. In permitting margin
computation based on actual net risk,
member organizations are no longer
required to compute a margin
requirement for each individual
position or strategy in a customer’s
account (see NYSE Rule 431).
As discussed in more detail below,
utilizing portfolio margin for options
portfolios and any related instruments
enables the portfolio to be subjected to
certain preset market volatility
parameters that reflect historical moves
in the underlying security thereby
assessing potential loss in the portfolio
in the aggregate. Accordingly, such a
methodology provides an accurate and
realistic assessment of reasonable
margin requirements.
e. Proposed Amendments
The Exchange and CBOE received
letters in late September 2005 from
Commission Chairman Christopher Cox
asking the SROs to consider expanding
portfolio margining to a broader
universe of products. The Commission
encouraged the Exchanges to file a rule
proposal before year-end.16
Accordingly, the Exchange is proposing
the amendments discussed below.
f. Eligible Products/Minimum Equity
Requirements
The proposed amendments to Rule
431 seek to expand the eligible products
previously approved, provided all
products can be priced within a
prescribed risk-based theoretical pricing
methodology. Specifically, the proposed
amendments will expand the eligible
products to include security futures as
well as listed single stock options. The
proposed amendments will also permit
customers effecting transactions in
security futures and listed single stock
options to do so without maintaining
the $5 million equity requirement,
which is currently required under the
Pilot for all other eligible products.
erjones on PROD1PC61 with NOTICES
g. Valuation Points
Further, the proposed amendments
will establish theoretical prices at 10
equidistant valuation points within a
range consisting of an increase or a
decrease of +/¥15% 17 (i.e., +/¥3%,
16 Chairman of the Commission, Christopher Cox,
in a letter dated September 27, 2005, to William J.
Brodsky and John A. Thain, the Chief Executive
Offices of CBOE and NYSE, respectively,
encouraged each SRO to file a rule proposal to make
portfolio margin available to equity options and
security futures with the Commission by year-end
2005.
17 The Pilot established valuation points for the
following eligible products: Non-High
Capitalization/Broad-based U.S. Market Index
VerDate Aug<31>2005
13:01 Jan 20, 2006
Jkt 208001
6%, 9%, 12%, and 15%) in the current
market value of the underlying
instrument. As proposed, the price
range for computing a portfolio margin
requirement is the same parameter
required under Appendix A of Rule
15c3–1a 18 under the Exchange Act for
computing deductions to a firm’s net
capital for proprietary positions.
Currently the only theoretical model
qualified pursuant to Rule 15c3–1a
under the Exchange Act is the
Theoretical Intermarket Margin System
(‘‘TIMS’’) administered by The Options
Clearing Corporation.
h. Margin Deficiency
In addition, the proposed
amendments will require a member
organization to deduct from its net
capital the amount of any portfolio
margin maintenance call which is not
met by the close of business of trade
date plus one (T+1).19 Member
organizations will not be permitted to
deduct any portfolio margin
maintenance call amount from net
capital in lieu of collecting the required
margin.
i. Definitions
The proposed amendments expand
upon the core definition of the term
‘‘equity’’ as defined in section (a)(4) of
Rule 431 (see proposed Rule
431(g)(2)(H) for purposes of portfolio
margin and cross-margin to include the
market value of any long or short option
positions held in an eligible
participant’s account. In addition, other
non-substantive changes and/or
modification to other definitions in Rule
431 were made in light of the proposed
amendments.
Options (+/¥10%) and High Capitalization/Broadbased U.S. Market Index Options (+6%/¥8%).
18 17 CFR 240.15c3–1a(b)(1)(i)(B). The
requirements of this rule include, among other
things, that any model be non-proprietary,
approved by a Designated Examining Authority
(‘‘DEA’’) and available on the same terms to all
broker-dealers. Referencing to the SEC’s net capital
coupled with DEA approval and SEC review assures
uniformity across pricing models and that portfolio
and cross-margin requirements will not vary
significantly from firm to firm.
19 Several paragraphs in the proposed rule
amendments use the term ‘‘portfolio margin
maintenance call’’ rather than the term ‘‘portfolio
margin maintenance deficiency.’’ The proposed rule
text was intended to measure the time period for
a customer to meet a margin call or a member to
make a deduction in calculating net capital from the
time of the margin deficiency, not the time of the
margin call. The Exchange has represented that it
will amend the proposed rule changes to clarify this
technical non-substantive change prior to any
Commission approval of the proposed rule change.
Telephone conversation between William Jannace,
Director, Rule and Interpretive Standards, Member
Firm Regulation, NYSE and Randall Roy, Branch
Chief, and Sheila Swartz, Special Counsel, Division
of Market Regulation, Commission, on January 13,
2006.
PO 00000
Frm 00141
Fmt 4703
Sfmt 4703
j. Disclosure Document and Customer
Attestation
Exchange Rule 726 prescribes
requirements for the delivery of options
disclosure documents concerning the
opening of customer accounts. As part
of the Pilot amendments, members and
member organizations are 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 crossmargining. The statement discloses the
special risk and operation of portfolio
margin accounts, including crossmargining, and the differences between
portfolio margin and strategy-based
margin requirements. The disclosure
statement also addresses 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.
In addition, at or prior to the time a
portfolio margin account is initially
opened, members and member
organizations are required to obtain a
signed acknowledgement regarding
certain implications of portfolio
margining (e.g. treatment under
Exchange Act Rules 8c–1, 15c2–1 and
15c3–3) from the customer. Further,
prior to providing cross-margining,
members and member organizations are
required to obtain a second signed
customer acknowledgement relative to
the segregation treatment for futures
contracts and Securities Investor
Protection Corporation coverage. As
proposed, the disclosure document
required by Rule 726 is being amended
to incorporate the approved
Commission products.
Finally, the filing includes several
minor technical amendments to the
rules for purposes of clarity and
consistency.
2. Statutory Basis
The statutory basis for this proposed
rule change is Section 6(b)(5) 20 of the
Exchange Act which requires, among
other things, that the rules of the
Exchange are designed to prevent
fraudulent and manipulative acts and
practices, to promote just and equitable
principles of trade, to foster cooperation
and coordination with persons engaged
in regulating, clearing, settling,
processing information with respect to,
and facilitating transactions in
securities, to remove impediments to
perfect the mechanism of a free and
20 15
E:\FR\FM\23JAN1.SGM
U.S.C. 78f(b)(5).
23JAN1
Federal Register / Vol. 71, No. 14 / Monday, January 23, 2006 / Notices
open market and national market
system, and in general to protect
investors and the public interest. The
proposed amendments are consistent
with this section in that they will better
align margin requirements with the
actual risk of hedged products, will also
potentially alleviate excess margin calls
and potentially reduce the risk of forced
liquidations of positions in customer
accounts.
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 not
necessary or appropriate in furtherance
of the purposes of the Exchange 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.
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 is consistent with the Exchange
Act. Comments may be submitted by
any of the following methods:
All submissions should refer to File
Number SR–NYSE–2005–93. This file
number should be included on the
subject line if e-mail is used. To help the
Commission process and review your
comments more efficiently, please use
only one method. The Commission will
post all comments on the Commission’s
Internet Web site (https://www.sec.gov/
rules/sro/shtml). 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 also will be
available for inspection and copying at
the principal office of the NYSE. All
comments received will be posted
without change; the Commission does
not edit personal identifying
information from submissions. You
should submit only information that
you wish to make available publicly. All
submission should refer to File Number
SR-NYSE–2005–93 and should be
submitted on or before February 13,
2006.
For the Commission, by the Division of
Market Regulation, pursuant to delegated
authority.21
Nancy M. Morris,
Secretary.
