Customer Margin Rules Relating to Security Futures, 36434-36454 [2019-15400]

Download as PDF 36434 Federal Register / Vol. 84, No. 144 / Friday, July 26, 2019 / Proposed Rules COMMODITY FUTURES TRADING COMMISSION 17 CFR Part 41 RIN 3038–AE88 SECURITIES AND EXCHANGE COMMISSION 17 CFR Part 242 [Release No. 34–86304; File No. S7–09–19] RIN 3235–AM55 Customer Margin Rules Relating to Security Futures Commodity Futures Trading Commission and Securities and Exchange Commission. ACTION: Joint proposed rules. jbell on DSK3GLQ082PROD with PROPOSALS4 AGENCY: SUMMARY: The Commodity Futures Trading Commission (‘‘CFTC’’) and the Securities and Exchange Commission (‘‘SEC’’) (collectively, the ‘‘Commissions’’) are proposing amendments to regulations that establish minimum customer margin requirements for security futures. More specifically, the proposed amendments would lower the margin requirement for an unhedged security futures position from 20% to 15%, as well as propose certain revisions to the margin offset table consistent with the proposed reduction in margin. DATES: Comments should be received on or before August 26, 2019. ADDRESSES: Comments should be sent to both agencies at the addresses listed below. CFTC: You may submit comments, identified by RIN 3038–AE88, by any of the following methods: • CFTC Website: https:// comments.cftc.gov. Follow the instructions for submitting comments through the website. • Mail: Christopher Kirkpatrick, Secretary of the Commission, Commodity Futures Trading Commission, Three Lafayette Centre, 1155 21st Street NW, Washington, DC 20581. • Hand Delivery/Courier: Same as Mail above. Please submit your comments using only one method. All comments must be submitted in English, or if not, accompanied by an English translation. Comments will be posted as received to https:// www.cftc.gov. You should submit only information that you wish to make available publicly. If you wish for the CFTC to consider information that you believe is exempt from disclosure under VerDate Sep<11>2014 21:41 Jul 25, 2019 Jkt 247001 the Freedom of Information Act, a petition for confidential treatment of the exempt information may be submitted according to the procedures established in CFTC Rule 145.9, 17 CFR 145.9. The CFTC reserves the right, but shall have no obligation, to review, prescreen, filter, redact, refuse, or remove any or all of your submission from https://www.cftc.gov that it may deem to be inappropriate for publication, such as obscene language. All submissions that have been redacted or removed that contain comments on the merits of the rulemaking will be retained in the public comment file and will be considered as required under the Administrative Procedure Act and other applicable laws, and may be accessible under the Freedom of Information Act. SEC: Comments may be submitted by any of the following methods: Electronic Comments • Use the SEC’s internet comment form (https://www.sec.gov/rules/ proposed.shtml); or • Send an email to rule-comments@ sec.gov. Please include File Number S7– 09–19 on the subject line. Paper Comments • Send paper comments to Secretary, Securities and Exchange Commission, 100 F Street NE, Washington, DC 20549–1090. All submissions should refer to File Number S7–09–19. This file number should be included on the subject line if email is used. To help the SEC process and review your comments more efficiently, please use only one method. The SEC will post all comments on the SEC’s website (https:// www.sec.gov/rules/proposed.shtml). Comments are also available for website viewing and printing in the SEC’s Public Reference Room, 100 F Street NE, Room 1580, Washington, DC 20549, on official business days between the hours of 10:00 a.m. and 3:00 p.m. All comments received will be posted without change. Persons submitting comments are cautioned that the SEC does not redact or edit personal identifying information from comment submissions. You should submit only information that you wish to make publicly available. Studies, memoranda, or other substantive items may be added by the SEC or staff to the comment file during this rulemaking. A notification of the inclusion in the comment file of any such materials will be made available on the SEC’s website. To ensure direct electronic receipt of such notifications, sign up through the ‘‘Stay Connected’’ PO 00000 Frm 00002 Fmt 4701 Sfmt 4702 option at www.sec.gov to receive notifications by email. FOR FURTHER INFORMATION CONTACT: CFTC: Melissa A. D’Arcy, Special Counsel and Sarah E. Josephson, Deputy Director, Division of Clearing and Risk, at (202) 418–5430; and Michael A. Penick, Economist at (202) 418–5279, and Ayla Kayhan, Economist at (202) 418–5947, Office of the Chief Economist, Commodity Futures Trading Commission, Three Lafayette Centre, 1155 21st Street NW, Washington, DC 20581. SEC: Michael A. Macchiaroli, Associate Director, at (202) 551–5525; Thomas K. McGowan, Associate Director, at (202) 551–5521; Randall W. Roy, Deputy Associate Director, at (202) 551–5522; Sheila Dombal Swartz, Senior Special Counsel, at (202) 551– 5545; or Abraham Jacob, Special Counsel, at (202) 551–5583; Division of Trading and Markets, Securities and Exchange Commission, 100 F Street NE, Washington, DC 20549–7010. SUPPLEMENTARY INFORMATION: I. Background A. Applicable Statutory Framework B. Prior Regulatory Action by the Commissions C. Consideration of SROs’ Risk-Based Portfolio Margining Approaches D. Consideration of Statutory Requirements II. Discussion A. Minimum Margin for Unhedged Positions 1. Current Security Futures Margin Rules 2. SRO Risk-Based Portfolio Margin Accounts May Hold Comparable Exchange-Traded Options 3. Minimum Levels of Margin Required for Security Futures 4. The Commissions Have Authority To Determine Which Exchange-Traded Options Are Comparable to Security Futures 5. The Margin Requirements Are Consistent for Comparable ExchangeTraded Options 6. The Proposed Margin Rule Is Consistent With the Federal Reserve’s Regulation T 7. The Proposed Margin Rule Permits Higher Margin Requirements 8. Request for Comments B. Margin Offsets III. Paperwork Reduction Act A. CFTC B. SEC IV. Consideration of Costs and Benefits (CFTC) and Economic Analysis (SEC) of the Proposed Amendments A. CFTC 1. Introduction 2. Economic Baseline 3. Summary of Proposed Amendment 4. Description of Possible Costs i. Risk-Related Costs for Security Futures Intermediaries and Customers ii. Appropriateness of Margin Requirements iii. Costs Associated With Margin Offsets Table E:\FR\FM\26JYP4.SGM 26JYP4 Federal Register / Vol. 84, No. 144 / Friday, July 26, 2019 / Proposed Rules 5. Description of Possible Benefits 6. Consideration of Section 15(a) Factors i. Protection of Market Participants and the Public ii. The Efficiency, Competitiveness and Financial Integrity of the Markets iii. Price Discovery iv. Risk Management v. Other Public Interest Considerations 7. Request for Comment B. SEC 1. Introduction 2. Baseline i. The Security Futures Market ii. Regulation 3. Analysis of the Proposals i. Benefits ii. Costs iii. Effects on Efficiency, Competition, and Capital Formation iv. Alternatives Considered V. Regulatory Flexibility Act A. CFTC B. SEC VI. Small Business Regulatory Enforcement Fairness Act VII. Anti-Trust Considerations VIII. Statutory Basis The CFTC is proposing to amend CFTC Rule 41.45(b)(1), 17 CFR 41.45(b)(1), and the SEC is proposing to amend SEC Rule 403(b)(1), 17 CFR 242.403(b)(1),1 under authority delegated by the Board of Governors of the Federal Reserve System (‘‘Federal Reserve Board’’) pursuant to Section 7(c)(2) of the Securities Exchange Act of 1934 (‘‘Exchange Act’’).2 The Commissions also are proposing to revise the margin offset table, consistent with the proposed reduction in margin. jbell on DSK3GLQ082PROD with PROPOSALS4 I. Background The Commodity Futures Modernization Act of 2000 (‘‘CFMA’’),3 which became law on December 21, 2000, lifted the ban on trading security futures 4 and established a framework for the joint regulation of security futures by the CFTC and the SEC. A security future is a futures contract on a single security or on a narrow-based security index.5 1 CFTC regulations referred to herein are found at 17 CFR Ch. 1; SEC regulations referred to herein are found at 17 CFR Ch. 2. 2 15 U.S.C. 78g(c)(2). 3 Appendix E of Public Law No. 106–554, 114 Stat. 2763 (2000). 4 See Section 1a(31) of the Commodity Exchange Act (‘‘CEA’’), 7 U.S.C. 1a(44); and Section 3(a)(55) of the Exchange Act, 15 U.S.C. 78c(a)(55) (defining the term ‘‘security future’’). 5 Id. A ‘‘security future’’ is distinguished from a ‘‘security futures product,’’ which is defined to include security futures as well as any put, call, straddle, option, or privilege on any security future. See Section 1a(45) of the CEA, 7 U.S.C. 1a(45); and Section 3(a)(56) of the Exchange Act, 15 U.S.C. 78c(a)(56) (defining the term ‘‘security futures product’’). Futures on indexes that are not narrowbased security indexes are subject to the exclusive jurisdiction of the CFTC. This rule proposal applies only to margin on security futures and not to VerDate Sep<11>2014 21:41 Jul 25, 2019 Jkt 247001 A. Applicable Statutory Framework As part of the statutory scheme for the regulation of security futures, the CFMA provided for the issuance of regulations governing customer margin for security futures. Customer margin for security futures includes two types of margin, (i) initial margin, and (ii) maintenance margin. Together, the initial and maintenance margin must satisfy the required margin established by the Commissions.6 The CFMA added a new subsection (2) to Section 7(c) of the Exchange Act,7 which directs the Federal Reserve Board to prescribe regulations establishing initial and maintenance customer margin requirements imposed by brokers, dealers, and members 8 of national securities exchanges 9 for security futures. In addition, Section 7(c)(2) provides that the Federal Reserve Board may delegate this rulemaking authority jointly to the Commissions. Section 7(c)(2)(B) of the Exchange Act provides that the customer margin requirements, ‘‘including the establishment of levels of margin 10 margin on options on security futures. For the purposes of this proposal, most discussion will relate to security futures only. For the sake of clarity and consistency, the term ‘‘security futures products’’ will be used when discussing security futures and the options on security futures together throughout this proposal. Under CEA Section 2(a)(1)(D)(iii)(II) and Exchange Act Section 6(h)(6), the CFTC and SEC may, by order, jointly determine to permit the listing of options on security futures; that authority has not been exercised. 6 Initial margin must be deposited as collateral when a customer makes an initial investment in security futures. Maintenance margin is the minimum amount a customer must maintain in its margin account while owning security futures. If a customer’s margin level falls below the maintenance margin amount, a customer may be required to make an additional deposit. Maintenance margin for security futures is different from variation settlement. Variation settlement is a daily or intraday mark to market payment for a security future. See CFTC Rule 41.43(a)(32), 17 CFR 41.43(a)(32); SEC Rule 401(a)(32), 17 CFR 242.401(a)(32). 7 15 U.S.C. 78g(c)(2). 8 Futures commission merchants (as defined in Section 1(a)(28) of the CEA), which may be members of national securities exchanges, clearing members at clearinghouses, or customers of clearing members at clearinghouses, are discussed in detail below. 9 OneChicago, LLC (‘‘OCX’’), the only U.S. national securities exchange currently listing security futures, filed a rulemaking petition, dated August 1, 2008, requesting that the minimum required margin for unhedged security futures be reduced from 20% to 15%. Letter from Donald L. Horwitz, Managing Director and General Counsel, OCX, to David Stawick, Secretary, CFTC, and Nancy M. Morris, Secretary, SEC, dated Aug. 1, 2008, at 2 (‘‘OCX Petition’’). OCX also is a designated contract market registered with the CFTC. 10 The terms ‘‘margin level’’ and ‘‘level of margin’’, when used with respect to a security futures product, mean the amount of margin required to secure any extension or maintenance of PO 00000 Frm 00003 Fmt 4701 Sfmt 4702 36435 (initial and maintenance) for security futures products,’’ must satisfy four requirements. First, they must preserve the financial integrity of markets trading security futures products. Second, they must prevent systemic risk. Third, they must (1) be consistent with the margin requirements for comparable options traded on any exchange registered pursuant to Section 6(a) of the Exchange Act; 11 and (2) provide for initial and maintenance margin levels that are not lower than the lowest level of margin, exclusive of premium, required for any comparable exchange-traded options. Fourth, they must be, and remain consistent with, the margin requirements established by the Federal Reserve Board under Regulation T (‘‘Regulation T’’).12 With regard to the third requirement, there is limited legislative history 13 regarding how or why the comparison should be to exchange-traded options. As discussed further below, under certain circumstances the products behave similarly in terms of their overall risk profiles. However, from the perspective of market participants, exchange-traded options and security futures often serve two distinct economic functions. Exchange-traded options are tools for hedging and speculating on the underlying equity markets. On the other hand, security futures are ‘‘delta one derivatives’’ 14 that are more similar to total return equity swaps insofar as they provide exposure to equities without requiring ownership of the underlying instrument. Specifically, security futures are used to (1) establish synthetic long or short exposure to the underlying equity security or equity securities, and/or (2) temporarily transfer securities, similar to securities credit, or the amount of margin required as a performance bond related to the purchase, sale, or carrying of a security futures product. 15 U.S.C. 78c(a)(57)(B). 11 Given the statutory language, for the sake of clarity and consistency, the term ‘‘comparable exchange-traded options’’ will be used to describe single stock options throughout this proposal. 12 12 CFR 220 et seq. 13 For example, earlier versions of the statutory language stated that margin should be set at levels appropriate to ‘‘prevent competitive distortions between markets offering similar products’’, and the reasons given for instituting the margin requirements was that ‘‘[u]nder the bill, margin levels on these products would be required to be harmonized with the options markets.’’ See S. Report 106–390 (Aug. 25, 2000) at pp.5 and 39. 14 Delta one derivatives are financial instruments with a delta that is close or equal to one. Delta measures the rate of change in a derivative relative to a unit of change in the underlying instrument. Delta one derivatives have no optionality, and therefore, as the price of the underlying instrument moves, the price of the derivative is expected to move at, or close to, the same rate. E:\FR\FM\26JYP4.SGM 26JYP4 36436 Federal Register / Vol. 84, No. 144 / Friday, July 26, 2019 / Proposed Rules lending or equity repurchase agreements.15 However, while exchange-traded options and security futures can serve distinct economic functions, they generally share similar risk profiles for purposes of assessing margin. For example, both short security futures positions and certain exchangetraded options strategies produce unlimited downside risk. Investors in security futures and writers of options may lose their margin deposits and premium payments and be required to pay additional funds. As a result, the margin requirements for security futures can be compared to margin practices for exchange-traded options in order to determine appropriate margin levels. In comparison, security futures traded in Europe are subject to risk-based margin calculations that differ from the margin requirements that apply to security futures in the U.S. LCH Ltd. applies a Standard Portfolio Analysis of Risk (‘‘SPAN’’) margin methodology for the security futures it clears,16 and Eurex applies portfolio-based margining through its new margin methodology, Eurex Clearing Prisma, to its cleared security futures.17 As described below, in the U.S., security futures may be portfolio margined under current rules only if they are held in a securities account.18 B. Prior Regulatory Action by the Commissions jbell on DSK3GLQ082PROD with PROPOSALS4 On March 6, 2001, the Federal Reserve Board delegated its authority under Section 7(c)(2) to the Commissions.19 Pursuant to that 15 See e.g., OCX (describing trading strategies for security futures), available at https:// www.onechicago.com/?page_id=25157. 16 See LCH’s discussion of ‘‘London SPAN’’, available at https://www.lch.com/risk-collateralmanagement/group-risk-management/riskmanagement-ltd/ltd-margin-methodology/london. 17 See Eurex Exchange’s discussion of ‘‘Risk parameters and initial margins’’, available at https:// www.eurexchange.com/exchange-en/market-data/ clearing-data/risk-parameters. 18 See the Financial Industry Regulatory Authority, Inc. (‘‘FINRA’’) Rule 4210(g) and the Cboe Exchange, Inc. (‘‘CBOE’’) Rule 12.4. See also Section 713 of the Dodd-Frank Wall Street Reform and Consumer Protection Act (‘‘Dodd-Frank Act’’). Public Law 111–203,124 Stat. 1376 (2010). The Dodd-Frank Act provided the SEC and CFTC with authority to facilitate portfolio margining by allowing cash and securities to be held in a futures account, and futures and options on futures and related collateral to be held in a securities account, subject to certain conditions. See Exchange Act Section 15(c)(3)(C) and CEA Section 4d(h), 15 U.S.C. 78o(c)(3)(C), and 7 U.S.C. 6d(h). 19 Letter from Jennifer J. Johnson, Secretary of the Board, Federal Reserve Board, to James E. Newsome, Acting Chairman, CFTC, and Laura S. Unger, Acting Chairman, SEC (Mar. 6, 2001) (‘‘FRB Letter’’), reprinted as Appendix B to Customer Margin Rules Relating to Security Futures, 66 FR 50720, 50741 (Oct. 4, 2001) (joint proposed VerDate Sep<11>2014 21:41 Jul 25, 2019 Jkt 247001 authority, the SEC and the CFTC adopted customer margin requirements for security futures.20 The 2002 Final Rules establish margin requirements for security futures to be collected by security futures intermediaries from their customers.21 A security futures intermediary is a creditor, as defined under Regulation T, with respect to its financial relations with any person involving security futures, and includes registered entities such as brokers, dealers, and futures commission merchants (‘‘FCMs’’).22 The amendments proposed today to CFTC regulation 41.45(b)(1) and SEC rule 242.403(b)(1) concern the minimum required margin such entities would be required to collect from customers in this context. In the 2002 Final Rules, the Commissions established minimum initial and maintenance margin levels for unhedged security futures at 20% of their ‘‘current market value.’’ 23 In addition, the Commissions’ rules permit self-regulatory organizations and selfregulatory authorities (together ‘‘SROs’’),24 to set margin levels lower than 20% of current market value for customers with certain strategy-based offset positions involving security futures and one or more related securities or futures.25 Neither the current regulations nor the proposed amendments prohibit SROs or security futures intermediaries rulemaking by the Commissions) (‘‘2001 Proposed Rules’’). 20 See Customer Margin Rules Relating to Security Futures, 67 FR 53146 (Aug. 14, 2002) (joint rulemaking by the Commissions, hereinafter the ‘‘2002 Final Rules’’); 17 CFR 41.42–41.49 (CFTC regulations); 17 CFR 242.400–242.406 (SEC regulations). 21 See CFTC Rule 41.45(a), 17 CFR 41.45(a); SEC Rule 403, 17 CFR 242.403. 22 See CFTC Rule 41.43(a)(29), 17 CFR 41.43(a)(29); SEC Rule 401(a)(29), 17 CFR 242.401(a)(29). A security future is both a security and a future, so customers who wish to buy or sell security futures must conduct the transaction through a person registered both with the CFTC as either an FCM or an introducing broker and the SEC as a broker-dealer. The term ‘‘security futures intermediary’’ includes FCMs that are clearing members or customers of clearing members of the Options Clearing Corporation (‘‘OCC’’), which is the clearinghouse that clears security futures listed on OCX. 23 See CFTC Rule 41.45(b)(1), 17 CFR 41.45(b)(1); SEC Rule 403(b)(1), 17 CFR 242.403(b)(1). See also CFTC Rule 41.43(a)(4), 17 CFR 41.43(a)(4); SEC Rule 401(a)(4), 17 CFR 242.401(a)(4) (defining the term ‘‘current market value’’). 24 For the sake of clarity and consistency, the defined term ‘‘SRO’’ will be used to describe selfregulatory organizations and self-regulatory authorities throughout this proposal. ‘‘Selfregulatory authority’’ is defined at CFTC Rule 41.43(a)(30), 17 CFR 41.43(a)(30) and SEC Rule 401(a)(30), 17 CFR 242.401(a)(30). 25 See CFTC Rule 41.45(b)(2), 17 CFR 41.45(b)(2); SEC Rule 403(b)(2), 17 CFR 242.403(b)(2). PO 00000 Frm 00004 Fmt 4701 Sfmt 4702 from establishing higher initial or maintenance margin levels than the required margin or from taking appropriate action to preserve their own financial integrity.26 SROs and security futures intermediaries may determine that higher margin levels are required for security futures under certain market conditions. Similar to current regulations, the Commissions are proposing to preserve this flexibility because it is important for SROs and security futures intermediaries to be able to manage their customers’ risks appropriately. The Commissions enumerated specific exclusions from the margin rule for security futures, and those exclusions would continue under the proposed amendments.27 For example, margin requirements that derivatives clearing organizations (‘‘DCOs’’) or clearing agencies impose on their members are not subject to the 20% security futures margin requirement, as this provides clearinghouses flexibility and discretion in managing their members’ exposures. In addition, Section 7(c)(2) of the Exchange Act does not confer authority over margin requirements for clearing agencies and DCOs.28 The margin rules of clearing agencies registered with the SEC are approved by the SEC pursuant to Section 19(b)(2) of the Exchange Act.29 The CFTC has authority to ensure compliance with core principles for DCOs registered with the CFTC under Sections 5b and 5c of the CEA.30 Another exclusion is for margin calculated by a portfolio margining system under rules that meet the four criteria set forth in Section 7(c)(2)(B) of the Exchange Act 31 and that have been approved by the SEC and, as applicable, the CFTC.32 Subsequent to the adoption of 2002 Final Rules, and consistent with the exclusion, three SROs 33 initiated 26 See CFTC Rule 41.42(c)(1), 17 CFR 41.42(c)(1); SEC Rule 400(c)(1), 17 CFR 242.400(c)(1). 27 See CFTC Rule 41.42(c)(2)(i)–(v), 17 CFR 41.42(c)(2)(i)–(v); SEC Rule 400(c)(2)(i)–(v), 17 CFR 242.400(c)(2)(i)–(v). 28 See CFTC Rule 41.42(c)(2)(iii), 17 CFR 41.42(c)(2)(iii); SEC Rule 400(c)(2)(iii), 17 CFR 242.400(c)(2)(iii). See also 15 U.S.C. 78g(c)(2) and FRB Letter (‘‘The authority delegated by the [Federal Reserve Board] is limited to customer margin requirements imposed by brokers, dealers, and members of national securities exchanges. It does not cover requirements imposed by clearing agencies on their members.’’). 29 15 U.S.C. 78s(b)(2). 30 7 U.S.C. 7a–1 and 7 U.S.C. 7a–2. 31 15 U.S.C. 78g(c)(2)(B). 32 See CFTC Rule 41.42(c)(2)(i), 17 CFR 41.42(c)(2)(i); SEC Rule 400(c)(2)(i), 17 CFR 242.400(c)(2)(i). 33 The three SROs that proposed pilot programs are FINRA, the New York Stock Exchange LLC (‘‘NYSE’’) and CBOE (formerly known as Chicago E:\FR\FM\26JYP4.SGM 26JYP4 Federal Register / Vol. 84, No. 144 / Friday, July 26, 2019 / Proposed Rules jbell on DSK3GLQ082PROD with PROPOSALS4 pilot programs for risk-based portfolio margining rules that permit a security futures intermediary to combine certain of a customer’s securities and futures positions in a securities portfolio margin account to compute the customer’s margin requirements based on the net market risk of all the customer’s positions in the account.34 As discussed in more detail below, these SRO riskbased portfolio margin rules established a margin requirement for unhedged exchange-traded options and security futures of 15% (i.e., a valuation point range of +/¥ 15%).35 In proposed rule filings seeking to make the pilots permanent, the SROs noted that they did not encounter any problems or difficulties relating to such pilot programs.36 These SRO risk-based portfolio margining rules—originally adopted as a pilot program—became Board Options Exchange, Inc.). The SEC has regulatory authority over all three SROs. In 2010, the CBOE conducted a restructuring transaction in which CBOE became a wholly-owned subsidiary of CBOE Holdings, Inc. The CFTC regulates the Cboe Futures Exchange, LLC (a wholly-owned subsidiary of CBOE Holdings, Inc.) as a designated contract market under Section 5 of the CEA. 34 See Exchange Act Release No. 55471 (Mar. 14, 2007), 72 FR 13149 (Mar. 20, 2007) (SR–NASD– 2007–013, relating to the National Association of Securities Dealers’ (now known as FINRA) rule change to permit members to adopt a portfolio margin methodology on a pilot basis); Exchange Act Release No. 54918 (Dec. 12, 2006), 71 FR 75790 (Dec. 18, 2006) (SR–NYSE–2006–13, relating to further amendments to the NYSE’s portfolio margin pilot program); Exchange Act Release No. 54919 (Dec. 12, 2006), 71 FR 75781 (Dec. 18, 2006) (SR– CBOE 2006–14, relating to amendments to CBOE’s portfolio margin pilot program to include security futures); Exchange Act Release No. 54125 (Jul. 11, 2006), 71 FR 40766 (Jul. 18, 2006) (SR–NYSE–2005– 93, relating to amendments to the NYSE’s portfolio margin pilot program to include security futures); Exchange Act Release No. 52031 (Jul. 14, 2005), 70 FR 42130 (Jul. 21, 2005) (SR–NYSE–2002–19, relating to the NYSE’s original portfolio margin pilot proposal); Exchange Act Release No. 52032 (Jul. 14, 2005), 70 FR 42118 (Jul. 21, 2005) (SR– CBOE–2002–03, relating to the CBOE’s original portfolio margin pilot proposal). 