[FR Doc. E6–668 Filed 1–20–06; 8:45 am]
BILLING CODE 8010–01–P
erjones on PROD1PC61 with NOTICES
Electronic Comments
• Use the Commission’s Internet
comment form (https://www.sec.gov/
rules/sro.shtml); or
• Send e-mail to rulecomments@sec.gov. Please include File
Number SR–NYSE–2005–93 on the
subject line.
Paper Comments
• Send paper comments in triplicate
to Nancy M. Morris, Secretary,
Securities and Exchange Commission,
100 F Street, NE., Washington, DC
20549–9303.
VerDate Aug<31>2005
13:01 Jan 20, 2006
Jkt 208001
SECURITIES AND EXCHANGE
COMMISSION
[Release No. 34–53124; File No. SR–NYSE–
2005–37]
Self-Regulatory Organizations; New
York Stock Exchange, Inc.; Order
Approving a Proposed Rule Change
and Amendments No. 1 and 2 Thereto
and Notice of Filing and Order
Granting Accelerated Approval to
Amendment No. 3 Thereto Relating to
Amendments to Certain Sections of
the Exchange Constitution Concerning
the Exchange’s Hearing Board and
Related Amendments to Exchange
Rule 475 and Rule 476
January 13, 2006.
I. Introduction
On May 23, 2005, the New York Stock
Exchange, Inc. (‘‘NYSE’’ 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 thereunder,2 a proposed rule
change to amend Article IX of the
Exchange’s Constitution and Exchange
Rules 475 and 476 to modify certain
aspects of the Exchange’s disciplinary
procedures and to provide a structure
for a summary suspension hearing and
a ‘‘call up’’ procedure for review by
members of the Board of Directors
(‘‘Board’’), certain members of the Board
of Executives listed in NYSE Rule
476(f), any member of the Regulation,
Enforcement and Listing Standards
Committee, and either the Division of
the Exchange that initiated the
proceedings or the respondent. On
September 9, 2005, the NYSE filed
Amendment No. 1 to the proposed rule
change. The proposed rule change, as
amended by Amendment No. 1, was
published for comment in the Federal
Register on October 26, 2005.3 The
Commission received no comments
regarding the proposal, as amended. On
November 28, 2005 and December 2,
2005, the NYSE filed Amendments No.
2 4 and 3,5 respectively, to the proposed
rule change. This order approves the
proposed rule change, as amended by
1 15
U.S.C. 78s(b)(1).
CFR 240.19b–4.
3 See Securities Exchange Act Release No. 52638
(October 19, 2005), 70 FR 61866.
4 In Amendment No. 2, the Exchange makes
minor, non-substantive changes to the rule text
contained in Exhibit 5 of the proposed rule change.
This was a technical amendment and is not subject
to notice and comment.
5 In Amendment No. 3, the Exchange proposes
that the proposed rule change, as amended, be
implemented on or about April 1, 2006 and attaches
a revised Exhibit 5 to reflect changes made to the
rule text in Amendments No. 1 and 2.
2 17
21 17
PO 00000
CFR 200.30–3(a)(12).
Frm 00142
Fmt 4703
Sfmt 4703
3595
E:\FR\FM\23JAN1.SGM
23JAN1
]]>Agencies
[Federal Register Volume 71, Number 14 (Monday, January 23, 2006)]
[Notices]
[Pages 3586-3595]
From the Federal Register Online via the Government Printing Office [www.gpo.gov]
[FR Doc No: E6-668]
-----------------------------------------------------------------------
SECURITIES AND EXCHANGE COMMISSION
[Release No. 34-53126; File No. SR-NYSE-2005-93]
Self-Regulatory Organizations; New York Stock Exchange, Inc;
Notice of Filing of Proposed Rule Change to Rule 431 (``Margin
Requirements'') and Rule 726 (``Delivery of Options Disclosure Document
and Prospectus'') To Expand the Products Eligible for Customer
Portfolio Margining and Cross-Margining
January 13, 2006.
Pursuant to Section 19(b)(1) of the Securities Exchange Act of 1934
(the ``Exchange Act''),\1\ and Rule 19b-4 thereunder,\2\ notice is
hereby given that on December 29, 2005, the New York Stock Exchange,
Inc. (``NYSE'' or the ``Exchange'') filed with the Securities and
Exchange Commission (the ``Commission'') the proposed rule change as
described in Items I, II, and III below, which Items have been prepared
by the Exchange. The Commission is publishing this notice to solicit
comments on the proposed rule change from interested persons.
---------------------------------------------------------------------------
\1\ 15 U.S.C. 78s(b)(1).
\2\ 17 CFR 240.19b-4.
---------------------------------------------------------------------------
I. Self-Regulatory Organization's Statement of the Terms of Substance
of the Proposed Rule Change
The NYSE is filing with the Commission proposed amendments to NYSE
Rule 431 (``Margin Requirements'') that would expand the scope of
products that are eligible for treatment as part of the Commission's
approved Portfolio Margin Pilot Program (the ``Pilot'').\3\ Amendments
to Rule 726 (``Options Disclosure Document'') also are proposed to
include the Commission approved products on the disclosure document
required to be furnished to customers pursuant to this rule. The text
of the proposed rule change is below. Additions are in italics.
Deletions are in brackets.
---------------------------------------------------------------------------
\3\ See Securities Exchange Act Release No. 52031 (July 14,
2005), 70 FR 42130 (July 21, 2005), (SR-NYSE-2002-19). On July 14,
2005, the Commission approved on a Pilot Basis expiring July 31,
2007, amendments to Exchange Rule 431 to permit the use of a
prescribed risk-based margin requirement (``portfolio margin'') for
certain specified products as an alternative to the strategy based
margin requirements currently required in section (a) through (f) of
the Rule. Amendments to Rule 726 were also approved to require
disclosure to, and written acknowledgement from, customers in
connection with the use of portfolio margin. See NYSE Information
Memo 05-56, dated August 18, 2005 for additional information.
---------------------------------------------------------------------------
* * * * *
Margin Requirements
Rule 431. (a) through (f) unchanged.
Portfolio Margin and Cross-Margin [for Index Options]
(g) As an alternative to the [``strategy'' based] ``strategy-
based'' margin requirements set forth in sections [paragraphs] (a)
through (f) of this Rule, member organizations may elect to apply the
portfolio margin requirements set forth in this section (g) to [margin
for] (1) listed, broad-based U.S. index options, index warrants and
underlying instruments and (2) listed security futures contracts \4\
and listed single stock options, (See section (g)(6)(C)(1)). [(as
defined below) in accordance with the portfolio margin requirements set
forth in this Rule.]
---------------------------------------------------------------------------
\4\ For purposes of this section of the Rule, the term
``security future'' utilizes the definition at section 3(a)(55) of
the Exchange Act, excluding narrow-based security indices.
---------------------------------------------------------------------------
In addition, member organizations, provided they are a Futures
Commission Merchant (``FCM'') and are either a clearing member of a
futures clearing organization or have an affiliate that is a clearing
member of a futures clearing organization, are permitted under this
section (g) to combine an eligible participant's [a customer's] related
instruments [(] as defined in section (g)(2)(C), [below) and] with
listed, broad-based U.S. index options, index warrants and underlying
instruments and compute a margin requirement for such combined products
[(``cross margin'')] on a portfolio margin basis[.](``cross-margin'').
Member organizations must confine cross-margin positions to a portfolio
margin account dedicated exclusively to cross-margining.
The portfolio margin and cross-margining provisions of this Rule
shall not apply to Individual Retirement Accounts (``IRAs'').
(1) Member organizations must [will be expected to] monitor the
risk of portfolio margin accounts and maintain a written risk analysis
methodology for assessing the potential risk to the member
organization's capital over a specified range of possible market
movements of positions maintained in such accounts. The risk analysis
methodology shall specify the computations to be made, the frequency of
computations, the records to be reviewed and maintained, and the
person(s) [position(s)] within the organization responsible for the
risk function. This risk analysis methodology shall be made available
to the Exchange upon request. In performing the risk analysis of
portfolio margin accounts required by this Rule, each member
organization shall include the following in the written risk analysis
methodology:
(A) Procedures and guidelines for the determination, review and
approval of credit limits to each eligible participant, [customer,] and
across all eligible participants, [customers,] utilizing a portfolio
margin account.
(B) Procedures and guidelines for monitoring credit risk exposure
to the member organization, including intra-day credit risk, related to
portfolio margin accounts.
(C) Procedures and guidelines for the use of stress testing of
portfolio margin accounts in order to monitor market risk exposure from
individual accounts and in the aggregate.
(D) Procedures providing for the regular review and testing of
these risk analysis procedures by an independent unit such as internal
audit or other comparable group.
(2) Definitions.--For purposes of this section [paragraph] (g), the
following terms shall have the meanings specified below:
(A) The term ``listed option'' [shall] means any option traded on a
registered national securities exchange or
[[Page 3587]]
automated facility of a registered national securities association.
(B) [(F)] The term ``underlying instrument'' means long and short
positions in an exchange traded fund or other fund product registered
under the Investment Company Act of 1940, that holds the same
securities, and in the same proportion, as contained in a broad-based
index on which options are listed. The term ``underlying instrument''
shall not be deemed to include[,] futures contracts, options on futures
contracts, underlying stock baskets, or unlisted instruments.
(C) [(E]) The term ``related instrument'' within an option class or
product group means futures contracts and options on futures contracts
covering the same underlying instrument.
(D) [(B)] The term ``options class'' refers to all options
contracts covering the same underlying instrument.
(E) [(C)] The term ``portfolio'' means any eligible product, as
defined in section (g)(6)(C)(1), [options of the same options class]
grouped with their underlying instruments and related instruments.
(F) [(D)] The term ``option series'' relates to listed options and
means all option contracts of the same type (either a call or a put)
and exercise style, covering the same underlying instrument with the
same exercise price, expiration date, and number of underlying units.
(G) The term ``product group'' means two or more portfolios of the
same type (see table in section [sub-paragraph] (g)(2) [(H)] (I) below)
for which it has been determined by Rule 15c3-1a under the Securities
Exchange Act of 1934 that a percentage of offsetting profits may be
applied to losses at the same valuation point.
(H) For purposes of portfolio margin and cross-margin the term
``equity'', as defined in section (a)(4) of this Rule, includes the
market value of any long or short option positions held in an eligible
participant's account.
(I) [(H)] The term ``theoretical gains and losses'' means the gain
and loss in the value of individual eligible products [option series]
and related instruments at 10 equidistant intervals (valuation points)
ranging from an assumed movement (both up and down) in the current
market value of the underlying instrument. The magnitude of the
valuation point range shall be as follows: \5\ \6\
---------------------------------------------------------------------------
\5\ In accordance with section [sub-paragraph] (b)(1)(i)(B) of
Rule 15c3-1a (Appendix A to Rule 15c3-1) under the Securities
Exchange Act of 1934, 17 CFR 240.15c3-1a(b)(1)(i)(B).
\6\ See footnote above.
------------------------------------------------------------------------
Up/down
market move
Portfolio type (high & low
valuation
points)
------------------------------------------------------------------------
Listed Security Futures Contract and Listed Single Stock +/-15%
Option....................................................
Non-High Capitalization, Broad-based U.S. Market Index +/-10%
Option....................................................
High Capitalization, Broad-based U.S. Market Index Option.. +6%/-8%
------------------------------------------------------------------------
(3) Approved Theoretical Pricing Models.--Theoretical pricing
models must be approved by a Designated Examining Authority and
reviewed by the Securities and Exchange Commission (``The Commission'')
in order to qualify. Currently, the theoretical model utilized by [The]
the Options Clearing Corporation (``[The] OCC'')[,] is the only model
qualified pursuant to [The] the Commission's Net Capital Rule. All
member organizations [participating in the pilot program] shall obtain
their theoretical values from [The] the OCC.
(4) Eligible Participants.--The application of the portfolio margin
provisions of this section [paragraph] (g), including cross-margining,
is limited to the following:
(A) any broker or dealer registered pursuant to Section 15 of the
Securities Exchange Act of 1934;
(B) any member of a national futures exchange to the extent that
listed index options hedge the member's index futures; and
(C) any other person or entity not included in sections (g)(4)(A)
and [through] (g)(4)(B) above that has or establishes, and maintains,
equity of at least five [5] million dollars. For purposes of this
equity requirement, all securities and futures accounts carried by the
member organization for the same eligible participant [customer] may be
combined provided ownership across the accounts is identical. A
guarantee pursuant to section [paragraph] (f)(4) of this Rule is not
permitted for purposes of the minimum equity requirement. For those
accounts that are solely limited to listed security futures contracts
and listed single stock options, the five million dollar equity
requirement shall be waived.
(5) Opening of Accounts.
(A) Member organizations must notify and receive approval from the
Exchange prior to establishing a portfolio margin or cross-margin
methodology for eligible participants.
(B) [(A)] Only eligible participants [customers] that have been
approved for options transactions and approved to engage in uncovered
short option contracts pursuant to Exchange Rule 721, are permitted to
utilize a portfolio margin account.
(C) [(B)] On or before the date of the initial transaction in a
portfolio margin account, a member organization shall:
(1) [(i)] furnish the eligible participant [customer] with a
special written disclosure statement describing the nature and risks of
portfolio margining and cross-margining which includes an
acknowledgement for all portfolio margin account owners to sign, and an
additional acknowledgement for owners that also engage in cross-
margining to sign, attesting that they have read and understood the
disclosure statement, and agree to the terms under which a portfolio
margin account and the cross-margin account respectively, are provided
(see Exchange Rule 726 (d)), and (2) [(ii)] obtain the signed
acknowledgement(s) noted above from the eligible participant [customer]
(both of which are required for cross-margining eligible participants
[customers]) and record the date of receipt.
(6) Establishing Account and Eligible Positions.
(A) [(1)] Portfolio Margin Account. For purposes of applying the
portfolio margin requirements [provided] prescribed in this [paragraph]
section (g), member organizations are to establish and utilize a
specific securities margin account, or sub-account of a margin account,
clearly identified as a portfolio margin account that is separate from
any other securities account carried for an eligible participant [a
customer].
(B) [(2)] Cross-Margin Account. For purposes of combining related
instruments [and] with listed, broad-based U.S. index options, index
warrants, and underlying instruments, and applying the portfolio margin
requirements, member[s] organizations are to establish [and utilize a
portfolio margin account, clearly identified as] a cross-margin
account[,] that is separate from any other securities account or
portfolio margin account carried for an eligible participant. [a
customer.]
[[Page 3588]]
A margin deficit in either the portfolio margin account or the
cross-margin account of an eligible participant [a customer] may not be
considered as satisfied by excess equity in the other account. Funds
and/or securities must be transferred to the deficient account and a
written record created and maintained.