35 See discussion in section I.C. below. 36 See Exchange Act Release No. 58251 (Jul. 30, 2008), 73 FR 45506 (Aug. 5, 2008) (SR–FINRA– 2008–041, relating to the FINRA’s proposal to make the portfolio margin pilot program permanent under NASD Rule 2520(g) and Incorporated NYSE Rule 431(g)); Exchange Act Release No. 58243 (Jul. 29, 2008), 73 FR 45505 (Aug. 5, 2008) (SR–CBOE– 2008–73, relating to the CBOE’s proposal to make the portfolio margin pilot program permanent); and Exchange Act Release No. 58261 (Jul. 30, 2008), 73 FR 46116 (Aug. 7, 2008) (SR–NYSE–2008–66, relating to the NYSE’s proposal to make the portfolio margin pilot program permanent). FINRA Rule 4210 (Margin Requirements) became effective December 2, 2010. See Exchange Act Release No. 62482 (July 12, 2010) 75 FR 41562 (July 16, 2010) (SR–FINRA–2010–024, relating to FINRA’s proposal to adopt FINRA Rule 4210 (Margin Requirements) as part of the process of developing a consolidated FINRA rulebook) and FINRA Regulatory Notice 10– 45. As of February 14, 2019, of the 3,777 brokerdealers registered with the SEC, FINRA is the designated examining authority for 3,654 firms (96.7%). VerDate Sep<11>2014 21:41 Jul 25, 2019 Jkt 247001 permanent in 2008. These SRO rules require 15% margin (i.e., a valuation point range of +/¥ 15%) for an unhedged exchange-traded option on an equity security or narrow-based index.37 Subsequent to the adoption of 2002 Final Rules, each Commission adopted rules to enhance core principles and standards for the operation and governance of DCOs and covered clearing agencies that, as discussed below, also are generally applicable to the clearance and settlement of security futures. In 2011, the CFTC issued regulations applicable to DCOs, including CFTC Rule 39.13, which concerns margin—both initial and variation margin—that is required to be collected by a DCO from its clearing members.38 Any DCO clearing security futures is subject to CFTC Rule 39.13,39 and most of the requirements under CFTC Rule 39.13 apply broadly to all transactions cleared by the DCO, but in some cases security futures transactions are excluded.40 Any of a DCO’s clearing members that are FCMs and that are clearing security futures on behalf of customers would be subject to CFTC Rule 41.45(b)(1).41 In 2016, the SEC adopted final rules applicable to clearing agencies registered with the SEC, including SEC Rule 17Ad–22(e)(6), to establish enhanced standards for the operation and governance of registered clearing agencies that meet the definition of ‘‘covered clearing agency.42 This rule requires a covered clearing agency that 37 Id. 38 See DCO General Provisions and Core Principles, 76 FR 69334, 69364–69379 (Nov. 8, 2011). 39 The CFTC adopted enhanced risk management requirements for all registered DCOs in 2011. See id. 40 For example, CFTC Rule 39.13(g)(8)(ii) (requiring DCOs to collect customer initial margin, for non-hedge positions, at a level that is greater than 100% of the DCO’s initial margin requirements) does not apply to initial margin collected for security futures positions. In September 2012, the CFTC’s Division of Clearing and Risk issued an interpretive letter regarding CFTC Rule 39.13(g)(8)(ii) to provide clarifications to DCOs complying with the rule. CFTC Letter No. 12– 08 (Sept. 14, 2012). CFTC Letter No. 12–08 states that the customer margin rule under CFTC Rule 39.13(g)(8)(ii) ‘‘does not apply to customer initial margin collected as performance bond for customer security futures positions.’’ CFTC Letter No. 12–08 is limited in its discussion to CFTC Rule 39.13(g)(8)(ii) only and, accordingly, the remaining provisions of CFTC Rule 39.13 continue to apply to DCOs clearing security futures. 41 Currently, the OCC is the only clearinghouse in the United States that clears security futures. OCC is registered with the SEC as a clearing agency pursuant to Section 17A of the Exchange Act and registered with the CFTC as a DCO pursuant to Section 5b of the CEA. 42 See Standards for Covered Clearing Agencies, Exchange Act Release No. 78961 (Sept. 28, 2016), 81 FR 70786 (Oct. 13, 2016). PO 00000 Frm 00005 Fmt 4701 Sfmt 4702 36437 provides central clearing services to establish, implement, maintain, and enforce written policies and procedures reasonably designed to, as applicable, cover its credit exposures to its participants by establishing a risk-based margin system that meets certain minimum standards prescribed in the rule.43 OCC, as a covered clearing agency, is subject to these rules, and its broker-dealer clearing members that clear security futures are subject to SEC Rule 403(b)(1).44 C. Consideration of SROs’ Risk-Based Portfolio Margining Approaches As discussed below, the Commissions are proposing to amend the customer margin requirements for security futures that are held outside of risk-based portfolio margining accounts. This amended margin requirement would equal the level of margin required to be collected for security futures under riskbased portfolio margining methodologies. The amended margin requirement also would equal the margin requirement for an unhedged exchange-traded option held in a securities portfolio margin account. Security futures and exchange-traded options held in securities accounts are permitted to take advantage of SRO riskbased portfolio margining, and the Commissions are seeking to align the margin requirement for security futures not held in portfolio margin accounts (by lowering their overall margin rate) with security futures and exchangedtraded options held in these securities accounts. Under the SRO risk-based portfolio margining rules, the minimum initial and maintenance margin on a customer’s entire portfolio, including an unhedged position in a security future or exchange-traded option, shall be the greater of: (i) The amount of any of the ten equidistant valuation points representing the largest theoretical loss in the portfolio as calculated under the rule,45 or (ii) the total calculated by multiplying $0.375 for each position by the instrument’s multiplier, not to 43 17 CFR 240.17Ad–22(e)(6). CFR 242.403(b)(1). 45 The actual percentage used to stress a financial instrument will depend on the financial instrument. For example, the up/down market move (high and low valuation points) is +6%/¥8% for high capitalization, broad-based market indexes; +/ ¥10% for non-high capitalization, broad-based market indexes; and +/¥15% for any other eligible product that is, or is based on, an equity security or a narrow-based index. See FINRA Rule 4210(g)(2)(F) and CBOE Rule 12.4(a)(11). Portfolio types containing volatility indexes are subject to market moves of +/¥20% for 30-day implied volatility, and +/¥40% for 9-day implied volatility. See CBOE Rule 12.4(a)(11). 44 17 E:\FR\FM\26JYP4.SGM 26JYP4 jbell on DSK3GLQ082PROD with PROPOSALS4 36438 Federal Register / Vol. 84, No. 144 / Friday, July 26, 2019 / Proposed Rules exceed the market value in the case of long positions.46 The SRO risk-based portfolio margining system approved by the SEC is a methodology for determining a customer’s margin requirement by calculating the greatest theoretical loss on a portfolio of financial instruments at ten equidistant points along a range representing a potential percentage increase and decrease in the value of the instrument or underlying instrument in the case of a derivative. Theoretical gains and losses for each instrument in the portfolio are netted at each valuation point along the range to derive a potential portfolio-wide gain or loss for the point. Under current SRO risk-based portfolio margining rules, the range of theoretical gains and losses for portfolios of security futures and exchange-traded options that are based on a single equity security or narrowbased index is a market increase of 15% and a decrease of 15% (i.e., the valuation points would be +/¥ 3%, 6%, 9%, 12%, and 15%).47 In addition to requiring a 15% margin for unhedged security futures and exchange-traded options, as a precondition to offering portfolio margining to customers under the SRO risk-based portfolio margining system, security futures intermediaries are required to establish a comprehensive, written risk analysis methodology to assess the potential risk to the security futures intermediary’s capital over a specified range of possible market movements for positions held in a securities portfolio margin account.48 traded options, and that the initial and maintenance margin levels for security futures may not be lower than the lowest level of margin, exclusive of premium, required for any comparable exchange-traded option. As noted above, despite some distinct economic uses for exchange-traded options and security futures, both products share similar risk profiles. Accordingly, the Commissions are proposing to apply margin requirements to security futures that are consistent with the margin requirements for comparable exchange-traded options. In summary, as discussed in detail below, because unhedged exchangetraded options and security futures in SRO risk-based portfolio margining programs were permitted to be margined at a lower 15% rate as early as 2008, when the SRO risk-based portfolio margining programs became permanent,50 the Commissions are proposing to amend their joint margin rules relating to security futures to reduce the minimum required margin for unhedged security futures from 20% to 15%, reflecting the current margin requirements available for comparable exchange-traded options.51 With regard to the other three statutory requirements, the Commissions preliminarily believe this proposed action is consistent with preserving the financial integrity of the security futures market, is unlikely to lead to systemic risk, and is consistent with the margin requirements established by the Federal Reserve Board under Regulation T.52 D. Consideration of Statutory Requirements As noted above, in Section 7(c)(2)(B)(iii) of the Exchange Act 49 Congress provided that the margin requirements for security futures must be consistent with the margin requirements for comparable exchange- II. DISCUSSION 46 See FINRA Rule 4210(g)(7) and CBOE Rule 12.4(e). 47 A theoretical options pricing model is used to derive position values at each valuation point for the purpose of determining the gain or loss. See FINRA Rule 4210(g)(2)(F) (defining the term ‘‘theoretical gains and losses’’). For example, assuming that the 15% market move creates the largest theoretical loss in the portfolio and that security futures have a linear function (i.e., a price movement in the underlying instrument will translate into a specific dollar value change in the security future), the initial and maintenance margin for a security future will equal close to 15% of the overall unhedged security futures portfolio. 48 See FINRA Rule 4210(g)(1) and CBOE Rule 15.8A. See also CFTC Rule 1.11 (requiring FCMs to establish risk management programs that address market, credit, liquidity, capital and other applicable risks, regardless of the type of margining offered). 49 15 U.S.C. 78g(c)(2)(B)(iii). VerDate Sep<11>2014 21:41 Jul 25, 2019 Jkt 247001 A. Minimum Margin for Unhedged Positions 1. Current Security Futures Margin Rules Under existing CFTC and SEC regulations, the current minimum initial and maintenance margin levels required of customers for each unhedged long or short position in security futures is 20% of the current market value of such a security future.53 This margin level was supra note 36. 2001 Proposed Rules, 66 FR at 50726 (‘‘Pending adoption of such [portfolio margin] systems by regulatory authorities, however, the 20 percent level is consistent with the current requirements for comparable equity options.’’). 52 As discussed in the CFTC’s Consideration of Costs and Benefits and the SEC’s Economic Analysis, in sections IV.A and B, respectively, the Commissions believe that margin coverage is sufficient and tailored to preserve financial integrity and prevent systemic risk in the security futures market. 53 See CFTC Rule 41.45(b), 17 CFR 41.45(b); SEC Rule 403(b), 17 CFR 242.403(b). PO 00000 50 See 51 See Frm 00006 Fmt 4701 Sfmt 4702 based on the margin requirements for an unhedged short, at-the-money exchangetraded option in 2002.54 Currently, the margin requirement for an unhedged short, at-the-money exchange-traded option held in a customer account that is not subject to SRO risk-based portfolio margining, where the underlying instrument is either an equity security or a narrow-based index of equity securities, is 100% of the exchange-traded option proceeds, plus 20% of the value of the underlying security or narrow-based index.55 2. SRO Risk-Based Portfolio Margin Accounts May Hold Comparable Exchange-Traded Options When the Commissions adopted the 2002 Final Rules, market participants had no opportunity to margin short exchange-traded options on an equity security or a narrow-based index, at a rate lower than 20%. Therefore, according to Section 7(c)(2)(B)(iii)(II) of the Exchange Act, the Commissions could not establish a margin level for security futures that was lower than the 20% margin level applicable to exchange-traded options. Now, after the adoption of the SRO risk-based portfolio margining for securities customer accounts, market participants may choose to hold their exchange-traded options in accounts that are margined at levels of 15% or lower.56 At the time of the 2002 Final Rules, the SROs had not yet proposed portfolio margining rules for exchange-traded options. As of the publication of the 2002 Final Rules, all short exchangetraded options on an equity security or a narrow-based index were required to satisfy a 20% margin rate and it was the Commissions’ view that security futures should be subject to the same margin rate for those comparable exchangetraded options. Today, there is an alternative margin methodology for exchange-traded options that are held in a securities 54 See 2002 Final Rules, 67 FR at 53157. generally FINRA Rule 4210 and CBOE Rule 12.3. For long, exchange-traded options, the purchaser is generally required to pay the full amount of the contract. 56 As stated above, SRO risk-based portfolio margin rules permit a security futures intermediary to combine certain of a customer’s securities positions to compute margin requirements. In cases where a customer holds hedged positions (such as options) on the same underlying security, the portfolio margin requirement may be less than 15%. For purposes of the analysis of the proposed rule amendments, however, the Commissions are determining whether the proposed 15% margin requirement for an unhedged security future held outside a securities portfolio margin account is comparable to a 15% margin requirement for unhedged exchanged-traded options held in a securities portfolio margin account. 55 See E:\FR\FM\26JYP4.SGM 26JYP4 Federal Register / Vol. 84, No. 144 / Friday, July 26, 2019 / Proposed Rules margin account and subject to permanent portfolio margin requirements implemented successfully by market participants. The Commissions preliminarily believe that they have satisfied the third prong of the Exchange Act’s margin requirements to determine that the margin rate for security futures should be consistent with the margin rate for those exchangetraded options. The Commissions preliminarily believe there is sufficient basis to make that determination at this time, and are proposing that the margin rate for unhedged security futures be consistent with, and the same as, the margin rate for unhedged exchangetraded options held in a risk-based portfolio margining account. jbell on DSK3GLQ082PROD with PROPOSALS4 3. Minimum Levels of Margin Required for Security Futures Congress stated explicitly that the margin level for a security future should not be lower than the lowest level of margin for any comparable exchangetraded option,57 but it did not state a specific amount that the Commissions would be required to set as a minimum margin requirement. Today, there are exchange-traded options based on an equity security or narrow-based index that are margined at 15%, or lower, as a result of portfolio margining that is now being offered by a number of SROs. Congress intended for the Commissions to set a margin level for a security future that was not lower than the margin rate required for comparable exchangetraded options, which is to say that the Commissions cannot set a margin rate for security futures lower than 15%. The margin required for an unhedged exchange-traded option in a risk-based portfolio margin account, calculated using the SROs’ current rules, will equal 15% or less of the underlying equity security’s value, because the largest theoretical loss produced by shocking the portfolio will not be more than 15%. Because the current SRO required margin levels for unhedged exchangetraded options held in a portfolio margin account are set at a level based on shocking the portfolio at 15% price movements, the Commissions preliminarily believe that the unhedged security futures margin rate should not be lower than 15%. Therefore, the Commissions’ proposal to lower the margin requirement for security futures complies with the statutory requirement that the margin level for a security future be consistent with the margin for any comparable exchange-traded option. 57 15 4. The Commissions Have Authority to Determine Which Exchange-Traded Options Are Comparable to Security Futures In this proposal, the Commissions seek to align the margin rate for security futures with the lower portfolio-based margin rate for exchange-traded options because the Commissions view exchange-traded options held in portfolio margin accounts as comparable to security futures that may be held alongside the exchange-traded options. Congress did not instruct the Commissions to set the margin requirement for security futures at the same exact level as the margin requirements for exchange-traded options. The Commissions are required to establish a margin requirement that is ‘‘consistent’’ with the margin requirements for ‘‘comparable’’ exchange-traded options. Because the Commissions have some flexibility in establishing the margin rate for security futures, the Commissions are making the determination that establishing the margin rate for unhedged security futures at the same rate as the margin rate for exchange-traded options that are held alongside security futures inside a portfolio margin account subject to an SRO’s portfolio margining rules will provide the most consistent result for security futures. The Commissions are proposing to decrease the margin requirement for unhedged security futures from 20% to 15% in order to reflect the comparability between unhedged security futures and exchange-traded options that are held in risk-based portfolio margin accounts. The SRO portfolio margining rules, upon which this change is based, are discussed in more detail below. The Commissions explained in the 2001 proposing release for customer margin for security futures that ‘‘the Federal Reserve Board has expressed the view that ‘more risk-sensitive, portfoliobased approaches to margining security futures products’ should be adopted [citing the FRB Letter]. Pending adoption of such systems by regulatory authorities, however, the 20% level is consistent with the current requirements for comparable equity options.’’ 58 With the adoption of the SRO securities risk-based portfolio margining rules—including portfolio margining for security futures—the Commissions have preliminarily determined that a proposed minimum margin level of 15% meets the comparability standard of U.S.C. 78g(c)(2)(B)(iii)(II). VerDate Sep<11>2014 21:41 Jul 25, 2019 58 See Jkt 247001 PO 00000 2001 Proposed Rules, 66 FR at 50726. Frm 00007 Fmt 4701 Sfmt 4702 36439 Section 7(c)(2) of the Exchange Act.59 Under the SROs’ securities risk-based portfolio margining rules, a security futures intermediary may combine a customer’s related products and calculate margin for a group of similar products on a portfolio margin basis. Each group of products may be subject to a different margin calculation, depending on its risk profile.60 Portfolios containing exchange-traded options and security futures based on the same underlying security, such as an individual equity or narrow-based index are grouped together.61 SRO rules calculate the margin requirement for these exchange-traded options and security futures by exposing the instruments to market moves that are +/ ¥15%. The Commissions are proposing to allow security futures intermediaries to margin security futures held outside of these portfolios the same as security futures held inside of the portfolios with other instruments. As a result of this change, security futures held in futures accounts and strategy-based securities margin accounts would be subject to the same margin requirements as unhedged security futures held in securities portfolio margin accounts. The Commissions are proposing to require 15% margin for unhedged security futures because it would bring security futures held outside of a securities portfolio margin account into alignment with the margin requirements for unhedged security futures held within a securities account using risk-based portfolio margining. 5. The Margin Requirements Are Consistent for Comparable ExchangeTraded Options Under the statutory requirement, customer margin requirements, 59 See 15 U.S.C. 78g(c)(2). of the SROs has different portfolio types that will be margined according to the portfolio’s risk profile. These portfolio types include: (i) High capitalization, broad-based market index (margin required is calculated using +6/¥8% market moves), (ii) non-high capitalization, broad-based market index (margin required is calculated using +/¥10% market moves), (iii) narrow-based index (margin required is calculated using +/¥15% market moves), (iv) individual equity (margin required is calculated using +/¥15% market moves), (v) volatility index (30-day implied) (margin required is calculated using +/¥20% market moves), and (vi) volatility index (9-day implied) (margin required is calculated using +/ ¥40% market moves). See, e.g., FINRA Rule 4210(g)(2)(F) and CBOE Rule 12.4(a)(11). 61 Certain portfolios are allowed offsets such that, at the same valuation point, for example, 90% of a gain in one portfolio may reduce or offset a loss in another portfolio. These offsets would be allowed between portfolios within the narrow-based index group, but not for class groups containing different individual equity securities or eligible products (such as options and security futures) as the underlying security. 60 Each E:\FR\FM\26JYP4.SGM 26JYP4 36440 Federal Register / Vol. 84, No. 144 / Friday, July 26, 2019 / Proposed Rules jbell on DSK3GLQ082PROD with PROPOSALS4 including the establishment of levels of margin (initial and maintenance) for security futures must be consistent with the margin requirements for comparable options traded on any exchange registered pursuant to Section 6(a) of the Exchange Act. As noted above, the Commissions believe that certain types of exchange-traded options, no matter what type of an account they are in, are comparable to security futures. The margin requirements for comparable exchange-traded options and security futures must be consistent. Under this proposal, the Commissions are using a stress level percentage set out for unhedged exchange-traded options based on an equity security or narrow-based index in a portfolio margin account (e.g., +/¥15%) to establish a consistent margin level for security futures held outside of a securities portfolio margin account, which use a fixed-rate percentage of market value to set margin.62 While these two regimes reflect certain differences (in that portfolio margin calculates margin on a portfolio or net basis for securities with the same underlying position, and outside a securities portfolio margin account, margin is calculated on a position-byposition basis), the Commissions believe that these two regimes are consistent when comparing unhedged security futures with comparable exchangetraded options. As stated above, the Commissions noted in the 2001 Proposed Rules that ‘‘[p]ending adoption of such [portfolio margining] systems by regulatory authorities, however, the 20% level is consistent with the current requirements for comparable equity options.’’ 63 Since the adoption of the SRO risk-based portfolio margin rules, subsequent to the adoption of the 2002 Final Rules, unhedged exchangedtraded options based on an equity security or a narrow-based index and unhedged security futures held in a securities portfolio margin account may be margined at 15%. As a result of these developments, the Commissions are proposing to reduce the margin 62 While the Commissions are using a single unhedged option for comparison, the Commissions note that a long (short) security future position can be replicated by a portfolio containing one long (short) at-the-money call and one short (long) at-themoney put. This options portfolio creates a synthetic security futures position. The margin requirement applicable to the options portfolio, under approved SRO portfolio margin system rules, is also 15%. In addition, a very deep-in-the-money call or put on the same security (with a delta of one) is an option contract comparable to a security futures contract that will also result in a consistent 15% margin level. 63 2001 Proposed Rules, 66 FR at 50726. VerDate Sep<11>2014 21:41 Jul 25, 2019 Jkt 247001 requirement for an unhedged security future held outside of a securities portfolio margin account from 20% to 15%. Consequently, the Commissions preliminarily believe that the proposed level of margin is consistent with the margin requirements for comparable options traded on any exchange registered pursuant to Section 6(a) of the Exchange Act. 6. The Proposed Margin Rule Is Consistent With the Federal Reserve’s Regulation T Section 7(c)(2)(B)(iv) of the Exchange Act requires that margin requirements for security futures (other than levels of margin), including the type, form, and use of collateral, must be consistent with the requirements of Regulation T.64 In the 2002 Final Rules, while the Commissions determined not to apply Regulation T in its entirety to margin requirements for security futures, the Commissions adopted final rules which included certain provisions that govern account administration, type, form, and use of collateral, calculation of equity, withdrawals from accounts, and the treatment of undermargined accounts. In the 2002 Final Rules, the Commissions stated that ‘‘the inclusion of these provisions in the Final Rules satisfies the statutory requirement that the margin rules for security futures be consistent with Regulation T.’’ 65 Because the proposed amendments today solely relate to a reduction in the ‘‘levels of margin’’ for security futures, which are not required under the Exchange Act to be consistent with Regulation T, the Commissions preliminarily believe that the margin requirements for security futures as proposed to be amended would continue to be consistent with Regulation T. 7. The Proposed Margin Rule Permits Higher Margin Requirements Again, under this proposal, the joint margin regulations will continue to permit SROs and security futures intermediaries to establish higher margin levels and to take appropriate action to preserve their own financial integrity.66 The proposed minimum margin requirement of 15% would apply to an unhedged position in a security future, whether the position is held in a securities account or a futures account.67 The 15% margin requirement U.S.C. 78g(c)(2)(B)(iv). Final Rules, 67 FR at 53155. 66 See CFTC Rule 41.42(c)(1), 17 CFR 41.42(c)(1); SEC Rule 400(c)(1), 17 CFR 242.400(c)(1). 67 In its petition, OCX stated that ‘‘because of operational issues at the securities firms, almost all security futures positions are carried in a futures PO 00000 64 15 65 2002 Frm 00008 Fmt 4701 Sfmt 4702 for unhedged security futures would not preclude the use of an existing portfolio margining system, such as SPAN, by an FCM for security futures held in a futures account, so long as the portfolio margining system is modified to produce results that comply with the margin requirements for security futures.68 8. Request for Comments In summary, the Commissions propose that the required minimum margin for each long or short position in a security future shall be 15% of the current market value of such security future. The Commissions request comment on all aspects of the proposed amendment to reduce the margin requirement to 15%. In addition, the Commissions request comment, including empirical data in support of the comments, on the following questions related to the proposal: • As discussed above, the Commissions believe that because the margin requirement for a comparable option held in a portfolio margin account is calculated by exposing the option to market moves that are + / ¥15%, the margin methodologies for security futures and comparable exchange-traded options are consistent. Is the Commissions’ belief correct? If not, why not? • Is the proposed reduction in margin for security futures to 15% consistent with the margin requirements for comparable exchange-traded option contracts based on an equity security or narrow-based index held in a securities portfolio margin account? Is it appropriate to compare the proposed margin requirement for an unhedged security futures position held outside a portfolio margin account to an unhedged exchange-traded option held in a securities portfolio margin account for purposes of the comparability standard in Section 7(c)(2)(B)(iii)(I) of the Exchange Act? account regulated by the CFTC and not in a securities account. The proposed joint rulemaking would permit customers carrying security futures in futures accounts to receive margin treatment consistent with that permitted under the [portfolio] margining provisions of CBOE.’’ See OCX Petition at 2. 68 For example, a SPAN risk-based portfolio margining methodology can be used to compute required initial or maintenance margin that results in margin levels that are equal to or higher than the margin levels required by the proposed rules. In this regard, for example, the minimum margin requirement for unhedged security futures under the proposed rules would be 15%, and SPAN could not recognize any offset for combination positions that is not permitted under SRO rules, as provided in CFTC Rule 41.45(b)(2), 17 CFR 41.45(b)(2); SEC Rule 403(b)(2), 17 CFR 242.403(b)(2). See also note 27 in the 2002 Final Rules, 67 FR at 53148. E:\FR\FM\26JYP4.SGM 26JYP4 Federal Register / Vol. 84, No. 144 / Friday, July 26, 2019 / Proposed Rules • Are there any other comparisons or methodologies for comparison that the Commissions should consider in determining whether the proposed reduction in margin to 15% for security futures meets the standards in Section 7(c)(2)(B)(iii) of the Exchange Act with respect to comparing the margin requirements for security futures with the margin requirements for comparable exchange-traded options? For example, should the comparison or methodologies for comparable options be based on a specific option position (or positions) held in a securities portfolio margin account, such as a deep in-the-money options position or matched pairs of long-short options positions? If so, please identify the position or positions and explain how they would meet the comparability standards under the Exchange Act. • Are there any other risk-based margin methodologies that could be used to prescribe margin requirements for security futures? If so, please identify the margin methodologies and explain how they would meet the jbell on DSK3GLQ082PROD with PROPOSALS4 1. Long security future or short security future. 2. Long security future (or basket of security futures representing each component of a narrowbased securities index 1) and long put option 2 on the same underlying security (or index). 3. Short security future (or basket of security futures representing each component of a narrowbased securities index 1) and short put option on the same underlying security (or index). 4. Long security future and short position in the same security (or securities basket 1) underlying the security future. 5. Long security future (or basket of security futures representing each component of a narrowbased securities index 1) and short call option on the same underlying security (or index). 6. Long a basket of narrow-based security futures that together tracks a broad based index 1 and short a broad-based security index call option contract on the same index. The Commissions’ joint margin rules permit SROs 69 to establish margin levels for offsetting positions involving security futures, which are lower than the required margin levels for unhedged positions.70 Thus, an SRO may adopt rules that set the required initial or maintenance margin level for an offsetting position involving security futures and related positions at a level lower than the level that would be required if the positions were margined separately. Such rules must meet the criteria set forth in Section 7(c)(2)(B) of the Exchange Act 71 and must be effective in accordance with Section 19(b)(2) of the Exchange Act 72 and, as applicable, Section 5c(c) of the CEA.73 In issuing the 2002 Final Rules, the Commissions published a table of offsets for security futures that the Commissions had identified as consistent with those permitted for similar offsetting positions involving exchange-traded options and that would qualify for reduced margin levels.74 The Commissions are proposing to republish the table of offsets to reflect the proposed 15% minimum margin requirement. As compared to the offsets identified at the time of the adoption of the joint margin rules, certain offsets would reflect a 15% minimum margin requirement for certain offsetting positions (as opposed to the current 20% requirement) and would retain the same percentages for all other offsets.75 There are no additional adjustments to the offsets table, other than minor footnote edits. The Commissions preliminarily believe that the offsets identified in the following re-stated table are consistent with the strategy-based offsets permitted for comparable offset positions involving exchange-traded options. SROs seeking to permit trading in security futures generally should modify their rules that impose levels of required margin for offsetting positions involving security futures in accordance with the margin percentages identified in the following table of offsets. Initial margin requirement Maintenance margin requirement Individual stock or narrowbased security index. Individual stock or narrowbased security index. 15% of the current market value of the security future. 15% of the current market value of the long security future, plus pay for the long put in full. Individual stock or narrowbased security index. 15% of the current market value of the short security future, plus the aggregate put in-the-money amount, if any. Proceeds from the put sale may be applied. 15% of the current market value of the security future. The lower of: (1) 10% of the aggregate exercise price 3 of the put plus the aggregate put out-of-themoney 4 amount, if any; or (2) 15% of the current market value of the long security future. 15% of the current market value of the short security future, plus the aggregate put in-the-money amount, if any. 5 Individual stock or narrowbased security index. The initial margin required under Regulation T for the short stock or stocks. Individual stock or narrowbased security index. 15% of the current market value of the long security future, plus the aggregate call in-the-money amount, if any. Proceeds from the call sale may be applied. Narrow-based security index 15% of the current market value of the long basket of narrow-based security futures, plus the aggregate call in-the-money amount, if any. Proceeds from the call sale may be applied. 69 As noted above, for the sake of clarity and consistency, the defined term ‘‘SRO’’ is used to describe both self-regulatory organizations and selfregulatory authorities throughout this proposal. 70 See CFTC Rule 41.45(b)(2), 17 CFR 41.45(b)(2); SEC Rule 403(b)(2), 17 CFR 242.403(b)(2). 71 15 U.S.C. 78g(c)(2)(B). 21:41 Jul 25, 2019 B. Margin Offsets Security underlying the security future Description of offset VerDate Sep<11>2014 comparability standards under the Exchange Act. 36441 Jkt 247001 U.S.C. 78s(b)(2). U.S.C. 7a–2(c). 74 See 2002 Final Rules, 67 FR at 53159. The offset table was published in the 2002 Final Rules. It is not part of the Code of Federal Regulations. See also FINRA Rule 4210(f)(10)(B)(iii), CBOE Rule PO 00000 72 15 73 7 Frm 00009 Fmt 4701 Sfmt 4702 5% of the current market value as defined in Regulation T of the stock or stocks underlying the security future. 15% of the current market value of the long security future, plus the aggregate call in-the-money amount, if any. 15% of the current market value of the long basket of narrow-based security futures, plus the aggregate call in-the-money amount, if any. 12.3(k)(6), OCX Rule 515(m), and Schedule A to Chapter 5 of the OneChicago Exchange Rulebook. 75 The offset table lists the margin percentages for a long security future and a short security future. These percentages are the baseline, not offsets, but they are included in the table to preserve consistency with the earlier offset table. E:\FR\FM\26JYP4.SGM 26JYP4 jbell on DSK3GLQ082PROD with PROPOSALS4 36442 Federal Register / Vol. 84, No. 144 / Friday, July 26, 2019 / Proposed Rules Description of offset Security underlying the security future Initial margin requirement Maintenance margin requirement 7. Short a basket of narrow-based security futures that together tracks a broad-based security index1 and short a broad-based security index put option contract on the same index. 8. Long a basket of narrow-based security futures that together tracks a broad-based security index 1 and long a broad-based security index put option contract on the same index. 9. Short a basket of narrow-based security futures that together tracks a broad-based security index 1 and long a broad-based security index call option contract on the same index. 10. Long security future and short security future on the same underlying security (or index). Narrow-based security index 15% of the current market value of the short basket of narrow-based security futures, plus the aggregate put in-the-money amount, if any. Proceeds from the put sale may be applied. 15% of the current market value of the long basket of narrow-based security futures, plus pay for the long put in full. 15% of the current market value of the short basket of narrow-based security futures, plus the aggregate put in-the-money amount, if any. 11. Long security future, long put option and short call option. The long security future, long put and short call must be on the same underlying security and the put and call must have the same exercise price. (Conversion) 12. Long security future, long put option and short call option. The long security future, long put and short call must be on the same underlying security and the put exercise price must be below the call exercise price. (Collar). 13. Short security future and long position in the same security (or securities basket 1) underlying the security future. 14. Short security future and long position in a security immediately convertible into the same security underlying the security future, without restriction, including the payment of money. 15. Short security future (or basket of security futures representing each component of a narrow-based securities index 1) and long call option or warrant on the same underlying security (or index). 16. Short security future, Short put option and long call option. The short security future, short put and long call must be on the same underlying security and the put and call must have the same exercise price. (Reverse Conversion) 17. Long (short) a basket of security futures, each based on a narrow-based security index that together tracks the broadbased index 1 and short (long) a broad based-index future. VerDate Sep<11>2014 21:41 Jul 25, 2019 Narrow-based security index Narrow-based security index 15% of the current market value of the short basket of narrow-based security futures, plus pay for the long call in full. Individual stock or narrowbased security index. The greater of: 5% of the current market value of the long security future; or (2) 5% of the current market value of the short security future. 15% of the current market value of the long security future, plus the aggregate call in-the-money amount, if any, plus pay for the put in full. Proceeds from the call sale may be applied. Individual stock or narrowbased security index. The lower of: (1) 10% of the aggregate exercise price of the put, plus the aggregate put out-of-themoney amount, if any; or (2) 15% of the current market value of the long basket of security futures. The lower of: (1) 10% of the aggregate exercise price of the call, plus the aggregate call out-of-themoney amount, if any; or (2) 15% of the current market value of the short basket of security futures. The greater of: (1) 5% of the current market value of the long security future; or (2) 5% of the current market value of the short security future. 10% of the aggregate exercise price, plus the aggregate call in the money amount, if any. Individual stock or narrowbased security index. 15% of the current market value of the long security future, plus the aggregate call in-the-money amount, if any, plus pay for the put in full. Proceeds from call sale may be applied. The lower of: (1) 10% of the aggregate exercise price of the put plus the aggregate put out-of-themoney amount, if any; or (2) 15% of the aggregate exercise price of the call, plus the aggregate call in-the-money amount, if any. Individual stock or narrowbased security index. The initial margin required under Regulation T for the long stock or stocks. 5% of the current market value, as defined in Regulation T, of the long stock or stocks. Individual stock or narrowbased security index. The initial margin required under Regulation T for the long security. 10% of the current market value, as defined in Regulation T, of the long security. Individual stock or narrowbased security index. 15% of the current market value of the short security future, plus pay for the call in full. The lower of: (1) 10% of the aggregate exercise price of the call, plus the aggregate call out-of-themoney amount, if any; or (2) 15% of the current market value of the short security future. Individual stock or narrowbased security index. 15% of the current market value of the short security future, plus the aggregate put in-the-money amount, if any, plus pay for the call in full. Proceeds from put sale may be applied. 10% of the aggregate exercise price, plus the aggregate put inthe-money amount, if any. Narrow-based security index 5% of the current market value of the long (short) basket of security futures. 5% of the current market value of the long (short) basket of security futures. Jkt 247001 PO 00000 Frm 00010 Fmt 4701 Sfmt 4702 E:\FR\FM\26JYP4.SGM 26JYP4 Federal Register / Vol. 84, No. 144 / Friday, July 26, 2019 / Proposed Rules 36443 Description of offset Security underlying the security future Initial margin requirement Maintenance margin requirement 18. Long (short) a basket of security futures that together tracks a narrow-based index 1 and short (long) a narrow basedindex future. 19. Long (short) a security future and short (long) an identical security future traded on a different market 6. Individual stock and narrowbased security index. The greater of: (1) 5% of the current market value of the long security future(s); or (2) 5% of the current market value of the short security future(s). The greater of: (1) 3% of the current market value of the long security future(s); or (2) 3% of the current market value of the short security future(s). The greater of: (1) 5% of the current market value of the long security future(s); or (2) 5% of the current market value of the short security future(s). The greater of: (1) 3% of the current market value of the long security future(s); or (2) 3% of the current market value of the short security future(s). Individual stock and narrowbased security index. 1 Baskets of securities or security futures contracts replicate the securities that compose the index, and in the same proportion. unless otherwise specified, stock index warrants are treated as if they were index options. exercise price,’’ with respect to an option or warrant based on an underlying security, means the exercise price of an option or warrant contract multiplied by the numbers of units of the underlying security covered by the option contract or warrant. ‘‘Aggregate exercise price’’ with respect to an index option means the exercise price multiplied by the index multiplier. 4 ‘‘Out-of-the-money’’ amounts are determined as follows: (1) for stock call options and warrants, any excess of the aggregate exercise price of the option or warrant over the current market value of the equivalent number of shares of the underlying security; (2) for stock put options or warrants, any excess of the current market value of the equivalent number of shares of the underlying security over the aggregate exercise price of the option or warrant; (3) for stock index call options and warrants, any excess of the aggregate exercise price of the option or warrant over the product of the current index value and the applicable index multiplier; and (4) for stock index put options and warrants, any excess of the product of the current index value and the applicable index multiplier over the aggregate exercise price of the option or warrant. 5 ‘‘In the-money’’ amounts are determined as follows: (1) for stock call options and warrants, any excess of the current market value of the equivalent number of shares of the underlying security over the aggregate exercise price of the option or warrant; (2) for stock put options or warrants, any excess of the aggregate exercise price of the option or warrant over the current market value of the equivalent number of shares of the underlying security; (3) for stock index call options and warrants, any excess of the product of the current index value and the applicable index multiplier over the aggregate exercise price of the option or warrant; and (4) for stock index put options and warrants, any excess of the aggregate exercise price of the option or warrant over the product of the current index value and the applicable index multiplier. 6 Two security futures are considered ‘‘identical’’ for this purpose if they are issued by the same clearing agency or cleared and guaranteed by the same derivatives clearing organization, have identical contract specifications, and would offset each other at the clearing level. 2 Generally, jbell on DSK3GLQ082PROD with PROPOSALS4 3 ‘‘Aggregate The Commissions request comment on the re-stated table of offsets to reflect the proposed 15% minimum margin requirement. In addition, the Commissions request comment, including empirical data in support of the comments, on the following questions related to the re-stated table of offsets: • In light of the proposed reduction in margin requirements for unhedged security futures from 20% to 15%, should any of the other percentages in the offsets table also be reduced? If so, would those percentages still be consistent with the margin requirements for comparable exchange-traded options? • Are there offset positions in addition to those enumerated in the above chart that are consistent with the margin requirements for comparable exchange-traded options, and which the Commissions should consider adding to the list of offsets? • Are there offset positions included in the above chart which the Commissions should delete from the list of offsets? III. Paperwork Reduction Act A. CFTC The Paperwork Reduction Act of 1995 (‘‘PRA’’) 76 imposes certain requirements on federal agencies (including the CFTC and the SEC) in connection with their conducting or sponsoring any collection of information as defined by the PRA. The proposed rules do not require a new collection of information on the part of any entities subject to these rules. Accordingly, the requirements imposed by the PRA are not applicable to these rules. B. SEC The PRA77 imposes certain requirements on federal agencies (including the CFTC and the SEC) in connection with their conducting or sponsoring any collection of information as defined by the PRA. The proposed amendments do not contain a ‘‘collection of information’’ requirement within the meaning of the PRA. Accordingly, the PRA is not applicable. 76 44 21:41 Jul 25, 2019 Jkt 247001 PO 00000 A. CFTC 1. Introduction Section 15(a) of the CEA requires the CFTC to consider the costs and benefits of its actions before promulgating a regulation under the CEA or issuing certain orders.78 Section 15(a) further specifies that the costs and benefits shall be evaluated in light of five broad areas of market and public concern: (1) Protection of market participants and the public; (2) efficiency, competitiveness, and financial integrity of futures markets; (3) price discovery; (4) sound risk management practices; and (5) other public interest considerations. The CFTC considers the costs and benefits resulting from its discretionary determinations with respect to the Section 15(a) factors below. Where reasonably feasible, the CFTC has endeavored to estimate quantifiable costs and benefits. Where quantification is not feasible, the CFTC identifies and describes costs and benefits qualitatively. U.S.C. 3501 et seq. 77 Id. VerDate Sep<11>2014 IV. Consideration of Costs and Benefits (CFTC) and Economic Analysis (SEC) of the Proposed Amendments Frm 00011 78 7 Fmt 4701 Sfmt 4702 E:\FR\FM\26JYP4.SGM U.S.C. 19(a). 26JYP4 36444 Federal Register / Vol. 84, No. 144 / Friday, July 26, 2019 / Proposed Rules 2. Economic Baseline The CFTC’s economic baseline for purposes of considering the proposed amendment is the security futures margin rule that exists today. In the 2002 Final Rules, the Commissions adopted security futures margin rules that complied with the statutory requirements under Section 7(c)(2)(B) of the Exchange Act. The rules state that, ‘‘the required margin for each long or short position in a security future shall be twenty (20) percent of the current market value of such security future.’’ 79 The 2002 Final Rules also allow SROs to set margin levels lower than the 20% minimum requirement for customers with ‘‘an offsetting position involving security futures and related positions.’’ 80 In addition, the 2002 Final Rules permit certain customers to take advantage of exclusions to the minimum margin requirement for security futures. The CFTC will consider the costs and benefits of this rule proposal as compared with the baseline of the current minimum initial and maintenance margin levels for unhedged security futures, which is set at 20% of the current market value of such security future. 3. Summary of Proposed Amendment The proposed amendment would lower the minimum margin level for an unhedged position in a security future from 20% of its current market value to 15% of its current market value. In connection with this change, the security futures margin offsets table would be restated so that it is consistent with the proposed reduction in margin. jbell on DSK3GLQ082PROD with PROPOSALS4 4. Description of Possible Costs The CFTC has preliminarily determined that, to the extent that there are operational or technology costs associated with modifying operational and administrative systems for calculating security futures customer margin, such costs are not likely to be significant given that the infrastructure for calculating such margin already exists and is not likely to require major reprogramming. i. Risk-Related Costs for Security Futures Intermediaries and Customers There are three types of risk-related costs that could result from the adoption of the proposed amendment. The first risk-related cost is reducing margin requirements for security futures that could expose security futures 79 CFTC Rule 41.45(b)(1), 17 CFR 41.45(b)(1). See CFTC Rule 41.43(a)(4), 17 CFR 41.43(a)(4) (defining the term ‘‘current market value.’’). 