(C) [(A)] Portfolio Margin Account--Eligible [Positions] Products
(1) For eligible participants as described in sections (g)(4)(A)
through (g)(4)(C), [(i) A] a transaction in, or transfer of, [a listed,
broad-based U.S. index option or index warrant] an eligible product may
be effected in the portfolio margin account. Eligible products under
this section consist of:
(i) a listed, broad-based U.S. index option or index warrant and
underlying instrument.
(ii) a listed security futures contract or listed single stock
option.
(2) [(ii)] A transaction in, or transfer of, an underlying
instrument may be effected in the portfolio margin account provided a
position in an offsetting listed, broad-based U.S. index option or
index warrant is in the account or is established in the account on the
same day.
(3) A transaction in, or transfer of, a listed security futures
contract or listed single stock option may also be effected in the
portfolio margin account.
(4) Any long position or any short position in any eligible product
that is no longer part of a hedge strategy must be transferred from the
portfolio margin account to the appropriate securities account within
ten business days, subject to any applicable margin requirement, unless
the position becomes part of a hedge strategy again. Member
organizations must monitor portfolio margin accounts for possible abuse
of this provision.
[(iii) If, in the portfolio margin account, the listed, broad-based
U.S. index option or index warrant position offsetting an underlying
instrument position ceases to exist and is not replaced within ten
business days, the underlying instrument position must be transferred
to a regular margin account, subject to initial Regulation T and
margined according to the other provisions of this Rule. Member
organizations will be expected to monitor portfolio margin accounts for
possible abuse of this provision.
(iv) In the event that fully paid for long options and/or index
warrants are the only positions contained within a portfolio margin
account, such long positions must be transferred to a securities
account other than a portfolio margin account or cross-margin account
within 10 business days, subject to the margin required, unless the
status of the account changes such that it is no longer composed solely
of fully paid for long options and/or index warrants.]
(D)[(B)] Cross-Margin Account--Eligible [Positions] Products
(1) For eligible participants, as described in sections (g)(4)(A)
through (g)(4)(C), a transaction in, or transfer of, an eligible
product may be effected in the cross-margin account.
(2) [(i)] A transaction in, or transfer of, a related instrument
may be effected in the cross-margin account provided a position in an
offsetting eligible product [listed, U.S. broad-based index option,
index warrant or underlying instrument] is in the account or is
established in the account on the same day.
(3) Any long position or any short position in any eligible product
that is no longer part of a hedge strategy must be transferred from the
cross-margin account to the appropriate securities account or futures
account within ten business days, subject to any applicable margin
requirement, unless the position becomes part of a hedge strategy
again. Member organizations must monitor cross-margin accounts for
possible abuse of this provision.
[(ii) If the listed, U.S. broad-based index option, index warrant
or underlying instrument position offsetting a related instrument
ceases to exist and is not replaced within ten business days, the
related instrument position must be transferred to a futures account
and margined accordingly. Member organizations will be expected to
monitor cross-margin accounts for possible abuse of this provision.
(iii) In the event that fully paid for long options and/or index
warrants (securities) are the only positions contained within a cross-
margin account, such long positions must be transferred to a securities
account other than a portfolio margin account or cross margin account
within 10 business days, subject to the margin required, unless the
status of the account changes such that it is no longer composed solely
of fully paid for long options and/or index warrants.]
(7) Initial and Maintenance Margin Required.--The amount of margin
required under this section [paragraph] (g) for each portfolio shall be
the greater of:
(A) the amount for any of the 10 equidistant valuation points
representing the largest theoretical loss as calculated pursuant to
section [paragraph] (g)(8) below, or
(B) $.375 for each contract [listed index option] and related
instrument multiplied by the contract's or instrument's multiplier, not
to exceed the market value in the case of long positions in eligible
products. [listed options and options on futures contracts.]
(C) Account guarantees pursuant to section [paragraph] (f)(4) of
this Rule are not permitted for purposes of meeting initial and
maintenance margin requirements.
(8) Method of Calculation.
(A) Long and short contracts, [positions in listed options,]
including underlying instruments and related instruments, are to be
grouped [by option class; each option class group being] as a
``portfolio.''[.] Each portfolio is categorized as one of the portfolio
types specified in section [sub-paragraph] (g)(2)(I) [(H)] above.
(B) For each portfolio, theoretical gains and losses are calculated
for each position as specified in section [sub-paragraph] (g)(2)(I)
[(H)] above. For purposes of determining the theoretical gains and
losses at each valuation point, member organizations shall obtain and
utilize the theoretical values of eligible products as described in
this section [a listed index option, underlying instrument or related
instrument] rendered by an approved [a] theoretical pricing model.
[that, in accordance with sub-paragraph (b)(1)(i)(B) of Rule 15c3-1a
under the Securities Exchange Act of 1934, qualifies for purposes of
determining the amount to be deducted in computing net capital under a
portfolio based methodology.]
(C) Offsets. Within each portfolio, theoretical gains and losses
may be netted fully at each valuation point.
Offsets between portfolios within eligible product groups, as
described in section (g)(2)(I), [the High Capitalization, Broad-based
Index Option product group and the Non-High Capitalization, Broad-based
Index Option product group] may then be applied as permitted by Rule
15c3-1a under the Securities Exchange Act of 1934.
(D) After applying the [Offsets] offsets above, the sum of the
greatest loss from each portfolio is computed to arrive at the total
margin required for the account (subject to the per contract minimum).
(9) Portfolio Margin Minimum Equity Call [Equity Deficiency .--]
(A) If, at any time, the equity in the portfolio margin or cross-
margin account of an eligible participant, as described in section
(g)(4)(C), declines below the [5] five million dollar minimum equity
required, [under sub-paragraph (4)(D) of this paragraph (g)] and is not
restored to at least [5] five million dollars within three [(3)]
business days (T+3) by a deposit of
[[Page 3589]]
funds and/or securities, [;] member organizations are prohibited from
accepting opening orders starting on T+4, except that opening orders
entered for the purpose of hedging existing positions may be accepted
if the result would be to lower margin requirements. This prohibition
shall remain in effect until equity of five [5] million dollars is
established. For those accounts that are solely limited to security
futures contracts and single stock options, the five million dollar
equity requirement shall be waived.
(B) Member organizations will not be permitted to deduct any
portfolio margin minimum equity call amount from Net Capital in lieu of
collecting the minimum equity required.
(10) [(11)] Portfolio Margin Maintenance Call [Additional Margin.
--]
(A) If at any time, the equity in the [any] portfolio margin or
cross-margin account of an eligible participant, as described in
sections (g)(4)(A) through (g)(4)(C), is less than the margin required,
the eligible participant [customer] may deposit additional margin or
establish a hedge to meet the margin requirement within [one] three
business days [(T+1)] (T+3). During the three business day period,
member organizations are prohibited from accepting opening orders,
except that opening orders entered for the purpose of hedging existing
positions may be accepted if the result would be to lower margin
requirements. In the event an eligible participant [a customer] fails
to hedge existing positions or deposit additional margin within [one]
three business days, the member organization must liquidate positions
in an amount sufficient to, at a minimum, lower the total margin
required to an amount less than or equal to the account equity.
[Paragraph (f)(7) of this Rule--Practice of Meeting Regulation T Margin
Calls by Liquidation Prohibited shall not apply to portfolio margin
accounts. However, member organizations will be expected to monitor
portfolio margin and cross-margin accounts for possible abuse of this
provision.]
(B) If the portfolio margin maintenance call is not met by the
close of business T+1, member organizations will be required to deduct
from Net Capital the amount of the call until such time the call is
satisfied.
(C) Member organizations will not be permitted to deduct any
portfolio margin maintenance call amount from Net Capital in lieu of
collecting the margin required.