80 CFTC Rule 41.45(b)(2), 17 CFR 41.45(b)(2). VerDate Sep<11>2014 21:41 Jul 25, 2019 Jkt 247001 intermediaries and their customers to losses in the event that margin collected is insufficient to protect against market moves and there is a default of a security futures intermediary or its customer. Pursuant to OCC’s bylaws, any security futures intermediary that is a clearing member of OCC grants a security interest in any account it establishes and maintains to OCC, and therefore a customer’s assets may be obligated to OCC upon default.81 As a result, FCMs could be exposed to a loss if the 15% margin rate for security futures is insufficient. However, this risk is mitigated by the fact that if a 15% margin level is determined to be insufficient, the security futures intermediary has the authority to collect margin in an amount that exceeds the minimum requirement in order to protect its financial integrity.82 A second type of risk-related cost might arise where an FCM collects the minimum margin required from customers in order to maintain or expand its customer business. Lower margin requirements might facilitate an FCM permitting its customers to take on additional risk in their positions in order to increase business for the FCM. Such additional risks could put the FCM at risk if the customer were to default, and other customers at the FCM could risk losses if the FCM or one of its customers defaulted. A related third type of risk-related cost stems from the possibility of increased leverage among security futures customers. Customers posting less margin to cover security futures positions might be able to increase their overall market exposure and thereby increase their leverage. The second and third risk-related costs are mitigated, to some degree, by regulations that apply to security futures intermediaries that are registered as FCMs. For example, FCMs are subject to capital requirements under CFTC regulations,83 and in instances where the security futures intermediary is jointly registered as a broker-dealer FCM, the SEC’s capital rules also apply.84 In addition, FCMs are required to establish a system of risk management policies and procedures pursuant to CFTC Rule 1.11. This risk management program is designed to protect the FCM and its customers 81 See OCC Bylaws, Maintenance of Accounts, Section 3, Interpretations and Policies .07, adopted September 22, 2003, last accessed on January 3, 2018, available at https://www.theocc.com/ components/docs/legal/rules_and_bylaws/occ_ bylaws.pdf. 82 See CFTC Rule 41.42(c)(1), 17 CFR 41.42(c)(1); SEC Rule 400(c)(1), 17 CFR 242.400(c)(1). 83 See CFTC Rule 1.17, 17 CFR 1.17. 84 See SEC Rule 240.15c3–1, 17 CFR 240.15c3–1. PO 00000 Frm 00012 Fmt 4701 Sfmt 4702 against a variety of risks, including the potential future exposure of a security futures position that initial and maintenance margin is designed to address. Lastly, risk-related costs to the security futures intermediary are further mitigated by the fact that OCX represents that the vast majority of its open interest is held by eligible contract participants (‘‘ECPs’’) as defined in Section 1a(18) of the CEA.85 Generally speaking, ECPs are financial entities or individuals with significant financial resources or other qualifications, that make them appropriate persons for certain investments.86 According to data provided by OCX, over 99% of the notional value of OCX’s products was held by ECPs as of March 1, 2016 and March 1, 2017. ii. Appropriateness of Margin Requirements A possible risk-related cost of lowering margin requirements for security futures is that a DCO may not have sufficient margin on deposit to cover the potential future exposure of cleared security futures positions. However, as explained above, a review of margin coverage data for related options on futures supports the view that decreasing margin requirements from 20% to 15% margin will not have a significant effect on the safety and soundness of the security futures intermediaries and DCOs. Moreover, the risk management expertise at security futures intermediaries and DCOs, as well as the general applicability of CFTC Rule 39.13 to security futures, supports a view that DCOs and security futures intermediaries will continue to manage the risks of these products effectively even with lower margin requirements.87 The CFTC has reviewed the security futures markets under normal market 85 See also CFTC Rule 1.3, 17 CFR 1.3. example, an individual can qualify as an ECP if the individual has amounts invested on a discretionary basis, the aggregate of which is in excess of: (i) $10,000,000; or (ii) $5,000,000 if the individual also enters into an agreement, contract, or transaction in order to manage the risk associated with an asset owned or liability incurred, or reasonably likely to be owned or incurred, by the individual. 87 As discussed above, security futures intermediaries are authorized to collect margin above the amounts required by the Commissions. However, as for-profit entities, security futures intermediaries may be incentivized to lower their margin rates in order to compete for customer business. If security futures intermediaries engage in competition for business based on margin pricing, it is possible that security futures intermediaries will collect only the required level of margin (i.e., 15% under the proposed rule change), regardless of the market conditions, which could impair their ability to protect against market risk and losses. 86 For E:\FR\FM\26JYP4.SGM 26JYP4 Federal Register / Vol. 84, No. 144 / Friday, July 26, 2019 / Proposed Rules jbell on DSK3GLQ082PROD with PROPOSALS4 conditions and observed that a 15% level of margin would be sufficient to cover daily price moves in most instances (i.e., more than 99.5%).88 Therefore, the CFTC preliminarily believes that the proposed amendment will not have a substantial negative impact on (1) the protection of market participants or the public, (2) the financial integrity of security futures markets, or (3) sound risk management practices of DCOs or security futures intermediaries. The risk customers and/or intermediaries face from reducing margin for security futures is addressed at the clearinghouse level because there are additional protections under CFTC regulations. For example, CFTC Rule 39.13 requires a DCO to establish initial margin requirements that are commensurate with the risks of each product and portfolio. In addition, CFTC Rule 39.13 requires that initial margin models meet set liquidation time horizons and have established confidence levels of at least 99%. These DCO initial margin requirements are distinct from the margin requirements that are the subject of this proposal and serve to mitigate the possibility that a DCO may default (resulting in a systemic event). In the event that a DCO determined that a 15% margin level for security futures is insufficient to satisfy a DCO’s obligation under CFTC Rule 39.13, the DCO would be required to collect additional margin from its clearing members.89 88 Conducting a value-at-risk analysis of 74 of the most liquid security futures contracts during a limited time-frame (November 2002–June 2010), CFTC staff found that there were 195 instances where a 15% margin was insufficient and 99 instances where a 20% margin was insufficient. For all observations, a 15% margin was sufficient for 99.81% of all observations while a 20% margin was sufficient for 99.91% of all observations. CFTC staff notes that this period covers the fall of 2008, one of the most volatile quarters in history. The CFTC staff also notes that since 2010, volatility in the equity markets has typically been lower (e.g., as measured by the Chicago Board Options Exchange Volatility Index (‘‘VIX’’)) than in the 2002 to 2010 period. In particular, the VIX, which measures market expectations of near term volatility as conveyed by stock index option prices, has, at its highest levels since June 2010, never reached levels higher than 48 (as compared to almost 90 at the peak during the financial crisis). It is therefore reasonable to conclude that a 15% margin would be sufficient for almost all days since 2010. See, e.g., VIX data available from the Federal Reserve Bank of Saint Louis at https://fred.stlouisfed.org/ series/VIXCLS. 89 The CFTC expects that any difference between the margin charged at the DCO and the margin charged by the security futures intermediary will be addressed by additional margin calls, if necessary. The DCO can require additional margin from its clearing members (which in some cases will be the security futures intermediary), to cover changes in market positions. DCOs and clearing members are familiar with margin call procedures and have VerDate Sep<11>2014 21:41 Jul 25, 2019 Jkt 247001 The CFTC observes that the current and proposed margin requirements for security futures are materially distinct from initial margin requirements for DCOs. The initial margin requirements for DCOs are risk-based and designed to permit DCOs to use risk-based margin models to determine the appropriate level of margin to be collected, subject to the CFTC’s minimum requirements under CFTC regulations in Part 39. The current and proposed margin requirements for security futures do not incorporate risk-based strategies or calculations. Despite proposing a nonrisk-based margin requirement for security futures, the CFTC continues to support the use of risk-based margin models for all derivatives because use of such models are a sound way for DCOs to manage their clearing risks appropriately. iii. Costs Associated With Margin Offsets Table The Commissions are proposing to restate the table of offsets for security futures to reflect the proposed 15% minimum margin requirement. The CFTC does not believe that lowering the margin requirements for certain offsets will increase costs to customers, security futures intermediaries, or DCOs. The categories of permissible offsets will remain the same and there will be no change to the inputs used to calculate the offset, other than to decrease the initial and maintenance margin on all security futures from 20 to 15%. Moreover, the same risk to the customers and security futures intermediaries will exist if the Commissions decrease the margin required for security futures trading combinations eligible for offsets as it established rules and policies to efficiently transfer funds when needed. If a customer’s account has insufficient funds to meet the margin call, its clearing member may provide the amount to the DCO and collect it from the customer at a later time. In this scenario, the clearing member may take on a liability or additional risk on the customer’s behalf for a short period of time. The CFTC notes that this practice is the same for security futures as it is for other products subject to clearing and it does not view this temporary shifting of risk between the clearing member and the customer as a unique source of risk to security futures. Furthermore, this proposed change in required margin from 20% to 15% would not alter the relationship between DCOs and their clearing members, or between clearing members and their customers. The CFTC acknowledges that it is possible that DCOs and security futures intermediaries will collect different levels of margin, but it is not necessarily a result of this proposed rule change. Moreover, the difference in margin collected is not an unmitigated source of risk for the security futures intermediaries because they have the authority to collect additional funds from their customers in the event of a margin call and can choose to set margin levels higher than the minimum level required by the Commissions. PO 00000 Frm 00013 Fmt 4701 Sfmt 4702 36445 will with security futures without an offset. Finally, the CFTC notes that security futures intermediaries and customers will continue to be required to comply with daily mark-to-market and variation settlement procedures applied to security futures, as well as the large trader reporting regime that applies to futures accounts. 5. Description of Possible Benefits The CFTC has preliminarily determined that there are significant benefits associated with the proposed amendment. The proposed amendments would align customer margin requirements for security futures held in a futures or securities account with those that are held in a securities riskbased portfolio margin account. The CFTC believes that it would increase competition by establishing a level playing field between security futures carried in the SRO securities risk-based portfolio margining account and security futures carried in a futures account or a securities account. Additionally, the reduced minimum margin level could facilitate more trading in security futures, which would increase market liquidity to the benefit of market participants and the public. Increased liquidity could contribute to the financial integrity of security futures markets, particularly in the event an FCM finds that it must manage the default of a customer’s security futures positions. The lower minimum margin requirement also might decrease the direct cost of trading in security futures and increase capital efficiency because more funds would be available for other uses. Lowering the minimum margin requirement also could enable the one U.S. security futures exchange to better compete in the global marketplace, where security futures traded on foreign exchanges are subject to risk-based margin requirements that are generally lower than those applied to security futures traded in the U.S. The proposal restates the table of offsets for security futures to reflect the proposed 15% minimum margin requirement. These offsets would continue to provide the benefits of capital efficiency to customers because offsets recognize the unique features of certain specified combined strategies and would permit margin requirements that better reflect the risk of these strategies. Moreover, the same benefits of lowering margin costs for customers and increasing business in security futures could result from lowering margin requirements for offsetting security futures positions. E:\FR\FM\26JYP4.SGM 26JYP4 36446 Federal Register / Vol. 84, No. 144 / Friday, July 26, 2019 / Proposed Rules 6. Consideration of Section 15(a) Factors This section will discuss the expected results of the proposal to amend CFTC Rule 41.45(b)(1) to reduce the minimum initial and maintenance margin levels for each security future to 15% of the current market value of such contract from the current requirement of 20% in light of the five factors under Section 15(a) of the CEA, as itemized above. i. Protection of Market Participants and the Public The proposed amendment continues to protect market participants and the public from the risks of a default in the security futures market. As discussed above, the CFTC believes that a 15% minimum initial and maintenance margin requirement in combination with other protections, such as the general applicability of CFTC Rule 39.13 to DCOs that offer to clear security futures products, will protect U.S. market participants, including security futures customers and security futures intermediaries, from the risk of a default in security futures. In addition, security futures intermediaries, such as FCMs, are authorized to collect additional margin from their customer if the FCM believes a customer’s positions may pose excessive risk. The existence of separate margin requirements at the DCO level provides assurance to the CFTC that lowering the minimum margin level for security futures will not present a risk to the financial system.90 In cases where the 15% margin level as determined by the security futures intermediary is insufficient to satisfy a DCO’s obligation under CFTC Rule 39.13, the DCO would be required to collect additional margin from its clearing members. As a result, DCOs will always have adequate margin to manage risks presented by security futures. Finally, the CFTC staff has reviewed market activity in security futures and found that a 15% level of margin would be sufficient to cover daily price moves in a significant number of instances (i.e., more than 99.5%).91 jbell on DSK3GLQ082PROD with PROPOSALS4 ii. The Efficiency, Competitiveness and Financial Integrity of the Markets This proposal is intended to enhance the efficiency and competitiveness of the security futures market in the U.S. by bringing the initial and maintenance margin requirements for security futures in line with requirements for security futures subject to an SRO risk-based 90 See 91 See CFTC Rule 39.13, 17 CFR 39.13. supra note 88. VerDate Sep<11>2014 21:41 Jul 25, 2019 Jkt 247001 portfolio margining program.92 Market participants trading in security futures will benefit from lower margin requirements, that more accurately reflect their risk exposures, and they will be able to use their capital more efficiently in other investment opportunities. Furthermore, a decrease in initial and maintenance margin requirements from 20% to 15% of the current market value of each security futures contract may increase the attractiveness of the U.S. security futures market and may increase the competitiveness of the U.S. security futures market with international markets. The proposal also improves the competitiveness of security futures as compared to exchange-traded options. For example, it would help to reestablish a level playing field between options exchanges and the security futures exchange, and between brokerdealers/securities accounts and FCMs/ futures accounts. Overall, the CFTC preliminarily believes that this proposal will have a positive effect on competition in the U.S. security futures market.93 Furthermore, this proposal could enhance the financial integrity of the security futures market in the U.S. Lowering the amount of initial and maintenance margin required for customers trading in security futures may increase the number of customers trading in security futures and/or increase the amount of trading. Either an increase in the number of customers or trades in security futures market would strengthen the financial integrity of the security futures market by enhancing its liquidity. The CFTC preliminarily believes that a 15% margin requirement will be sufficient to protect against the risk of default in greater than 99% of cases. After examining the economic data, the CFTC believes that a 15% margin requirement for security futures will protect other customers and DCOs against most risks of default. Again, the CFTC notes that the DCOs clearing security futures are subject to CFTC regulations requiring the DCO to maintain adequate risk management policies, including initial margin requirements. DCOs may require additional margin, in an amount that is greater than 15%, on certain security futures positions or portfolios if the DCO notes particular risks associated with the products or portfolios. Accordingly, the proposed rule amendment would maintain or possibly improve the financial integrity of the security futures markets in the U.S. 92 The CFTC preliminarily believes that this proposal effectively balances the need for greater efficiency with the statutory requirements under Section 7(c)(2)(B)(iii) of the Exchange Act, which prevents the CFTC from considering any alternatives to this proposal that would reduce the minimum initial margin and maintenance margin levels for unhedged security futures below 15%. The CFTC worked to identify alternatives, but it does not believe that there are any reasonable alternatives to this proposal. 93 See also the CFTC’s analysis of anti-trust considerations in section VII. below. The CFTC has preliminarily identified no anticompetitive effects of this proposal. 7. Request for Comment The CFTC requests comment on all aspects of the costs and benefits associated with the proposed rule amendments, specifically, with regard to all Section 15(a) risk factors. In particular, the CFTC requests that commenters provide data and any other information or data upon which the commenters relied to reach any conclusions regarding the proposal. Finally, the CFTC seeks estimates and PO 00000 Frm 00014 Fmt 4701 Sfmt 4702 iii. Price Discovery As discussed above, the CFTC preliminarily believes that the proposed amendment is expected to have a positive effect on competition, which may result in some new customers entering the security futures market and increased trading by existing customers. In addition, trading from foreign markets may shift to the U.S. security futures market. This increased activity in the U.S. security futures market may have a positive effect on price discovery in the security futures market. While changes in price discovery may be difficult to measure, this proposal is unlikely to harm price discovery and indeed may improve price discovery in the security futures market in the U.S. iv. Risk Management As discussed further above, margin requirements are a critical component of any risk management program for cleared financial products. Security futures have been risk-managed through central clearing and initial and maintenance margin requirements for over fifteen years. The CFTC recognizes the necessity of sound initial and maintenance margin requirements for DCO and FCM risk management programs. Initial and maintenance margin collected addresses potential future exposure, and in the event of a default, such margin protects nondefaulting parties from losses. v. Other Public Interest Considerations The CFTC has not identified any additional public interest considerations related to the costs and benefits of this proposal. E:\FR\FM\26JYP4.SGM 26JYP4 Federal Register / Vol. 84, No. 144 / Friday, July 26, 2019 / Proposed Rules views regarding the specific costs and benefits for a security futures clearing organization, exchange, intermediary, or trader that may result from the adoption of the proposed rule amendment. The CFTC seeks estimates of the costs and benefits that may result from the adoption of the proposed rule amendments to reduce the minimum margin requirement to 15% of current market value or the application of permitted margin offsets. B. SEC 1. Introduction jbell on DSK3GLQ082PROD with PROPOSALS4 In the following economic analysis, the SEC considers the benefits and costs, as well as the effects on efficiency, competition, and capital formation that would result from the SEC’s proposed amendments. 94 The SEC evaluates these benefits, costs, and other economic effects relative to a baseline, which the SEC takes to be the state of the markets for security futures products and the regulations applicable to those markets at the time of this proposal. The amendments that the SEC is proposing would reduce minimum margin requirements for security futures positions held in customer accounts of broker-dealers 95 not subject to an approved portfolio margining system. As a result of the SEC’s proposed amendments, the minimum margin requirements on customers’ unhedged security futures positions would be lowered to 15%.96 Similarly, the SEC’s guidance on minimum margin requirements for certain hedged security futures positions would also be lowered in a conforming manner.97 The SEC’s 94 The Exchange Act states that when the SEC is engaging in rulemaking under the Exchange Act and is required to consider or determine whether an action is necessary or appropriate in the public interest, the SEC shall consider, in addition to the protection of investors, whether the action will promote efficiency, competition, and capital formation. 15 U.S.C. 78c(f). In addition, Exchange Act Section 23(a)(2) requires the SEC, when making rules or regulations under the Exchange Act, to consider, among other matters, the impact that any such rule or regulation would have on competition and states that the SEC shall not adopt any such rule or regulation which would impose a burden on competition that is not necessary or appropriate in furtherance of the Exchange Act. See 15 U.S.C. 78w(a)(2). 95 The 2002 Final Rules established margin requirements for customers’ security futures accounts held through ‘‘security futures intermediaries’’, including registered entities such as brokers, dealers, and FCMs. The SEC’s proposed amendments affect broker-dealers. See supra note 22 and accompanying text. 96 See proposed SEC Rule 403(b)(1). 97 Conforming reductions to minimum margin percentages on hedged security futures positions would be reflected in a restatement of the table of offsets published in the 2002 Final Rules. This table VerDate Sep<11>2014 21:41 Jul 25, 2019 Jkt 247001 proposed amendments would make minimum margin requirements on security futures positions held in securities accounts not eligible for portfolio margining consistent with the minimum margin requirements that would currently apply to those positions were they to be held in separate 98 accounts eligible for portfolio margining.99 As discussed below, the SEC believes that the proposed rule amendments will primarily benefit broker-dealers offering security futures trading accounts that are not eligible for portfolio margining, their customers who trade (or wish to trade) security futures at higher levels of leverage than currently permitted, and exchanges that offer trading in security futures products.100 The SEC does not believe that the proposed rule amendments will impose any direct costs on market participants. Although the SEC believes that the proposed rule amendments will not impose any direct costs, they could nonetheless impose various indirect costs. Most importantly, lower minimum margin requirements are likely to facilitate greater leverage, which can harm financial stability, imposing costs on the broader financial system. However, because of the very small size of the U.S. security futures markets and their insignificance to the broader U.S. financial markets, the SEC does not believe the proposed amendments will have material impact on financial stability.101 In addition, the greater leverage permitted under the proposed rule amendments may result in customers taking on additional risk. Customers who are not aware of these risks may suffer unexpected losses as a result.102 The SEC believes that the proposed rule amendments will improve competition among providers of customer security futures accounts (i.e., FCMs and broker-dealers), and increase the potential for competition across security futures, options, and other related markets. The SEC also believes that their impact on economic efficiency and capital formation will be minimal.103 Many of the costs, benefits, and other effects the SEC discusses are difficult to of offsets is not part of the Code of Federal Regulations. See 2002 Final Rules, 67 FR at 53159. 