(11) [(10)] Determination of Value for Margin Purposes.--For the
purposes of this section [paragraph] (g), all eligible products [listed
index options] and related instrument positions shall be valued at
current market prices. Account equity for the purposes of this section
[paragraph] (g) shall be calculated separately for each portfolio
margin or cross-margin account. [by adding the current market value of
all long positions, subtracting the current market value of all short
positions, and adding the credit (or subtracting the debit) balance in
the account.]
(12) Net Capital Treatment of Portfolio Margin and Cross-Margin
Accounts.
(A) No member organization that requires margin in any eligible
participant [customer] account pursuant to section [paragraph] (g) of
this Rule shall permit [gross] the aggregate eligible participant
[customer] portfolio margin and cross-margin initial and maintenance
requirements to exceed [1,000 percent] ten times [of] its net capital
for any period exceeding three business days. The member organization
shall, beginning on the fourth business day, cease opening new
portfolio margin and cross-margin accounts until compliance is
achieved.
(B) If, at any time, a member organization's [gross] aggregate
eligible participant [customer] portfolio margin and cross-margin
requirements exceed [1,000 percent] ten times [of] its net capital, the
member organization shall immediately transmit telegraphic or facsimile
notice of such deficiency to the principal office of the Securities and
Exchange Commission in Washington, DC, [450 Fifth Street, NW.,
Washington, DC 20549; to] the district or regional office of the
Securities and Exchange Commission for the district or region in which
the member organization maintains its principal place of business; and
to the New York Stock Exchange. [its Designated Examining Authority.]
(13) Day Trading Requirements.--The requirements of section [sub-
paragraph] (f)(8)(B) of this Rule--Day-Trading shall not apply to
portfolio margin accounts or [including] cross-margin accounts.
(14) Cross-Margin Accounts--Requirements to Liquidate
(A) A member is required immediately either to liquidate, or
transfer to another broker-dealer eligible to carry cross-margin
accounts, all eligible participant [customer] cross-margin accounts
that contain positions eligible for cross-margining [in futures and/or
options on futures] if the member is:
(1) [(i)] insolvent as defined in section 101 of title 11 of the
United States Code, or is unable to meet its obligations as they
mature;
(2) [(ii)] the subject of a proceeding pending in any court or
before any agency of the United States or any State in which a
receiver, trustee, or liquidator for such debtor has been appointed;
(3) [(iii)] not in compliance with applicable requirements under
the Securities Exchange Act of 1934 or rules of the Securities and
Exchange Commission or any self-regulatory organization with respect to
financial responsibility or hypothecation of eligible participant's
[customer's] securities; or
(4) [(iv)] unable to make such computations as may be necessary to
establish compliance with such financial responsibility or
hypothecation rules.
(B) Nothing in this section [paragraph] (14) shall be construed as
limiting or restricting in any way the exercise of any right of a
registered clearing agency to liquidate or cause the liquidation of
positions in accordance with its by-laws and rules.
* * * * *
Delivery of Options Disclosure Document and Prospectus
Rule 726 (a) through (c) unchanged.
Portfolio Margining and Cross-Margining Disclosure Statement and
Acknowledgement
(d) The special written disclosure statement describing the nature
and risks of portfolio margining and cross-margining, and
acknowledgement for an eligible participant [customer] signature,
required by Rule 431(g)(5)(B) shall be in a format prescribed by the
Exchange or in a format developed by the member organization, provided
it contains substantially similar information as in the prescribed
Exchange format and has received the prior written approval of the
Exchange.
Sample Portfolio Margining and Cross-Margining Risk Disclosure
Statement To Satisfy Requirements of Exchange Rule 431(g)
Overview of Portfolio Margining
1. 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 ``product group'' as determined
by an options pricing model using multiple pricing scenarios. These
pricing 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. Portfolio margining is currently
[[Page 3590]]
limited to product classes and groups of index products relating to
listed, broad-based market indexes, listed security futures contracts
and listed single stock options.
2. The goal of portfolio margining is to set levels of margin that
more precisely reflects actual net risk. The eligible participant
[customer] benefits from portfolio margining in that margin
requirements calculated on net risk are generally lower than
alternative ``position'' or ``strategy'' based methodologies for
determining margin requirements. Lower margin requirements allow the
customer more leverage in an account.
Customers Eligible for Portfolio Margining
3. To be eligible for portfolio margining, customers (other than
broker-dealers) must meet the basic standards for having an options
account that is approved for uncovered writing and must have and
maintain at all times account net equity of not less than [$5] five
million dollars, aggregated across all accounts under identical
ownership at the clearing broker. [The] This identical ownership
requirement excludes accounts held by the same customer in different
capacities (e.g., as a trustee and as an individual) and accounts where
ownership is overlapping but not identical (e.g., individual accounts
and joint accounts). For those accounts that are solely limited to
listed security futures contracts and listed single stock options, the
five million dollar equity requirement shall be waived.
Positions Eligible for a Portfolio Margin Account
4. All positions in listed security futures contracts, listed
single stock options, listed, broad-based U.S. market index options
[and] or index warrants, [listed on a national securities exchange,
and] exchange traded funds and other products registered under the
Investment Company Act of 1940 that are managed to track the same index
that underlies permitted index options, are eligible for a portfolio
margin account.
Special Rules for Portfolio Margin Accounts
5. A portfolio margin account may be either a separate account or a
sub-account of a customer's standard [regular] margin account. In the
case of a sub-account, equity in the standard [regular] account will be
available to satisfy any margin requirement in the portfolio margin
sub-account without transfer to the sub-account.
6. A portfolio margin account or sub-account will be subject to a
minimum margin requirement of $.375 multiplied by the contract's
[index] multiplier for every contract [option contract or index
warrant] carried long or short in the account. No minimum margin is
required in the case of eligible exchange traded funds or other
eligible fund products.
7. Margin calls in the portfolio margin account or sub-account,
regardless of whether due to new commitments or the effect of adverse
market [moves] movements on existing positions, must be met within
[one] three business days. Any shortfall in aggregate net equity across
accounts must be met within three business days. Failure to meet a
portfolio margin maintenance call when due will result in immediate
liquidation of positions to the extent necessary to reduce the margin
requirement. Failure to meet [an] a minimum equity call prior to the
end of the third business day will result in a prohibition on entering
any opening orders, with the exception of opening orders that hedge
existing positions, beginning on the fourth business day and continuing
until such time as the minimum equity requirement is satisfied.
8. A position in an exchange traded index fund or other eligible
fund product may not be established in a portfolio margin account
unless there exists, or there is established on the same day, an
offsetting position in securities options, or other eligible
securities. The position(s) [Exchange traded index funds and/or other
eligible funds] will be transferred out of the portfolio margin account
and into a standard [regular] securities account subject to any
applicable margin requirement [initial Regulation T and NYSE Rule 431
margin] if the offsetting securities options, other eligible securities
and/or related instruments no longer remain in the account for ten
business days.
9. When a broker-dealer carries a standard [regular] cash account
or margin account for a customer, the broker-dealer is limited by rules
of the Securities and Exchange Commission and of The Options Clearing
Corporation (``OCC'') to the extent to which the broker-dealer may
permit OCC to have a lien against long option positions in those
accounts. In contrast, OCC will have a lien against all long option
positions that are carried by a broker-dealer in a portfolio margin
account, and this could, under certain circumstances, result in greater
losses to a customer having long option positions in such an account in
the event of the insolvency of the customer's broker. Accordingly, to
the extent that a customer does not borrow against long option
positions in a portfolio margin account or have margin requirements in
the account against which the long option can be credited, there is no
advantage to carrying the long options in a portfolio margin account
and the customer should consider carrying them in an account other than
a portfolio margin account.