98 The presence of other (related) securities in the portfolio margin account (e.g., positions in the underlying) could affect the required margin for the security futures position. 99 See supra note 47 and accompanying text. 100 See infra sections IV.B.3.i. and ii. 101 See infra section IV.B.2. 102 See infra sections IV.B.3.i. and ii. 103 See infra section IV.B.3.iii. PO 00000 Frm 00015 Fmt 4701 Sfmt 4702 36447 quantify. Therefore, much of the discussion is qualitative in nature. The SEC’s inability to quantify certain costs, benefits, and effects does not imply that such costs, benefits, or effects are less significant. The lack of a quantitative analysis is largely due to the SEC’s lack of data on the markets for security futures.104 The SEC requests that commenters provide relevant data and information to assist the SEC in analyzing the economic consequences of the proposed amendments. More generally, the SEC requests comment on all aspects of this initial economic analysis, including on whether the analysis has: (1) Identified all benefits and costs, including all effects on efficiency, competition, and capital formation; and (2) given due consideration to each benefit and cost, including each effect on efficiency, competition, and capital formation. The SEC also requests comment on any reasonable alternatives to the proposed rule amendments. 2. Baseline The SEC evaluates the impact of rules relative to specific baselines. Here, the SEC takes the baseline to be the regulatory regime applicable to the markets for security futures as well as the state of these markets as of the end of 2017. As discussed above, the term ‘‘security futures’’ refers to futures on a single security and futures on narrowbased security indexes.105 More generally, ‘‘security futures product’’ refers to security futures and options on security futures. Unlike futures markets on commodities or ‘‘broad-based’’ equity indexes, the U.S. market for security futures is currently small and does not play a significant role in the U.S. financial system.106 The limited role of security futures markets is likely due to their short history,107 uncertainty relating to tax treatment,108 and competition from the more developed equity and options markets.109 Incentives to participate in the security futures markets (rather than the markets 104 See infra sections IV.B.2. and IV.B.3.i. supra section I. 106 See infra section IV.B.2.i. 107 Trading in security futures became possible only after the passage of CFMA in 2000. See supra notes 4 and 5, and accompanying text. 108 Specifically, the proposition that exchangefor-physical single stock security futures qualify for the same tax treatment as stock loan transactions under Section 1058 of the Internal Revenue Code has not been tested. See e.g., Exchange Act Release No. 71505 (Feb. 7, 2014). 109 Security futures markets face competition from equity and options markets because in principle, the payoff from a security futures position is readily replicated using either the underlying security, or through options on the underlying security. 105 See E:\FR\FM\26JYP4.SGM 26JYP4 36448 Federal Register / Vol. 84, No. 144 / Friday, July 26, 2019 / Proposed Rules for the underlying or the options markets) arise either from reduced market frictions (e.g., short sale constraints, pin risk) or from a regulatory advantage (e.g., lower margin requirements). As with other types of futures, both the buyer and seller in a security futures transaction can potentially default on his or her respective obligation. Because of this, an intermediary to a security futures transaction will typically require a performance bond (‘‘margin’’) from both parties to the transaction. Higher margin levels imply lower leverage, which reduces risk. Private incentives encourage a counterparty that intermediates security futures transactions to require a level of margin that adequately protects its interests. However, in the presence of market failures, private incentives alone may lead to margin levels that are inefficient. For example, margin levels set by intermediaries may allow investors who do not fully understand the risk of security futures products to take highly leveraged positions that may result in unexpected losses. Moreover, even when all parties are fully aware of the risks of leverage, privately-negotiated margin arrangements may be too low. For example, the risk resulting from higher leverage levels can impose negative externalities on financial system stability, the costs of which would not be reflected in privatelynegotiated margin arrangements. Such market failures provide an economic rationale for regulatory minimum margin requirements.110 jbell on DSK3GLQ082PROD with PROPOSALS4 i. The Security Futures Market The security futures markets provide a convenient means of obtaining delta exposure to an underlying security.111 To effectively compete with other venues for obtaining similar exposures (i.e., equity and options markets), security futures markets must reduce market frictions or provide more favorable regulatory treatment.112 Security futures markets may reduce market frictions by providing lower cost means of financing equity exposures. They can simplify taking short positions by eliminating the need to ‘‘locate’’ borrowable securities.113 They can also 110 Monetary authorities may also rely on regulatory margin requirements as a policy tool. The SEC does not consider such motives here. 111 The derivative of the theoretical price of a futures contract with respect to the price of the underlying (i.e., the ‘‘delta’’) is 1: For a $1 increase (decrease) in the price of an underlying security, the theoretical price of its security future increases (decreases) by $1. 112 See supra note 109. 113 In these respects, a security future functions like a cleared total return swap. VerDate Sep<11>2014 21:41 Jul 25, 2019 Jkt 247001 provide an opportunity for customers to gain greater leverage through lower margin requirements (relative to margin in security or options transactions). The SEC does not currently have data on participants in the security futures markets or their trading motives. Currently only one U.S. exchange, OCX, provides trading in security futures. OCX is a designated contract market regulated by the CFTC and a notice-registered national securities exchange.114 As of the end of 2017, 13,652 security futures contracts on 1,759 names were traded on the exchange.115 Of these 13,652 contracts, 730 had open interest at the end of the year. Total open interest at the end of the year was 476,430 contracts, with a gross notional value of $3 billion. Annual trading volume in 2017 was 15 million contracts, an increase of 39% from the prior year. Although growing, the security futures market is currently very small. For comparison, as of the end of 2017, open interest in equity options was 290 million contracts with annual trading volume of 3.7 billion contracts.116 According to OCX, almost all security futures positions were carried in futures accounts of CFTC-regulated FCMs and introducing brokers (‘‘IBs’’).117 Consequently, the SEC believes only a small fraction of security futures accounts fall under the SEC’s margin rules. The SEC believes that none of the accounts that are subject to the SEC’s margin rules are currently using riskbased portfolio margining.118 Therefore, 114 Section 6(g) of the Exchange Act permits a notice of registration to be filed by an exchange registering as a national securities exchange for the sole purpose of trading security futures products. 15 U.S.C. 78f(g). See also Rule 6a–4 (Notice of registration under Section 6(g) of the Act, amendment to such notice, and supplemental materials to be filed by exchanges registered under Section 6(g) of the Act). 17 CFR 240.6a–4. 115 Security futures data from OCX, available at https://ftp.onechicago.com/market_data/. 116 Options data from OCC, available at https:// www.theocc.com/webapps/historical-volume-query. 117 See OCX Petition. 118 If security futures positions were held in accounts eligible for portfolio margining, they would be included in the risk-based portfolio margin calculation and thus effectively subject to a lower (i.e., 15%) margin requirement under the baseline. There are approximately 18 broker-dealers that have been approved by SROs to offer portfolio margining and are members of OCC to clear security futures. However, based on an analysis of FOCUS filings from year-end 2017, no broker-dealers had collected margin for security futures accounts subject to portfolio margining. See infra note 138. See also Exchange Act Release No. 54919 (Dec. 12, 2006), 71 FR 75781 (Dec. 18, 2006) (SR–CBOE 2006–14, relating to amendments to CBOE’s portfolio margin pilot program to include security futures); Exchange Act Release No. 54125 (Jul. 11, 2006), 71 FR 40766 (Jul. 18, 2006) (SR–NYSE–2005– 93, relating to amendments to the NYSE’s portfolio margin pilot program to include security futures). PO 00000 Frm 00016 Fmt 4701 Sfmt 4702 the SEC believes that all of the accounts falling under the SEC’s margin rules are currently subject to the general margin requirement and the associated strategybased offsets.119 The SEC is seeking comment on the characterization of the market for security futures: • What are the principal motives for participants transacting in security futures? What are the advantages of these markets (vis-a`-vis options or equity markets)? What are the disadvantages? • Do customers transact in security futures through securities accounts ? Why or why not? • To the extent that customers transact security futures transactions through securities accounts, are these accounts subject to portfolio margining? If not, why not? ii. Regulation Under existing SEC rules the minimum margin requirement for a customer’s unhedged security futures position not subject to an exemption is 20%.120 SROs may allow margin levels lower than 20%for accounts with ‘‘strategy-based offsets’’ (i.e., hedged positions).121 Strategy-based offsets can involve security futures as well as one or more related securities or futures positions. Accounts subject to an SRO’s approved portfolio margining system are also exempt from the minimum margin requirement.122 Under currently approved SRO portfolio margining systems, the effective margin requirement for an unhedged exposure to a security futures position on a narrow-based index or an individual equity would be 15%.123 Under current rules, only customer securities accounts held through SEC-regulated brokerdealers could potentially be subject to portfolio margining; however, the SEC is not aware of any broker-dealers offering such accounts. Margin requirements for security futures positions of clearing members (i.e., their accounts at a clearing agency or DCO) are not subject to the aforementioned margin requirements.124 119 See supra note 25 and accompanying text. supra notes 20–23 and accompanying text. 121 See supra note 25 and accompanying text. 122 See CFTC Rule 41.42(c)(2)(i), 17 CFR 41.42(c)(2)(i); SEC Rule 400(c)(2)(i), 17 CFR 242.400(c)(2)(i). 123 This follows from the methodology of current SRO risk-based portfolio margining rules as applied to delta one securities. See supra notes 47 and 111. 124 See SEC Rule 400(c)(2)(i)–(v). 17 CFR 242.400(c)(2)(i)–(v). Clearing members are instead subject to margin rules of the clearing organization as approved by the SEC pursuant to Section 19(b)(2) of the Exchange Act, 15 U.S.C. 78s(b)(2). See notes 42–44 and accompanying text. 120 See E:\FR\FM\26JYP4.SGM 26JYP4 Federal Register / Vol. 84, No. 144 / Friday, July 26, 2019 / Proposed Rules 3. Analysis of the Proposals The SEC is proposing to amend SEC Rule 403(b)(1) to reduce the minimum initial and maintenance margin levels for unhedged security futures to 15% from the current requirement of 20%.125 To the extent that the SROs file proposed rule changes and the SEC approves them, this would have the effect of reducing minimum margin on security futures positions held in customer securities accounts at brokerdealers that are not currently authorized to use a portfolio margining system.126 As described in the previous section, the vast majority of security futures positions are held in futures accounts at CFTC-regulated entities. Consequently, the proposed changes to the margin requirements are expected to have very limited effects.127 jbell on DSK3GLQ082PROD with PROPOSALS4 i. Benefits The SEC believes that the proposed amendment to SEC Rule 403(b)(1) 128 would benefit customers currently trading security futures through securities accounts not subject to portfolio margining and whose house margin requirement is set (by the broker-dealer) to the current regulatory minimum. To the extent that customers with security futures accounts held at broker-dealers are currently subject to margin levels reflecting the regulatory minimums,129 the proposed reductions to margin requirements could reduce these customers’ costs of engaging in security futures transactions, increase their liquidity, and provide an opportunity for greater leverage. The SEC believes that these benefits are likely to result in increased positiontaking by customers, with attendant benefits to broker-dealers providing 125 17 CFR 242.403(b)(1). In addition, the Commissions are proposing to publish a re-stated table of offsets to reflect the proposed reduction in margin. See section II.B. above. This table of offsets is not part of the Code of Federal Regulations. See 2002 Final Rules, 67 FR at 53159. SROs seeking to permit trading in security futures may modify their rules to parallel the levels identified in the re-stated table of offsets. 126 Specifically, the SEC expects broker-dealers that become subject to lower regulatory minimum customer margin requirements on security futures to reduce customer margin requirements on security futures positions that are currently set at the regulatory lower bound (i.e., 20%). See supra text accompanying note 100. 127 Concurrently, the CFTC is proposing to similarly amend CFTC Rule 41.45(b), affecting security futures positions held in futures accounts at CFTC-regulated entities. See supra section II.A. 128 Throughout, the analysis of costs and benefits is limited to the effects of the SEC’s rule change, and does not reflect costs and benefits resulting from corresponding changes to CFTC rules. 129 Security futures accounts may be subject to ‘‘house’’ margin requirements that exceed the regulatory minimums. VerDate Sep<11>2014 21:41 Jul 25, 2019 Jkt 247001 security futures trading accounts, and to security futures trading exchanges.130 Based on data provided by OCX, at the end of 2017, open interest in the U.S. security futures markets was 476,430 contracts, with a gross notional value of $3 billion.131 SEC staff understands that approximately 2% of these contracts are believed to involve securities accounts subject to SEC margin requirements. None of these accounts are believed to be subject to portfolio margining.132 The SEC constructed an estimate of the upper bound of margin collected under SEC margin rules as the sum (across all contracts listed on OCX) of twice 133 the product of: The contract settlement price, 20% (current margin requirement), the contract’s open interest, and 2% (the fraction of accounts believed to be subject to SEC customer margin rules). Because some of the contracts held in securities accounts may be subject to strategy offsets (that would result in lower margin requirements), this represents an upper bound. The SEC estimates that the margin requirements on customers’ security futures positions held in securities accounts was no more than $24 million. To the extent that the proposed reduction in regulatory minimums is passed on to customers, the SEC estimates that the amount of margin required to secure security futures transactions in securities accounts could be reduced by as much as $6 million. This reduction would benefit affected customers by improving their liquidity.134 As part of this rulemaking, the Commissions are proposing to publish a restated table of offsets for hedged security futures positions.135 This restatement would make the table of offsets conform to the proposed 15% minimum margin requirement on unhedged positions.136 These revisions to the offset table would provide guidance consistent with the lower general margin levels on unhedged positions that the SEC is proposing. Because the SEC does not have data on specific hedged positions held in broker-dealers’ customer accounts 130 Increased position-taking by customers is expected to increase fees collected related to security futures transactions effected by brokerdealers and security futures exchanges. 131 See supra note 115. 132 See supra note 118. 133 Both sides of a security futures contract may potentially be subject to SEC customer margin requirements. 134 See Telser, Lester G., ‘‘Why There Are Organized Futures Markets,’’ The Journal of Law and Economics 24, no. 1 (Apr. 1, 1981): 1–22. 135 See 2002 Final Rules, 67 FR at 53159. 136 See 17 CFR 242.403(b)(2). PO 00000 Frm 00017 Fmt 4701 Sfmt 4702 36449 subject to SEC margin rules, the SEC is unable to further quantify the reductions in margin that would be attributable specifically to any potential SRO rules that follow the restatement of the offset table. The reductions to margin requirements the SEC is proposing will have the immediate effect of improving the liquidity of customers trading security futures through broker-dealer accounts. These improvements to liquidity could lead to increased participation in security futures markets with attendant benefits to broker-dealers providing security futures accounts, security futures exchanges, and clearing agencies.137 In addition, the SEC believes that the proposed rule amendments may reduce costs for participants in the security futures markets through improved operational efficiency. In particular, the customers of broker-dealers that do not offer portfolio margining may be able to avail themselves of lower margin requirements on security futures transactions without having to maintain separate accounts with broker-dealers that do provide portfolio margining. It is not possible for the SEC to estimate broker-dealers’ customers’ sensitivity to margin requirements on security futures due to an absence of historical data. The SEC also does not possess data on current customer margin requirements (broker-dealers may set requirements above regulatory minimums),138 nor does the SEC possess data on broker-dealers’,139 security futures exchanges’,140 or clearing agencies’ 141 profits related to security futures transactions, as this information is not reported to the SEC. Because the SEC lacks these data, the SEC is currently unable to quantify the benefits to broker-dealers, security futures exchanges, and clearing agencies resulting from any reduction to minimum margin requirements. ii. Costs Because broker-dealers may set customer margin levels higher than the proposed regulatory minimums, the proposed rule amendments do not 137 See supra note 130. respect to security futures, the SEC currently requires broker-dealers to provide only one item on quarterly regulatory filings: The amount of margin collected from accounts subject to portfolio margining rules (FOCUS item 4467). In the fourth quarter of 2017, no broker-dealer reported collecting any such margin; see also supra note 118. 139 See id. 140 OCX does not release financial statements. 141 OCC’s annual financial reports do not provide a breakdown of profits based on the type of product cleared. 138 With E:\FR\FM\26JYP4.SGM 26JYP4 36450 Federal Register / Vol. 84, No. 144 / Friday, July 26, 2019 / Proposed Rules jbell on DSK3GLQ082PROD with PROPOSALS4 impose direct conduct costs on brokerdealers. The SEC believes that brokerdealers will weigh any additional private costs associated with lower margin requirements against the private benefits of lower margin requirements.142 In so doing they may opt to leave margins at a higher level than the regulatory minimum.143 If the reduction to the minimum margin requirement on security futures is—as the SEC expects—passed on to customers, it will lower the costs of customer position taking and provide opportunities for greater leverage. As described above, the SEC believes this will generally benefit investors trading in security futures.144 However, to the extent that unsophisticated retail investors who trade security futures are not fully aware of the risks,145 reducing margin requirements would increase the potential for them to suffer unexpected losses.146 Thus, the proposed reduction in margin requirements could impose indirect costs on unsophisticated retail investors. Under the baseline, retail investors are believed to represent a very small fraction (less than 1%) of open interest in security futures. Thus, the SEC believes that the potential costs borne by unsophisticated retail investors will be low. Moreover, the ability of margin requirements to serve as an efficient instrument of customer protection is questionable.147 142 That is, in weighing the costs and benefits the SEC does not expect broker-dealers to consider externalities resulting from their choices. 143 Under broker-dealer margin rules, brokerdealers also can establish ‘‘house’’ margin requirements as long as they are at least as restrictive as the Federal Reserve and SRO margin rules. See, e.g., FINRA Rule 4210(d). 144 To the extent that regulatory margin requirements serve a micro-prudential function, these benefits may be reduced or eliminated. However the SEC does not believe that microprudential effects are a major consideration here. See infra note 152. 145 See FINRA, Security Futures—Know Your Risks, or Risk Your Future, available at https:// www.finra.org/Investors/InvestmentChoices/ P005912 and National Futures Association, Security Futures, An Introduction to Their Uses and Risks (2002), available at https://www.nfa.futures.org/ members/member-resources/files/securityfutures.pdf. 146 The judgement of retail investors receives significant criticism in the academic literature. See e.g., Odean, Terrance. ‘‘Do Investors Trade Too Much?’’ The American Economic Review 89, no. 5 (1999): 1279–98. See also Barber, Brad M, and Terrance Odean. ‘‘Trading Is Hazardous to Your Wealth: The Common Stock Investment Performance of Individual Investors.’’ The Journal of Finance 55, no. 2 (April 1, 2000): 773–806. See also Heimer, Rawley Z, and Alp Simsek. ‘‘Should Retail Investors’ Leverage Be Limited?’’ Working Paper. National Bureau of Economic Research, December 2017. 147 Fixed margin requirements cannot differentiate between different types of customers (e.g., sophisticated vs. unsophisticated, financially constrained vs. unconstrained) or the risk of the VerDate Sep<11>2014 21:41 Jul 25, 2019 Jkt 247001 In addition, to the extent that the proposed reductions in regulatory margin requirements lead broker-dealers to decrease customer margin requirements, they could increase the risk of the broker-dealer defaulting. Such a default may impose costs on the defaulting broker-dealer’s customers as well as its counterparties. However, broker-dealers participating in security futures markets are subject to clearing organizations’ prudential margin requirements and the SEC believes that such requirements are reasonably designed to mitigate the risk of a brokerdealers’ default.148 In addition, the SEC believes that in the event of such a default, the SEC’s customer protection rule would protect customers’ assets held in a securities account.149 Because broker-dealers affected by the proposed amendments are already subject to a regulatory minimum level for customer margin requirements, and because they would be under no obligation to alter their existing customer margin requirements, the SEC believes that the compliance costs resulting from the proposed reduction to said minimum would be de minimis.150 In addition, the SEC does not believe that the affected entities would bear any additional compliance costs as a result of the proposed rule amendments. The SEC requests comments, data, and estimates on all aspects of the costs and benefits associated with the proposed calculations for margin on security futures. The SEC requests data to quantify the potential costs and benefits described above. The SEC seeks estimates of these costs and benefits, as well as any costs and benefits that the SEC has not identified that may result from the adoption of these proposed rule amendments. The SEC also requests qualitative feedback on the nature of the potential benefits and costs described above and any benefits and costs the SEC may have overlooked. position. See Figlewski Stephen, ‘‘Margins and Market Integrity: Margin Setting for Stock Index Futures and Options,’’ Journal of Futures Markets 4, no. 3 (1984): 385–416. See also FRB, A Review and Evaluation of Federal Margin Regulation: A Study (1984). 148 See supra notes 42–44 and accompanying text. 149 See Rule 15c3–3, 17 CFR 240.15c3–3. See also Applicability of CFTC and SEC Customer Protection, Recordkeeping, Reporting, and Bankruptcy Rules and the Securities Investor Protection Act of 1970 to Accounts Holding Security Futures Products, Final Rule, Exchange Act Release No. 46473 (Sept. 9, 2002), 67 FR 58284 (Sept. 13, 2002). 150 Under the proposed rule, broker-dealers could maintain existing customer margin requirements and avoid incurring any implementation costs. PO 00000 Frm 00018 Fmt 4701 Sfmt 4702 iii. Effects on Efficiency, Competition, and Capital Formation In addition to the specific costs and benefits discussed above, the reductions to margin requirements on security futures that the SEC is proposing may have broader effects on efficiency, competition, and capital formation. The SEC believes that these effects will generally be positive, but unlikely to be significant. The SEC discusses these effects in more detail in the remainder of this section. The SEC requests comment on all aspects of this analysis of the burden on competition and promotion of efficiency, competition, and capital formation. a. Efficiency As discussed in the previous section, the SEC believes that broker-dealers will weigh the costs associated with customer defaults against the benefits of lower margin requirements when setting margin requirements for their customers. Although private considerations would render marketdetermined margin levels optimal from a broker-dealer’s perspective, market imperfections could lead broker-dealers to impose margin requirements that are not economically efficient.151 The relevant market imperfections in the context of margin requirements relate to externalities on financial stability arising from excessive leverage.152 Historically, a key aspect of the rationale for regulatory margin requirements on securities transactions was the belief that such requirements could improve economic efficiency by limiting stock market volatility resulting from ‘‘pyramiding credit.’’ 153 Leveraged 151 See supra note 142. SEC acknowledges that other market imperfections (e.g., asymmetric information, adverse selection) may also play a role, although the SEC believes these to be less relevant to this context. Asymmetric information about market participants’ quality can lead privately-negotiated margin levels to be inefficient. For example, competition among broker-dealers may lead to a ‘‘race to the bottom’’ in margin requirements when customers’ ‘‘quality’’ is not perfectly observable. See e.g., Santos, Tano, and Jose A. Scheinkman, ‘‘Competition among Exchanges,’’ The Quarterly Journal of Economics 116, no. 3 (Aug. 1, 2001): 1027–61. Alternatively, problems of adverse selection (e.g., potential to re-invest customer margin in risky investments) or moral hazard (e.g., expectations of government rescue) may also create incentives for broker-dealers to offer margin requirements that are too low. Asymmetric information about broker-dealer quality may make it impossible for customers to provide sufficient market discipline, leading to a problem similar to that faced by bank depositors. See Dewatripont, Mathias, and Jean Tirole, ‘‘Efficient Governance Structure: Implications for Banking Regulation,’’ Capital Markets and Financial Intermediation, 1993, 12–35. 153 See Moore, Thomas Gale, ‘‘Stock Market Margin Requirements,’’ Journal of Political Economy 74, no. 2 (April 1, 1966): 158–67. 152 The E:\FR\FM\26JYP4.SGM 26JYP4 Federal Register / Vol. 84, No. 144 / Friday, July 26, 2019 / Proposed Rules exposures built up during price run ups could lead to the collapse of prices when a small shock triggers margin calls and a cascade of de-leveraging. The utility of margin requirements in limiting such ‘‘excess’’ volatility and the contribution of derivative markets to such volatility have been a perennial topic of debate in the academic literature, rekindled periodically by crisis episodes.154 Most recently, the 2007–2008 financial crisis saw similar concerns (i.e., procyclical leverage, margin call-induced selling spirals) raised in the securitized debt markets.155 While the SEC believes that lower margin requirements can increase the risk and severity of market dislocations, the SEC does not believe— given the current limited scale of the security futures markets and the limited role played by SEC registrants in these markets—that the proposed reductions to minimum margin requirements present a material financial stability concern.156 b. Competition jbell on DSK3GLQ082PROD with PROPOSALS4 Under the baseline, risk-based portfolio margining is not available to customers holding security futures positions in futures accounts, and these positions are thus subject to the 20% margin requirement. The proposed reduction in margin would permit customers holding security futures in futures accounts to receive margin treatment consistent with margin treatment for customers holding security futures positions in a securities account permitted under the current SRO securities portfolio margining rules.157 This could establish a more level playing field between options exchanges and security futures exchanges, and between broker-dealers/securities accounts and FCMs/futures accounts. 154 See id. See also Figlewski, Stephen, ‘‘Futures Trading and Volatility in the GNMA Market,’’ The Journal of Finance 36, no. 2 (1981): 445–56. See also Edwards, Franklin R, ‘‘Does Futures Trading Increase Stock Market Volatility?,’’ Financial Analysts Journal 44, no. 1 (1988): 63–69. See also Kupiec, Paul H, ‘‘Margin Requirements, Volatility, and Market Integrity: What Have We Learned Since the Crash?,’’ Journal of Financial Services Research 13, no. 3 (June 1, 1998): 231–55. 155 See e.g., Adrian, Tobias, and Hyun Song Shin, ‘‘Liquidity and Leverage,’’ Journal of Financial Intermediation 19, no. 3 (2010): 418–437. 156 If the security futures market were to significantly increase in size as a result of these proposed changes or other factors, the impact of lower margin requirements on overall market stability would be greater than the minimal impact the SEC expects under current market conditions. However, for reasons described in notes 106–108 and accompanying text, above, the SEC does not believe this type of significant growth is likely in the foreseeable future. 157 See OCX Petition. VerDate Sep<11>2014 21:41 Jul 25, 2019 Jkt 247001 In principle, a more level playing field should enhance competition among broker-dealers and FCMs for security futures business. In practice however, the majority of security futures transactions are already conducted through futures accounts, and of those that are not, none are subject to portfolio margining.158 It is therefore unlikely that the proposed changes will have an immediate impact on competition among existing intermediaries of security futures transactions (i.e., broker-dealers and FCMs). However, it is likely that the reduction in margin levels will increase participation in the security futures markets. If sufficiently large, such increased participation may spur additional broker-dealers and FCMs to offer security futures trading. More broadly, by aligning margin requirements applicable to a security futures position (which generally are not portfolio margined) with those applicable to equivalent options positions 159 (which generally are subject to portfolio margining), the proposed amendment could be expected to encourage growth of the security futures market. The security futures market can provide a low-friction means of obtaining delta exposures, and relatively high margin requirements (vis-a`-vis comparable options positions) which may have played a role in restraining its development. To the extent that reducing margin requirements leads to significant growth of this market, it may have additional— less direct—competitive implications. For example, increased liquidity in security futures may lead to increased use of this market to obtain short exposures, which could, in turn, adversely affect intermediaries’ securities lending business. c. Capital Formation The proposed rule changes are not expected to have an immediate material impact on capital formation. To the extent that the proposed reductions in margin requirements encourage significant growth in the security futures markets, it may, in time, improve price discovery for underlying securities. In particular, a more active security futures market can reduce the frictions associated with shorting equity exposures, making it easier for negative information about a firm’s fundamentals to be incorporated into security prices. This could promote more efficient supra note 118. long (short) security future position can be replicated by a portfolio containing one long (short) at-the-money call and one short (long) at-the-money put. The margin requirement applicable to the latter under approved portfolio margin systems is 15%. PO 00000 158 See 159 A Frm 00019 Fmt 4701 Sfmt 4702 36451 capital allocations by facilitating the flow of financial resources to their most productive uses. The SEC generally requests comment on all aspects of this analysis of the burden on competition and promotion of efficiency, competition, and capital formation. iv. Alternatives Considered The SEC believes that reducing minimum customer margin requirements for security futures to a level between 15% and 20% would maintain inconsistencies in margin requirements across security futures and options, without providing significant benefits as compared to the proposed amendments. Accordingly, in light of the objectives of this particular rulemaking, and in the context of the statutory framework discussed above, the SEC does not believe that there are reasonable alternatives to the proposal to reduce the minimum initial and maintenance margin levels for unhedged security futures to 15%. V. Regulatory Flexibility Act A. CFTC The Regulatory Flexibility Act (‘‘RFA’’) requires that federal agencies, in promulgating rules, consider the impact of those rules on small entities.160 The proposed amendments will affect designated contract markets, FCMs, and customers who trade in security futures. The CFTC has previously established certain definitions of ‘‘small entities’’ to be used by the CFTC in evaluating the impact of its rules on small entities in accordance with the RFA.161 In its previous determinations, the CFTC has concluded that contract markets are not small entities for purposes of the RFA, based on the vital role contract markets play in the national economy and the significant amount of resources required to operate as SROs.162 The CFTC also has determined that notice-designated contract markets are not small entities for purposes of the RFA.163 The CFTC has previously determined that FCMs are not small entities for purposes of the RFA, based on the fiduciary nature of FCM-customer 160 5 U.S.C. 601 et seq. Statement and Establishment of Definitions of ‘‘Small Entities’’ for Purposes of the Regulatory Flexibility Act, 47 FR 18618, 18618–21 (Apr. 30, 1982). 162 Id. at 18619. 163 Designated Contract Markets in Security Futures Products: Notice-Designation Requirements, Continuing Obligations, Applications for Exemptive Orders, and Exempt Provisions, 66 FR 44960, 44964 (Aug. 27, 2001). 161 Policy E:\FR\FM\26JYP4.SGM 26JYP4 36452 Federal Register / Vol. 84, No. 144 / Friday, July 26, 2019 / Proposed Rules relationships as well as the requirements that FCMs meet certain minimum financial requirements.164 In addition, the CFTC has determined that notice-registered FCMs,165 for the reasons applicable to FCMs registered in accordance with Section 4f(a)(1) of the CEA,166 are not small entities for purposes of the RFA.167 Finally, the CFTC notes that according to data from OCX, 99% of all customers transacting in security futures as of March 1, 2016 and March 1, 2017 qualified as ECPs. The CFTC has found that ECPs should not be considered small entities for the purposes of the RFA.168 An overwhelming majority of the customers transacting in security futures currently are ECPs and are not small entities. Therefore, a change in the margin level for security futures is not anticipated to affect small entities. Accordingly, the CFTC Chairman, on behalf of the CFTC, hereby certifies pursuant to 5 U.S.C. 605(b), that the proposed amendments will not have a significant economic impact on a substantial number of small entities. The CFTC invites public comments on this determination. B. SEC The RFA requires that federal agencies, in promulgating rules, consider the impact of those rules on small entities.169 Section 3(a) 170 of the RFA generally requires the SEC to undertake a regulatory flexibility analysis of all proposed rules to determine the impact of such rulemaking on small entities unless the SEC certifies that the rule amendments, if adopted, would not have a significant economic impact on a substantial number of small entities.171 For purposes of SEC rulemaking in connection with the RFA,172 a small 164 Supra note 159 at 18619. broker or dealer that is registered with the SEC and that limits its futures activities to those involving security futures products may notice register with the CFTC as an FCM in accordance with Section 4f(a)(2) of the CEA (7 U.S.C. 6f(a)(2)). 166 7 U.S.C. 6f(a)(1). 167 2002 Final Rules, 67 FR at 53171. 168 Opting Out of Segregation, 66 FR 20740, 20743 (Apr. 25, 2001). 169 5 U.S.C. 601 et seq. 170 5 U.S.C. 603. 171 5 U.S.C. 605(b). The proposed amendments are discussed in detail in section II. above. The SEC discusses the potential economic consequences of the amendments in section IV. (Economic Analysis) above. As discussed in section III (Paperwork Reduction Act) above, the proposed amendments do not contain a ‘‘collection of information’’ requirement within the meaning of the Paperwork Reduction Act. 172 Although Section 601 of the RFA defines the term ‘‘small entity,’’ the statute permits agencies to formulate their own definitions. The SEC has adopted definitions for the term ‘‘small entity’’ for jbell on DSK3GLQ082PROD with PROPOSALS4 165 A VerDate Sep<11>2014 21:41 Jul 25, 2019 Jkt 247001 entity includes a broker-dealer that had total capital (net worth plus subordinated liabilities) of less than $500,000 on the date in the prior fiscal year as of which its audited financial statements were prepared pursuant to SEC Rule 17a–5(d) (under the Exchange Act),173 or, if not required to file such statements, a broker-dealer with total capital (net worth plus subordinated liabilities) of less than $500,000 on the last day of the preceding fiscal year (or in the time that it has been in business, if shorter); and is not affiliated with any person (other than a natural person) that is not a small business or small organization.174 The proposed rule amendments would reduce the required margin for security futures from 20% to 15%. The proposed rule amendments would affect brokers, dealers, and members of national securities exchanges, including FCMs required to register as broker-dealers under Section 15(b)(11) of the Exchange Act, relating to security futures.175 IBs and FCMs may register as brokerdealers by filing Form BD-N.176 However, because such IBs may not collect customer margin they are not subject to these rules. In addition, the CFTC has concluded that FCMs are not considered small entities for purposes of the RFA.177 Accordingly, there are no IBs or FCMs that are small entities for purposes of the RFA that would be subject to the proposed rule amendments. In addition, all members of national securities exchanges registered under Section 6(a) of the Exchange Act are registered broker-dealers.178 The SEC estimates that as of December 31, 2017, there were approximately 1,060 brokerdealers that were ‘‘small’’ for the purposes of SEC Rule 0–10. Of these, the purposes of SEC rulemaking in accordance with the RFA. Those definitions, as relevant to this proposed rulemaking, are set forth in SEC Rule 010 (under the Exchange Act), 17 CFR 240.0–10. See Statement of Management on Internal Accounting Control, Exchange Act Release No. 18451 (Jan. 28, 1982), 47 FR 5215 (Feb. 4, 1982). 173 17 CFR 240.17a–5(d). 174 See 17 CFR 240.0–10(c). 175 See SEC Rule 400(a), 17 CFR 242.400(a). 176 These notice-registered broker-dealers are not included in the 1,060 small broker-dealers discussed below, as they are not required to file FOCUS Reports with the SEC. See SEC Rule 17a– 5(m)(4), 17 CFR 240.17a–5(m)(4). 177 See 47 FR 18618, 18618–21 (Apr. 30, 1982). See also 66 FR 14262, 14268 (Mar. 9, 2001). 178 National securities exchanges registered under Section 6(g) of the Exchange Act—notice registration of security futures product exchanges— may have members who are floor brokers or floor traders who are not registered broker-dealers; however, these entities cannot clear securities transactions or collect customer margin, and, therefore, the proposed rules would not apply to them. PO 00000 Frm 00020 Fmt 4701 Sfmt 4702 the SEC estimates that there are less than ten broker-dealers that are carrying broker-dealers (i.e., can carry customer margin accounts and extend credit). However, based on December 31, 2017 FOCUS Report data, none of these small carrying broker-dealers carried debit balances. This means these ‘‘small’’ carrying firms are not extending margin credit to their customers, and therefore, the proposed rules likely would not apply to them. Therefore, while SEC believes that some small broker-dealers could be affected by the proposed amendments, the amendments will not have a significant impact on a substantial number of small brokerdealers. Accordingly, the SEC certifies that the proposed rule amendments would not have a significant economic impact on a substantial number of small entities for purposes of the RFA. The SEC encourages written comments regarding this certification. The SEC solicits comment as to whether the proposed rule amendments could have an effect on small entities that has not been considered. The SEC requests that commenters describe the nature of any impact on small entities and provide empirical data to support the extent of such impact. VI. Small Business Regulatory Enforcement Fairness Act For purposes of the Small Business Regulatory Enforcement Fairness Act of 1996, or ‘‘SBREFA,’’ 179 a rule is considered ‘‘major’’ where, if adopted, it results or is likely to result in: • An annual effect on the economy of $100 million or more (either in the form of an increase or a decrease); • A major increase in costs or prices for consumers or individual industries; or • Significant adverse effect on competition, investment or innovation. If a rule is ‘‘major,’’ its effectiveness will generally be delayed for 60 days pending Congressional review. The Commissions request comment on the potential impact of the proposed amendments for margin requirements for security futures on: • The U.S. economy on an annual basis; • Any potential increase in costs or prices for consumers or individual industries; and • Any potential effect on competition, investment, or innovation. Commenters are requested to provide empirical data and other factual support for their view to the extent possible. 179 Public Law 104–121, Title II, 110 Stat. 857 (1996) (codified in various Sections of 5 U.S.C., 15 U.S.C. and as a note to 5 U.S.C. 601). E:\FR\FM\26JYP4.SGM 26JYP4 Federal Register / Vol. 84, No. 144 / Friday, July 26, 2019 / Proposed Rules VII. Anti-Trust Considerations Section 15(b) of the CEA requires the CFTC to ‘‘take into consideration the public interest to be protected by the antitrust laws and endeavor to take the least anticompetitive means of achieving the purposes of [the CEA], in issuing any order or adopting any [CFTC] rule or regulation (including any exemption under Section 4(c) or 4c(b)), or in requiring or approving any bylaw, rule, or regulation of a contract market or registered futures association established pursuant to Section 17 of [the CEA].’’ 180 The CFTC believes that the public interest to be protected by the antitrust laws is generally to protect competition. The CFTC requests comment on whether this proposal implicates any other specific public interest to be protected by the antitrust laws. The CFTC has considered the proposal to determine whether it is anticompetitive and has preliminarily identified no anticompetitive effects. The CFTC requests comment on whether the proposal is anticompetitive and, if it is, what the anticompetitive effects are. Because the CFTC has preliminarily determined that the proposal is not anticompetitive and has no anticompetitive effects, the CFTC has not identified any less anticompetitive means of achieving the purposes of the CEA. The CFTC requests comment on whether there are less anticompetitive means of achieving the relevant purposes of the CEA that would otherwise be served by adopting the proposal. VIII. Statutory Basis The SEC is proposing the amendment to SEC Rule 403(b)(1) pursuant to the Exchange Act, particularly Sections 3(b), 6, 7(c), 15A and 23(a). Further, these amendments are proposed pursuant to the authority delegated jointly to the SEC, together with the CFTC, by the Federal Reserve Board in accordance with Exchange Act Section 7(c)(2)(A). Text of Rules jbell on DSK3GLQ082PROD with PROPOSALS4 List of Subjects 17 CFR Part 41 Brokers, Margin, Reporting and recordkeeping requirements, Security futures products. 17 CFR Part 242 Brokers, Confidential business information, Reporting and recordkeeping requirements, Securities. 180 7 21:41 Jul 25, 2019 17 CFR Part 41 For the reasons discussed in the preamble, the Commodity Futures Trading Commission proposes to amend 17 CFR part 41 as set forth below: PART 41—SECURITY FUTURES PRODUCTS 1. The authority citation for part 41 continues to read as follows: ■ Authority: Sections 206, 251 and 252, Pub. L. 106–554, 114 Stat. 2763; 7 U.S.C. 1a, 2, 6f, 6j, 7aa–2, 12a; 15 U.S.C. 78g(c)(2). 2. Amend § 41.45 by revising paragraph (b)(1) to read as follows: ■ § 41.45 Required margin. * * * * * (b) Required margin. (1) General rule. The required margin for each long or short position in a security future shall be fifteen (15) percent of the current market value of such security future. * * * * * SECURITIES AND EXCHANGE COMMISSION 17 CFR Part 242 In accordance with the foregoing Title 17, chapter II, part 242 of the Code of Federal Regulations is proposed to be amended as follows: PART 242—REGULATIONS M, SHO, ATS, AC, NMS, AND SBSR AND CUSTOMER MARGIN REQUIREMENTS FOR SECURITY FUTURES 3. The authority citation for part 242 continues to read as follows: ■ Authority: 15 U.S.C. 77g, 77q(a), 77s(a), 78b, 78c, 78g(c)(2), 78i(a), 78j, 78ka–1(c), 78l, 78m, 78n, 78o(b), 78o(c), 78o(g), 78q(a), 78q(b), 78q(h), 78w(a), 78dda–1, 78mm, 80aa–23, 80aa–29, and 80aa–37. 4. Section 242.403 is amended by revising paragraph (b)(1) to read as follows: ■ § 242.403 Required margin. * * * * * (b) Required margin. (1) General rule. The required margin for each long or short position in a security future shall be fifteen (15) percent of the current market value of such security future. * * * * * By the Securities and Exchange Commission. U.S.C. 19(b). VerDate Sep<11>2014 COMMODITY FUTURES TRADING COMMISSION Jkt 247001 PO 00000 Frm 00021 Fmt 4701 Sfmt 4702 36453 Dated: July 3, 2019. Vanessa A. Countryman, Secretary. Issued in Washington, DC, on July 9, 2019, by the Commodity Futures Trading Commission. Christopher Kirkpatrick, Secretary of the Commission. Note: The following appendices will not appear in the Code of Federal Regulations. Commodity Futures Trading Commission (CFTC) Appendices to Customer Margin Rules Relating to Security Futures—CFTC Voting Summary and CFTC Commissioner’s Statement Appendix 1—CFTC Voting Summary On this matter, Chairman Giancarlo and Commissioners Quintenz, Behnam, Stump, and Berkovitz voted in the affirmative. No Commissioner voted in the negative. Appendix 2—Statement of CFTC Commissioner Dan M. Berkovitz I support issuing the joint notice of proposed rulemaking (‘‘Proposal’’) with the Securities Exchange Commission (‘‘SEC’’) (collectively with the CFTC, ‘‘Commissions’’) to amend the security futures margin requirements. In 2000, Congress passed the Commodity Futures Modernization Act (‘‘CFMA’’) which permitted security futures trading.1 The CFMA provides that customer margin requirements for security futures shall be set at levels that: (1) Require (a) consistency with the margin requirements for comparable exchangetraded options and (b) margin levels not lower than the lowest level of margin, exclusive of premium, required for any comparable exchange-traded options, (2) preserve the financial integrity of markets trading security futures products, (3) prevent systemic risk, and (4) are and remain consistent with certain margin requirements established by the Federal Reserve Board under its Regulation T.2 The Proposal would decrease the required minimum margin from 20 percent to 15 percent of the current market value. The Proposal reasons that amending the minimum required margin reflects the current stress level percentage of 15 percent set for unhedged exchange-traded options in self-regulated organization risk-based portfolio margining programs.3 This action would increase consistency in the markets by bringing the margin requirement for security futures held outside of a securities portfolio margin account into alignment with the margining for security futures under riskbased portfolio margining methodologies.4 The 20 percent level was originally set by the Commissions in 2002. Markets have 1 See App. E of Public Law 106–554, 114 Stat. 2,763 (2000). 2 See 15 U.S.C. 78g(c)(2)(B) (2018). 3 Proposal, section II.A.5. 4 See 15 U.S.C. 78g(c)(2)(B) (2018). E:\FR\FM\26JYP4.SGM 26JYP4 36454 Federal Register / Vol. 84, No. 144 / Friday, July 26, 2019 / Proposed Rules jbell on DSK3GLQ082PROD with PROPOSALS4 evolved since that time and it is appropriate to reconsider the margin level in light of the subsequent adoption of the risk-based portfolio margining programs. In doing so, the Proposal has followed the statutory mandate to set the security futures margin requirement at levels consistent with, and not lower than, levels for similar options. VerDate Sep<11>2014 21:41 Jul 25, 2019 Jkt 247001 In conclusion, I commend the joint work by the Commissions’ respective staffs in preparing the Proposal. The Proposal represents an opportunity for the Commissions to gain more knowledge about the security futures markets, reevaluate the status quo, and establish a more effective regulatory standard. I look forward to public PO 00000 Frm 00022 Fmt 4701 Sfmt 9990 comments in response to the Proposal, particularly comments that provide additional data and analysis regarding the appropriateness of the 15 percent level under each of the statutory factors the Commissions must consider. [FR Doc. 2019–15400 Filed 7–25–19; 8:45 am] BILLING CODE 6351–01–P E:\FR\FM\26JYP4.SGM 26JYP4