Special Risks of Portfolio Margin Accounts
10. Portfolio margining generally permits greater leverage in an
account, and greater leverage creates greater losses in the event of
adverse market movements.
11. Because the time limit for meeting margin calls is shorter than
in a standard [regular] margin account, there is increased risk that a
customer's portfolio margin account will be liquidated involuntarily,
possibly causing losses to the customer.
12. Because portfolio margin requirements are determined using
sophisticated mathematical calculations and theoretical values that
must be calculated from market data, it may be more difficult for
customers to predict the size of future margin calls in a portfolio
margin account. This is particularly true in the case of customers who
do not have access to specialized software necessary to make such
calculations or who do not receive theoretical values calculated and
distributed periodically by The Options Clearing Corporation.
13. For the reasons noted above, a customer that carries long
options positions in a portfolio margin account could, under certain
circumstances, be less likely to recover the full value of those
positions in the event of the insolvency of the carrying broker.
14. Trading of securities index products in a portfolio margin
account is generally subject to all the risks of trading those same
products in a standard [regular] securities margin account. Customers
should be thoroughly familiar with the risk disclosure materials
applicable to those products, including the booklet entitled
``Characteristics and Risks of Standardized Options''.
15. Customers should consult with their tax advisers to be certain
that they are familiar with the tax treatment of transactions in
securities options [index] and futures products.
16. The descriptions in this disclosure statement relating to
eligibility requirements for portfolio margin accounts, and minimum
equity and margin requirements for those accounts,
[[Page 3591]]
are minimums imposed under Exchange rules. Time frames within which
margin and equity calls must be met are maximums imposed under Exchange
rules. Broker-dealers may impose their own more stringent requirements.
Overview Of Cross-Margining
17. In a cross-margin account, [With cross-margining,] index
futures, [and] options on index futures are combined with offsetting
positions in securities index options and underlying instruments, for
the purpose of computing a margin requirement based on the net risk.
This generally produces lower margin requirements than if the related
instruments \7\ and securities products are viewed separately, thus
providing more leverage in the account.
---------------------------------------------------------------------------
\7\ For purposes of this Rule, the term ``related instruments,''
within an option class or product means futures contracts and
options on futures contracts covering the same underlying
instrument.
---------------------------------------------------------------------------
18. Cross-margining must be effected [done] in a portfolio margin
account type. A separate portfolio margin account must be established
exclusively for cross-margining.
19. Cross-margining is achieved when [When] index futures and
options on futures are combined with offsetting positions in index
options and underlying instruments in a dedicated account, and a
portfolio margining methodology is applied to them. [, cross-margining
is achieved.]
Customers Eligible for Cross-Margining
20. The eligibility requirements for cross-margining are generally
the same as for portfolio margining. [,] Accordingly, [and] any
customer eligible for portfolio margining is eligible for cross-
margining.
21. Members of futures exchanges on which cross-margining eligible
index contracts are traded are also permitted to carry positions in
cross-margin accounts without regard to the minimum aggregate account
equity.
Positions Eligible for Cross-Margining
22. All securities products eligible for portfolio margining are
also eligible for cross-margining.
23. All broad-based U.S. listed market index futures and options on
index futures traded on a designated contract market subject to the
jurisdiction of the Commodity Futures Trading Commission (``CFTC'') are
eligible for cross-margining.
Special Rules for Cross-Margining
24. Cross-margining must be conducted in a portfolio margin account
type. A separate portfolio margin account must be established
exclusively for cross-margining. A cross-margin account is a securities
account, and must be maintained separately from all other securities
account.
25. Cross-margining is automatically accomplished with the
portfolio margining methodology. Cross-margin positions are subject to
the same minimum margin requirement for every contract, including
futures contracts.
26. Margin calls arising in a cross-margin account, and any
shortfall in aggregate net equity across accounts, must be satisfied
within the same timeframe, and subject to the same consequences, as in
a portfolio margin account.
27. A position in a futures product may not be established in a
cross-margin account unless there exists, or there is established on
the same day, an offsetting position in securities options and/or other
eligible securities. Related instruments will be transferred out of the
cross-margin account and into a futures account if, for more than ten
business days and for any reason, the offsetting securities options
and/or other eligible securities no longer remain in the account. If
the transfer of related instruments to a futures account causes the
futures account to be undermargined, a margin call will be issued or
positions will be liquidated to the extent necessary to eliminate the
deficit.
28. Customers participating in cross-margining will be required to
sign an agreement acknowledging that their positions and property in
the cross-margin account will be subject to the customer protection
provisions of Rule 15c3-3 under the Securities Exchange Act of 1934 and
the Securities Investor Protection Act, and will not be subject to the
provisions of the Commodity Exchange Act, including segregation of
funds.
29. According to the rules of the exchanges, a broker-dealer is
required to immediately liquidate[,] or, if feasible, transfer to
another broker-dealer eligible to carry cross-margin accounts, all
customer cross-margin accounts that contain positions in futures and/or
options on futures in the event that the carrying broker-dealer becomes
insolvent.
30. In signing the agreement referred to in paragraph 28 above, a
customer also acknowledges that a cross-margin account that contains
positions in futures and/or options on futures will be immediately
liquidated, or, if feasible, transferred to another broker-dealer
eligible to carry cross-margin accounts, in the event that the carrying
broker-dealer becomes insolvent.
Special Risks of Cross-Margining
31. Cross-margining must be conducted in a portfolio margin account
type. Generally, cross-margining and the portfolio margining
methodology both contribute to provide greater leverage than a standard
[regular] margin account, and greater leverage creates greater losses
in the event of adverse market movements.
32. Since cross-margining must be conducted in a portfolio margin
account type, the time required for meeting margin calls is shorter
than in a standard [regular] securities margin account and may be
shorter than the time ordinarily required by a futures commission
merchant for meeting margin calls in a futures account. Consequently,
there is increased risk that a customer's cross-margin positions will
be liquidated involuntarily, causing possible loss to the customer.
33. As noted above, cross-margin accounts are securities accounts
and are subject to the customer protections set-forth in Rule 15c3-3
under the Securities Exchange Act of 1934 and the Securities Investor
Protection Act. Cross-margin positions are not subject to the customer
protection rules under the segregation provisions of the Commodity
Exchange Act and the rules of the CFTC adopted pursuant to the
Commodity Exchange Act.
34. Trading of index options and futures contracts in a cross-
margin account is generally subject to all the risks of trading those
same products in a futures account or a standard [regular] securities
margin account. Customers should be thoroughly familiar with the risk
disclosure materials applicable to those products, including the
booklet entitled Characteristics and Risks of Standardized Options and
the risk disclosure document required by the CFTC to be delivered to
futures customers. Because this disclosure statement does not disclose
the risks and other significant aspects of trading in futures and
options, customers should review those materials carefully before
trading in a cross-margin account.
35. Customers should bear in mind that the discrepancies in the
cash flow characteristics of futures and certain options are still
present even when those products are carried together in a cross-margin
account. Both futures and options contracts are generally marked to the
market at least once each business day, but the marks may take place
with different frequency and at different times within the day. When a
futures contract is marked to the market, the gain or loss is
immediately credited to
[[Page 3592]]
or debited from[, respectively,] the customer's account in cash. While
an increase in the value of a long option contract may increase the
equity in the account, the gain is not realized until the option is
sold or exercised. Accordingly, a customer may be required to deposit
cash in the account in order to meet a variation payment on a futures
contract even though the customer is in a hedged position and has
experienced a corresponding (but yet unrealized) gain on a long option.