Agencies

[Federal Register Volume 84, Number 144 (Friday, July 26, 2019)]
[Proposed Rules]
[Pages 36434-36454]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 2019-15400]



[[Page 36433]]

Vol. 84

Friday,

No. 144

July 26, 2019

Part VI





Commodity Futures Trading Commission





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17 CFR Part 41





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Securities and Exchange Commission





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17 CFR Part 242





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Customer Margin Rules Relating to Security Futures; Proposed Rule

Federal Register / Vol. 84, No. 144 / Friday, July 26, 2019 / 
Proposed Rules

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COMMODITY FUTURES TRADING COMMISSION

17 CFR Part 41

RIN 3038-AE88

SECURITIES AND EXCHANGE COMMISSION

17 CFR Part 242

[Release No. 34-86304; File No. S7-09-19]
RIN 3235-AM55


Customer Margin Rules Relating to Security Futures

AGENCY: Commodity Futures Trading Commission and Securities and 
Exchange Commission.

ACTION: Joint proposed rules.

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SUMMARY: The Commodity Futures Trading Commission (``CFTC'') and the 
Securities and Exchange Commission (``SEC'') (collectively, the 
``Commissions'') are proposing amendments to regulations that establish 
minimum customer margin requirements for security futures. More 
specifically, the proposed amendments would lower the margin 
requirement for an unhedged security futures position from 20% to 15%, 
as well as propose certain revisions to the margin offset table 
consistent with the proposed reduction in margin.

DATES: Comments should be received on or before August 26, 2019.

ADDRESSES: Comments should be sent to both agencies at the addresses 
listed below.
    CFTC: You may submit comments, identified by RIN 3038-AE88, by any 
of the following methods:
     CFTC Website: https://comments.cftc.gov. Follow the 
instructions for submitting comments through the website.
     Mail: Christopher Kirkpatrick, Secretary of the 
Commission, Commodity Futures Trading Commission, Three Lafayette 
Centre, 1155 21st Street NW, Washington, DC 20581.
     Hand Delivery/Courier: Same as Mail above.
    Please submit your comments using only one method.
    All comments must be submitted in English, or if not, accompanied 
by an English translation. Comments will be posted as received to 
https://www.cftc.gov. You should submit only information that you wish 
to make available publicly. If you wish for the CFTC to consider 
information that you believe is exempt from disclosure under the 
Freedom of Information Act, a petition for confidential treatment of 
the exempt information may be submitted according to the procedures 
established in CFTC Rule 145.9, 17 CFR 145.9.
    The CFTC reserves the right, but shall have no obligation, to 
review, pre-screen, filter, redact, refuse, or remove any or all of 
your submission from https://www.cftc.gov that it may deem to be 
inappropriate for publication, such as obscene language. All 
submissions that have been redacted or removed that contain comments on 
the merits of the rulemaking will be retained in the public comment 
file and will be considered as required under the Administrative 
Procedure Act and other applicable laws, and may be accessible under 
the Freedom of Information Act.
    SEC: Comments may be submitted by any of the following methods:

Electronic Comments

     Use the SEC's internet comment form (https://www.sec.gov/rules/proposed.shtml); or
     Send an email to [email protected]. Please include 
File Number S7-09-19 on the subject line.

Paper Comments

     Send paper comments to Secretary, Securities and Exchange 
Commission, 100 F Street NE, Washington, DC 20549-1090.

All submissions should refer to File Number S7-09-19. This file number 
should be included on the subject line if email is used. To help the 
SEC process and review your comments more efficiently, please use only 
one method. The SEC will post all comments on the SEC's website (https://www.sec.gov/rules/proposed.shtml). Comments are also available for 
website viewing and printing in the SEC's Public Reference Room, 100 F 
Street NE, Room 1580, Washington, DC 20549, on official business days 
between the hours of 10:00 a.m. and 3:00 p.m. All comments received 
will be posted without change. Persons submitting comments are 
cautioned that the SEC does not redact or edit personal identifying 
information from comment submissions. You should submit only 
information that you wish to make publicly available.
    Studies, memoranda, or other substantive items may be added by the 
SEC or staff to the comment file during this rulemaking. A notification 
of the inclusion in the comment file of any such materials will be made 
available on the SEC's website. To ensure direct electronic receipt of 
such notifications, sign up through the ``Stay Connected'' option at 
www.sec.gov to receive notifications by email.