Alternatively, a customer who is in a hedged position and would
otherwise be entitled to receive a variation payment on a futures
contract may find that the cash is required to be held in the account
as margin collateral on an offsetting option position.
36. Customers should consult with their tax advisers to be certain
that they are familiar with the tax treatment of transactions in index
products, including tax consequences of trading strategies involving
both futures and option contracts.
37. The descriptions in this disclosure statement relating to
eligibility requirements for cross-margining, and minimum equity and
margin requirements for cross margin accounts, are minimums imposed
under Exchange rules. Time frames within which margin and equity calls
must be met are maximums imposed under Exchange rules. The broker-
dealer carrying a customer's portfolio margin account, including any
cross-margin account, may impose [its own] more stringent requirements.
* * * * *
Sample Portfolio Margining and Cross-Margining Acknowledgements
Acknowledgement for Customers Utilizing a Portfolio Margin Account--
Cross-Margining And Non-Cross-Margining--
Rule 15c3-3 under the Securities Exchange Act of 1934 requires that
a broker or dealer promptly obtain and maintain physical possession or
control of all fully-paid securities and excess margin securities of a
customer. Fully-paid securities are securities carried in a cash
account and margin equity securities carried in a margin or special
account (other than a cash account) that have been fully paid for.
Excess margin securities are a customer's margin securities having a
market value in excess of 140% of the total of the debit balances in
the customer's non-cash accounts. For the purposes of Rule 15c3-3,
securities held subject to a lien to secure obligations of the broker-
dealer are not within the broker-dealer's physical possession or
control. The Commission staff has taken the position that all long
option positions in a customer's portfolio[-]margining account
(including any cross-margin account) may be subject to such a lien by
OCC and will not be deemed fully-paid or excess margin securities under
Rule 15c3-3.
The hypothecation rules under the Securities Exchange Act of 1934
(Rules 8c-1 and 15c2-1)[,] prohibit broker-dealers from permitting the
hypothecation of customer securities in a manner that allows those
securities to be subject to any lien or liens in an amount that exceeds
the customer's aggregate indebtedness. However, all long option
positions in a portfolio[-]margining account (including any cross-
margining account) will be subject to OCC's lien, including any
positions that exceed the customer's aggregate indebtedness. The
Commission staff has taken a position that would [to] allow customers
to carry positions in portfolio[-]margining accounts[,] (including any
cross-margining account) even when those positions exceed the
customer's aggregate indebtedness. Accordingly, within a portfolio
margin account or cross-margin account, to the extent that you have
long option positions that do not operate to offset your aggregate
indebtedness and thereby reduce your margin requirement, you receive no
benefit from carrying those positions in your portfolio[-]margin
account or cross-margin account and incur the additional risk of OCC's
lien on your long option position(s).
By signing below the customer affirms that the customer has read
and understood the foregoing disclosure statement and acknowledges and
agrees that long option positions in portfolio[-]margining accounts,
and cross-margining accounts, will be exempted from certain customer
protection rules of the Securities and Exchange Commission as described
above and will be subject to a lien by the options clearing corporation
without regard to such rules.
Customer Name:---------------------------------------------------------
By:--------------------------------------------------------------------
Date:------------------------------------------------------------------
(Signature/title)
Acknowledgement for Customers Engaged in Cross-Margining
As disclosed above, futures contracts and other property carried in
customer accounts with Futures Commission Merchants (``FCM'') are
normally subject to special protection afforded under the customer
segregation provisions of the Commodity Exchange Act (``CEA'') and the
rules of the Commodity Futures Trading Commission adopted pursuant to
the CEA. These rules require that customer funds be segregated from the
accounts of financial intermediaries and be accounted for separately.
However, they do not provide for, and standard [regular] futures
accounts do not enjoy the benefit of, insurance protecting customer
accounts against loss in the event of the insolvency of the
intermediary carrying the accounts.
As discussed above, cross-margining must be conducted in a
portfolio margin account, dedicated exclusively to cross-margining and
cross-margin accounts are not treated as a futures account with an FCM.
Instead, cross-margin accounts are treated as securities accounts
carried with broker-dealers. As such, cross-margin accounts are covered
by Rule 15c3-3 under the Securities Exchange Act of 1934, which
protects customer accounts. Rule 15c3-3, among other things, requires a
broker-dealer to maintain physical possession or control of all fully-
paid and excess margin securities and maintain a special reserve
account for the benefit of their customers. However, with regard to
cross-margin accounts, there is an exception to the possession or
control requirement of Rule 15c3-3 that permits The Options Clearing
Corporation to have a lien on long positions. This exception is
outlined in a separate acknowledgement form that must be signed prior
to or concurrent with this form. Additionally, the Securities Investor
Protection Corporation (``SIPC'') insures customer accounts against the
financial insolvency of a broker-dealer in the amount of up to $500,000
to protect against the loss of registered securities and cash
maintained in the account for purchasing securities or as proceeds from
selling securities (although the limit on cash claims is $100,000).
According to the rules of the exchanges, a broker-dealer is required to
immediately liquidate[,] or, if feasible, transfer to another broker-
dealer eligible to carry cross-margin accounts, all customer cross-
margin accounts that contain positions in futures and/or options on
futures in the event that the carrying broker-dealer becomes insolvent.
By signing below the customer affirms that the customer has read
and understood the foregoing disclosure statement and acknowledges and
agrees that: (1) Positions and property in cross-margining accounts,
will not be subject to the customer protection rules under the customer
segregation provisions of the Commodity Exchange Act and the
[[Page 3593]]
rules of the Commodity Futures Trading Commission adopted pursuant to
the CEA and (2) cross-margining accounts that contain positions in
futures and/or options on futures will be immediately liquidated, or if
feasible, transferred to another broker-dealer eligible to carry cross-
margin accounts in the event that the carrying broker-dealer becomes
insolvent.
Customer Name:---------------------------------------------------------
By:--------------------------------------------------------------------
Date:------------------------------------------------------------------
(Signature/title)
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
Amendments to NYSE Rule 431 (``Margin Requirements'') are proposed
that would include security futures \8\ and single stock options as
products eligible for treatment under portfolio margin requirements as
part of the Portfolio Margin Pilot Program recently approved by the
Commission. Amendments to Rule 726 (``Delivery of Options Disclosure
Document and Prospectus'') also are proposed to include the SEC
approved products on the disclosure document required to be furnished
to customers pursuant to this rule.
---------------------------------------------------------------------------
\8\ For purposes of this filing term ``security futures''
utilizes the definition at Section 3(a)(55) of the Exchange Act,
excluding narrow-based security indices.
---------------------------------------------------------------------------
a. Background
Section 7(a) \9\ of the Exchange Act of 1934 \10\ empowers the
Board of Governors of the Federal Reserve System to prescribe the rules
and regulations regarding credit that may be extended by broker-dealers
on securities (Regulation T) to their customers. NYSE Rule 431
prescribes specific margin requirements that must be maintained in all
customer accounts, based on the type of securities products held in
such accounts.
---------------------------------------------------------------------------
\9\ 15 U.S.C. 78g.
\10\ 15 U.S.C. 78a et seq.
---------------------------------------------------------------------------
In April 1996, the Exchange established a Rule 431 Committee (the
``Committee'') to assess the adequacy of 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 Committee has
endorsed the proposed amendments discussed below.\11\
---------------------------------------------------------------------------
\11\ The Committee is composed of several member organizations,
including Goldman, Sachs & Co., Morgan Stanley & Co., Inc., Merrill
Lynch, Pierce, Fenner and Smith, Inc., Bear Stearns Corp. and Credit
Suisse First Boston Corp. and several self-regulatory organizations,
including: the NYSE, the Chicago Board Options Exchange, the
Options, Clearing Corporation, the American Stock Exchange, the
Chicago Board of Trade, the Chicago Mercantile Exchange, and the
National Association of Securities Dealers.
---------------------------------------------------------------------------
b. The Pilot
The Board of Governors of the Federal Reserve System in its
amendments to Regulation T in 1998 permitted SROs to implement
portfolio margin rules, subject to SEC approval.\12\ As noted above, on
July 14, 2005 the Commission approved amendments to Exchange Rules 431
and 726 to permit, on a two year pilot basis, the use of a prescribed
risk-based methodology (``Portfolio Margin'') \13\ for certain products
as an alternative to the strategy or position based margin requirements
currently required in Rule 431(a) through (f). Exchange member
organizations may utilize portfolio margin for listed, broad-based U.S.
index options and index warrants, along with any underlying
instruments.\14\ These positions are to be margined (either for initial
or maintenance) in a separate portfolio margin account dedicated
exclusively for such margin computation.
---------------------------------------------------------------------------
\12\ See Federal Reserve System, ``Securities Credit
Transactions; Borrowing by Broker and Dealers;'' Regulations G, T, U
and X; Docket Nos. R-0905, R-0923 and R-0944, 63 FR 2806 (January
16, 1998).
\13\ As a pre-condition to permitting portfolio margining,
member organization are required to establish procedures and
guidelines to monitor credit risk to the member organization's
capital, including intra-day credit risk and stress testing of
portfolio margin accounts. Further, member organizations must
establish procedures for regular review and testing of these
required risk analysis procedures (see Rule 431(g)(1)).
\14\ For purposes of these amendments, the term ``underlying
instrument,'' means long and short positions in an exchange traded
fund of other fund product registered under the Investment Company
Act of 1940, that holds the same securities, and in the same
proportion, as contained in a broad-based index on which options are
listed. The term ``underlying instrument'' shall not be deemed to
include futures contracts, options on futures contracts, underlying
stock baskets, or unlisted instruments.
---------------------------------------------------------------------------
c. Strategy or Positioned-Based Margin Requirements
Prior to the Pilot, member organizations were subject, pursuant to
NYSE Rule 431, to strategy or positioned-based margin requirements.
This methodology applied specific margin percentage requirements as
prescribed in Rule 431 to each security position and/or strategy,
either long or short, held in a customer's account, irrespective of the
fact that all security (e.g., options) prices do not change equally (in
percentage terms) with a change in the price of the underlying
security. As discussed in more detail below, when utilizing a portfolio
margin methodology, offsets are fully realized, whereas under strategy
or position-based methodology, positions and or groups of positions
comprising a single strategy are margined independently of each other
and offsets between them do not efficiently impact the total margin
requirement.
d. Portfolio Margin Requirements
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. The Pilot utilizes a
Commission approved theoretical options pricing model using multiple
pricing scenarios to set or determine the risk level.\15\ 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.
---------------------------------------------------------------------------
\15\ The theoretical options pricing model is used to derive
position values at each valuation point for the purpose of
determining the gain or loss. The amount of initial and maintenance
margin required with respect to a portfolio would be the larger of:
(1) The greatest loss amount among the valuation calculations; or
(2) the sum of $.375 for each option and security future in the
portfolio multiplied by the contract's (e.g. 100 shares per
contract) or instrument's multiplier. This computation establishes a
minimum margin requirement to ensure that a certain level of margin
is required from a customer.
---------------------------------------------------------------------------
Generally, the purpose and benefit of portfolio margining is to
efficiently set levels of margin that reflect historical moves that
more precisely reflects actual net risk of all positions in the
account. A customer benefits from portfolio margining in that margin
requirements calculated on net position
[[Page 3594]]
risk are generally lower than strategy-based margin methodologies
currently in place. In permitting margin computation based on actual
net risk, member organizations are no longer required to compute a
margin requirement for each individual position or strategy in a
customer's account (see NYSE Rule 431).
As discussed in more detail below, utilizing portfolio margin for
options portfolios and any related instruments enables the portfolio to
be subjected to certain preset market volatility parameters that
reflect historical moves in the underlying security thereby assessing
potential loss in the portfolio in the aggregate. Accordingly, such a
methodology provides an accurate and realistic assessment of reasonable
margin requirements.
e. Proposed Amendments
The Exchange and CBOE received letters in late September 2005 from
Commission Chairman Christopher Cox asking the SROs to consider
expanding portfolio margining to a broader universe of products. The
Commission encouraged the Exchanges to file a rule proposal before
year-end.\16\ Accordingly, the Exchange is proposing the amendments
discussed below.
---------------------------------------------------------------------------
\16\ Chairman of the Commission, Christopher Cox, in a letter
dated September 27, 2005, to William J. Brodsky and John A. Thain,
the Chief Executive Offices of CBOE and NYSE, respectively,
encouraged each SRO to file a rule proposal to make portfolio margin
available to equity options and security futures with the Commission
by year-end 2005.
---------------------------------------------------------------------------
f. Eligible Products/Minimum Equity Requirements
The proposed amendments to Rule 431 seek to expand the eligible
products previously approved, provided all products can be priced
within a prescribed risk-based theoretical pricing methodology.
Specifically, the proposed amendments will expand the eligible products
to include security futures as well as listed single stock options. The
proposed amendments will also permit customers effecting transactions
in security futures and listed single stock options to do so without
maintaining the $5 million equity requirement, which is currently
required under the Pilot for all other eligible products.
g. Valuation Points
Further, the proposed amendments will establish theoretical prices
at 10 equidistant valuation points within a range consisting of an
increase or a decrease of +/-15% \17\ (i.e., +/-3%, 6%, 9%, 12%, and
15%) in the current market value of the underlying instrument. As
proposed, the price range for computing a portfolio margin requirement
is the same parameter required under Appendix A of Rule 15c3-1a \18\
under the Exchange Act for computing deductions to a firm's net capital
for proprietary positions. Currently the only theoretical model
qualified pursuant to Rule 15c3-1a under the Exchange Act is the
Theoretical Intermarket Margin System (``TIMS'') administered by The
Options Clearing Corporation.
---------------------------------------------------------------------------
\17\ The Pilot established valuation points for the following
eligible products: Non-High Capitalization/Broad-based U.S. Market
Index Options (+/-10%) and High Capitalization/Broad-based U.S.
Market Index Options (+6%/-8%).
\18\ 17 CFR 240.15c3-1a(b)(1)(i)(B). The requirements of this
rule include, among other things, that any model be non-proprietary,
approved by a Designated Examining Authority (``DEA'') and available
on the same terms to all broker-dealers. Referencing to the SEC's
net capital coupled with DEA approval and SEC review assures
uniformity across pricing models and that portfolio and cross-margin
requirements will not vary significantly from firm to firm.
---------------------------------------------------------------------------
h. Margin Deficiency
In addition, the proposed amendments will require a member
organization to deduct from its net capital the amount of any portfolio
margin maintenance call which is not met by the close of business of
trade date plus one (T+1).\19\ Member organizations will not be
permitted to deduct any portfolio margin maintenance call amount from
net capital in lieu of collecting the required margin.
---------------------------------------------------------------------------
\19\ Several paragraphs in the proposed rule amendments use the
term ``portfolio margin maintenance call'' rather than the term
``portfolio margin maintenance deficiency.'' The proposed rule text
was intended to measure the time period for a customer to meet a
margin call or a member to make a deduction in calculating net
capital from the time of the ma