FOR FURTHER INFORMATION CONTACT:
    CFTC: Melissa A. D'Arcy, Special Counsel and Sarah E. Josephson, 
Deputy Director, Division of Clearing and Risk, at (202) 418-5430; and 
Michael A. Penick, Economist at (202) 418-5279, and Ayla Kayhan, 
Economist at (202) 418-5947, Office of the Chief Economist, Commodity 
Futures Trading Commission, Three Lafayette Centre, 1155 21st Street 
NW, Washington, DC 20581.
    SEC: Michael A. Macchiaroli, Associate Director, at (202) 551-5525; 
Thomas K. McGowan, Associate Director, at (202) 551-5521; Randall W. 
Roy, Deputy Associate Director, at (202) 551-5522; Sheila Dombal 
Swartz, Senior Special Counsel, at (202) 551-5545; or Abraham Jacob, 
Special Counsel, at (202) 551-5583; Division of Trading and Markets, 
Securities and Exchange Commission, 100 F Street NE, Washington, DC 
20549-7010.

SUPPLEMENTARY INFORMATION:

I. Background
    A. Applicable Statutory Framework
    B. Prior Regulatory Action by the Commissions
    C. Consideration of SROs' Risk-Based Portfolio Margining 
Approaches
    D. Consideration of Statutory Requirements
II. Discussion
    A. Minimum Margin for Unhedged Positions
    1. Current Security Futures Margin Rules
    2. SRO Risk-Based Portfolio Margin Accounts May Hold Comparable 
Exchange-Traded Options
    3. Minimum Levels of Margin Required for Security Futures
    4. The Commissions Have Authority To Determine Which Exchange-
Traded Options Are Comparable to Security Futures
    5. The Margin Requirements Are Consistent for Comparable 
Exchange-Traded Options
    6. The Proposed Margin Rule Is Consistent With the Federal 
Reserve's Regulation T
    7. The Proposed Margin Rule Permits Higher Margin Requirements
    8. Request for Comments
    B. Margin Offsets
III. Paperwork Reduction Act
    A. CFTC
    B. SEC
IV. Consideration of Costs and Benefits (CFTC) and Economic Analysis 
(SEC) of the Proposed Amendments
    A. CFTC
    1. Introduction
    2. Economic Baseline
    3. Summary of Proposed Amendment
    4. Description of Possible Costs
    i. Risk-Related Costs for Security Futures Intermediaries and 
Customers
    ii. Appropriateness of Margin Requirements
    iii. Costs Associated With Margin Offsets Table

[[Page 36435]]

    5. Description of Possible Benefits
    6. Consideration of Section 15(a) Factors
    i. Protection of Market Participants and the Public
    ii. The Efficiency, Competitiveness and Financial Integrity of 
the Markets
    iii. Price Discovery
    iv. Risk Management
    v. Other Public Interest Considerations
    7. Request for Comment
    B. SEC
    1. Introduction
    2. Baseline
    i. The Security Futures Market
    ii. Regulation
    3. Analysis of the Proposals
    i. Benefits
    ii. Costs
    iii. Effects on Efficiency, Competition, and Capital Formation
    iv. Alternatives Considered
V. Regulatory Flexibility Act
    A. CFTC
    B. SEC
VI. Small Business Regulatory Enforcement Fairness Act
VII. Anti-Trust Considerations
VIII. Statutory Basis

    The CFTC is proposing to amend CFTC Rule 41.45(b)(1), 17 CFR 
41.45(b)(1), and the SEC is proposing to amend SEC Rule 403(b)(1), 17 
CFR 242.403(b)(1),\1\ under authority delegated by the Board of 
Governors of the Federal Reserve System (``Federal Reserve Board'') 
pursuant to Section 7(c)(2) of the Securities Exchange Act of 1934 
(``Exchange Act'').\2\ The Commissions also are proposing to revise the 
margin offset table, consistent with the proposed reduction in margin.
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    \1\ CFTC regulations referred to herein are found at 17 CFR Ch. 
1; SEC regulations referred to herein are found at 17 CFR Ch. 2.
    \2\ 15 U.S.C. 78g(c)(2).
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I. Background

    The Commodity Futures Modernization Act of 2000 (``CFMA''),\3\ 
which became law on December 21, 2000, lifted the ban on trading 
security futures \4\ and established a framework for the joint 
regulation of security futures by the CFTC and the SEC. A security 
future is a futures contract on a single security or on a narrow-based 
security index.\5\
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    \3\ Appendix E of Public Law No. 106-554, 114 Stat. 2763 (2000).
    \4\ See Section 1a(31) of the Commodity Exchange Act (``CEA''), 
7 U.S.C. 1a(44); and Section 3(a)(55) of the Exchange Act, 15 U.S.C. 
78c(a)(55) (defining the term ``security future'').
    \5\ Id. A ``security future'' is distinguished from a ``security 
futures product,'' which is defined to include security futures as 
well as any put, call, straddle, option, or privilege on any 
security future. See Section 1a(45) of the CEA, 7 U.S.C. 1a(45); and 
Section 3(a)(56) of the Exchange Act, 15 U.S.C. 78c(a)(56) (defining 
the term ``security futures product''). Futures on indexes that are 
not narrow-based security indexes are subject to the exclusive 
jurisdiction of the CFTC. This rule proposal applies only to margin 
on security futures and not to margin on options on security 
futures. For the purposes of this proposal, most discussion will 
relate to security futures only. For the sake of clarity and 
consistency, the term ``security futures products'' will be used 
when discussing security futures and the options on security futures 
together throughout this proposal. Under CEA Section 
2(a)(1)(D)(iii)(II) and Exchange Act Section 6(h)(6), the CFTC and 
SEC may, by order, jointly determine to permit the listing of 
options on security futures; that authority has not been exercised.
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A. Applicable Statutory Framework

    As part of the statutory scheme for the regulation of security 
futures, the CFMA provided for the issuance of regulations governing 
customer margin for security futures. Customer margin for security 
futures includes two types of margin, (i) initial margin, and (ii) 
maintenance margin. Together, the initial and maintenance margin must 
satisfy the required margin established by the Commissions.\6\
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    \6\ Initial margin must be deposited as collateral when a 
customer makes an initial investment in security futures. 
Maintenance margin is the minimum amount a customer must maintain in 
its margin account while owning security futures. If a customer's 
margin level falls below the maintenance margin amount, a customer 
may be required to make an additional deposit. Maintenance margin 
for security futures is different from variation settlement. 
Variation settlement is a daily or intraday mark to market payment 
for a security future. See CFTC Rule 41.43(a)(32), 17 CFR 
41.43(a)(32); SEC Rule 401(a)(32), 17 CFR 242.401(a)(32).
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    The CFMA added a new subsection (2) to Section 7(c) of the Exchange 
Act,\7\ which directs the Federal Reserve Board to prescribe 
regulations establishing initial and maintenance customer margin 
requirements imposed by brokers, dealers, and members \8\ of national 
securities exchanges \9\ for security futures. In addition, Section 
7(c)(2) provides that the Federal Reserve Board may delegate this 
rulemaking authority jointly to the Commissions.
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    \7\ 15 U.S.C. 78g(c)(2).
    \8\ Futures commission merchants (as defined in Section 1(a)(28) 
of the CEA), which may be members of national securities exchanges, 
clearing members at clearinghouses, or customers of clearing members 
at clearinghouses, are discussed in detail below.
    \9\ OneChicago, LLC (``OCX''), the only U.S. national securities 
exchange currently listing security futures, filed a rulemaking 
petition, dated August 1, 2008, requesting that the minimum required 
margin for unhedged security futures be reduced from 20% to 15%. 
Letter from Donald L. Horwitz, Managing Director and General 
Counsel, OCX, to David Stawick, Secretary, CFTC, and Nancy M. 
Morris, Secretary, SEC, dated Aug. 1, 2008, at 2 (``OCX Petition''). 
OCX also is a designated contract market registered with the CFTC.
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    Section 7(c)(2)(B) of the Exchange Act provides that the customer 
margin requirements, ``including the establishment of levels of margin 
\10\ (initial and maintenance) for security futures products,'' must 
satisfy four requirements. First, they must preserve the financial 
integrity of markets trading security futures products. Second, they 
must prevent systemic risk. Third, they must (1) be consistent with the 
margin requirements for comparable options traded on any exchange 
registered pursuant to Section 6(a) of the Exchange Act; \11\ and (2) 
provide for initial and maintenance margin levels that are not lower 
than the lowest level of margin, exclusive of premium, required for any 
comparable exchange-traded options. Fourth, they must be, and remain 
consistent with, the margin requirements established by the Federal 
Reserve Board under Regulation T (``Regulation T'').\12\
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    \10\ The terms ``margin level'' and ``level of margin'', when 
used with respect to a security futures product, mean the amount of 
margin required to secure any extension or maintenance of credit, or 
the amount of margin required as a performance bond related to the 
purchase, sale, or carrying of a security futures product. 15 U.S.C. 
78c(a)(57)(B).
    \11\ Given the statutory language, for the sake of clarity and 
consistency, the term ``comparable exchange-traded options'' will be 
used to describe single stock options throughout this proposal.
    \12\ 12 CFR 220 et seq.
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    With regard to the third requirement, there is limited legislative 
history \13\ regarding how or why the comparison should be to exchange-
traded options. As discussed further below, under certain circumstances 
the products behave similarly in terms of their overall risk profiles. 
However, from the perspective of market participants, exchange-traded 
options and security futures often serve two distinct economic 
functions.
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    \13\ For example, earlier versions of the statutory language 
stated that margin should be set at levels appropriate to ``prevent 
competitive distortions between markets offering similar products'', 
and the reasons given for instituting the margin requirements was 
that ``[u]nder the bill, margin levels on these products would be 
required to be harmonized with the options markets.'' See S. Report 
106-390 (Aug. 25, 2000) at pp.5 and 39.
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    Exchange-traded options are tools for hedging and speculating on 
the underlying equity markets. On the other hand, security futures are 
``delta one derivatives'' \14\ that are more similar to total return 
equity swaps insofar as they provide exposure to equities without 
requiring ownership of the underlying instrument. Specifically, 
security futures are used to (1) establish synthetic long or short 
exposure to the underlying equity security or equity securities, and/or 
(2) temporarily transfer securities, similar to securities

[[Page 36436]]

lending or equity repurchase agreements.\15\ However, while exchange-
traded options and security futures can serve distinct economic 
functions, they generally share similar risk profiles for purposes of 
assessing margin. For example, both short security futures positions 
and certain exchange-traded options strategies produce unlimited 
downside risk. Investors in security futures and writers of options may 
lose their margin deposits and premium payments and be required to pay 
additional funds. As a result, the margin requirements for security 
futures can be compared to margin practices for exchange-traded options 
in order to determine appropriate margin levels.
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    \14\ Delta one derivatives are financial instruments with a 
delta that is close or equal to one. Delta measures the rate of 
change in a derivative relative to a unit of change in the 
underlying instrument. Delta one derivatives have no optionality, 
and therefore, as the price of the underlying instrument moves, the 
price of the derivative is expected to move at, or close to, the 
same rate.
    \15\ See e.g., OCX (describing trading strategies for security 
futures), available at https://www.onechicago.com/?page_id=25157.
---------------------------------------------------------------------------

    In comparison, security futures traded in Europe are subject to 
risk-based margin calculations that differ from the margin requirements 
that apply to security futures in the U.S. LCH Ltd. applies a Standard 
Portfolio Analysis of Risk (``SPAN'') margin methodology for the 
security futures it clears,\16\ and Eurex applies portfolio-based 
margining through its new margin methodology, Eurex Clearing Prisma, to 
its cleared security futures.\17\ As described below, in the U.S., 
security futures may be portfolio margined under current rules only if 
they are held in a securities account.\18\
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    \16\ See LCH's discussion of ``London SPAN'', available at 
https://www.lch.com/risk-collateral-management/group-risk-management/risk-management-ltd/ltd-margin-methodology/london.
    \17\ See Eurex Exchange's discussion of ``Risk parameters and 
initial margins'', available at https://www.eurexchange.com/exchange-en/market-data/clearing-data/risk-parameters.
    \18\ See the Financial Industry Regulatory Authority, Inc. 
(``FINRA'') Rule 4210(g) and the Cboe Exchange, Inc. (``CBOE'') Rule 
12.4. See also Section 713 of the Dodd-Frank Wall Street Reform and 
Consumer Protection Act (``Dodd-Frank Act''). Public Law 111-203,124 
Stat. 1376 (2010). The Dodd-Frank Act provided the SEC and CFTC with 
authority to facilitate portfolio margining by allowing cash and 
securities to be held in a futures account, and futures and options 
on futures and related collateral to be held in a securities 
account, subject to certain conditions. See Exchange Act Section 
15(c)(3)(C) and CEA Section 4d(h), 15 U.S.C. 78o(c)(3)(C), and 7 
U.S.C. 6d(h).
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B. Prior Regulatory Action by the Commissions

    On March 6, 2001, the Federal Reserve Board delegated its authority 
under Section 7(c)(2) to the Commissions.\19\ Pursuant to that 
authority, the SEC and the CFTC adopted customer margin requirements 
for security futures.\20\
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    \19\ Letter from Jennifer J. Johnson, Secretary of the Board, 
Federal Reserve Board, to James E. Newsome, Acting Chairman, CFTC, 
and Laura S. Unger, Acting Chairman, SEC (Mar. 6, 2001) (``FRB 
Letter''), reprinted as Appendix B to Customer Margin Rules Relating 
to Security Futures, 66 FR 50720, 50741 (Oct. 4, 2001) (joint 
proposed rulemaking by the Commissions) (``2001 Proposed Rules'').
    \20\ See Customer Margin Rules Relating to Security Futures, 67 
FR 53146 (Aug. 14, 2002) (joint rulemaking by the Commissions, 
hereinafter the ``2002 Final Rules''); 17 CFR 41.42-41.49 (CFTC 
regulations); 17 CFR 242.400-242.406 (SEC regulations).
---------------------------------------------------------------------------

    The 2002 Final Rules establish margin requirements for security 
futures to be collected by security futures intermediaries from their 
customers.\21\ A security futures intermediary is a creditor, as 
defined under Regulation T, with respect to its financial relations 
with any person involving security futures, and includes registered 
entities such as brokers, dealers, and futures commission merchants 
(``FCMs'').\22\ The amendments proposed today to CFTC regulation 
41.45(b)(1) and SEC rule 242.403(b)(1) concern the minimum required 
margin such entities would be required to collect from customers in 
this context.
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    \21\ See CFTC Rule 41.45(a), 17 CFR 41.45(a); SEC Rule 403, 17 
CFR 242.403.
    \22\ See CFTC Rule 41.43(a)(29), 17 CFR 41.43(a)(29); SEC Rule 
401(a)(29), 17 CFR 242.401(a)(29). A security future is both a 
security and a future, so customers who wish to buy or sell security 
futures must conduct the transaction through a person registered 
both with the CFTC as either an FCM or an introducing broker and the 
SEC as a broker-dealer. The term ``security futures intermediary'' 
includes FCMs that are clearing members or customers of clearing 
members of the Options Clearing Corporation (``OCC''), which is the 
clearinghouse that clears security futures listed on OCX.
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    In the 2002 Final Rules, the Commissions established minimum 
initial and maintenance margin levels for unhedged security futures at 
20% of their ``current market value.'' \23\ In addition, the 
Commissions' rules permit self-regulatory organizations and self-
regulatory authorities (together ``SROs''),\24\ to set margin levels 
lower than 20% of current market value for customers with certain 
strategy-based offset positions involving security futures and one or 
more related securities or futures.\25\
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    \23\ See CFTC Rule 41.45(b)(1), 17 CFR 41.45(b)(1); SEC Rule 
403(b)(1), 17 CFR 242.403(b)(1). See also CFTC Rule 41.43(a)(4), 17 
CFR 41.43(a)(4); SEC Rule 401(a)(4), 17 CFR 242.401(a)(4) (defining 
the term ``current market value'').
    \24\ For the sake of clarity and consistency, the defined term 
``SRO'' will be used to describe self-regulatory organizations and 
self-regulatory authorities throughout this proposal. ``Self-
regulatory authority'' is defined at CFTC Rule 41.43(a)(30), 17 CFR 
41.43(a)(30) and SEC Rule 401(a)(30), 17 CFR 242.401(a)(30).
    \25\ See CFTC Rule 41.45(b)(2), 17 CFR 41.45(b)(2); SEC Rule 
403(b)(2), 17 CFR 242.403(b)(2).
---------------------------------------------------------------------------

    Neither the current regulations nor the proposed amendments 
prohibit SROs or security futures intermediaries from establishing 
higher initial or maintenance margin levels than the required margin or 
from taking appropriate action to preserve their own financial 
integrity.\26\ SROs and security futures intermediaries may determine 
that higher margin levels are required for security futures under 
certain market conditions. Similar to current regulations, the 
Commissions are proposing to preserve this flexibility because it is 
important for SROs and security futures intermediaries to be able to 
manage their customers' risks appropriately.
---------------------------------------------------------------------------

    \26\ See CFTC Rule 41.42(c)(1), 17 CFR 41.42(c)(1); SEC Rule 
400(c)(1), 17 CFR 242.400(c)(1).
---------------------------------------------------------------------------

    The Commissions enumerated specific exclusions from the margin rule 
for security futures, and those exclusions would continue under the 
proposed amendments.\27\ For example, margin requirements that 
derivatives clearing organizations (``DCOs'') or clearing agencies 
impose on their members are not subject to the 20% security futures 
margin requirement, as this provides clearinghouses flexibility and 
discretion in managing their members' exposures. In addition, Section 
7(c)(2) of the Exchange Act does not confer authority over margin 
requirements for clearing agencies and DCOs.\28\ The margin rules of 
clearing agencies registered with the SEC are approved by the SEC 
pursuant to Section 19(b)(2) of the Exchange Act.\29\ The CFTC has 
authority to ensure compliance with core principles for DCOs registered 
with the CFTC under Sections 5b and 5c of the CEA.\30\
---------------------------------------------------------------------------

    \27\ See CFTC Rule 41.42(c)(2)(i)-(v), 17 CFR 41.42(c)(2)(i)-
(v); SEC Rule 400(c)(2)(i)-(v), 17 CFR 242.400(c)(2)(i)-(v).
    \28\ See CFTC Rule 41.42(c)(2)(iii), 17 CFR 41.42(c)(2)(iii); 
SEC Rule 400(c)(2)(iii), 17 CFR 242.400(c)(2)(iii). See also 15 
U.S.C. 78g(c)(2) and FRB Letter (``The authority delegated by the 
[Federal Reserve Board] is limited to customer margin requirements 
imposed by brokers, dealers, and members of national securities 
exchanges. It does not cover requirements imposed by clearing 
agencies on their members.'').
    \29\ 15 U.S.C. 78s(b)(2).
    \30\ 7 U.S.C. 7a-1 and 7 U.S.C. 7a-2.
---------------------------------------------------------------------------

    Another exclusion is for margin calculated by a portfolio margining 
system under rules that meet the four criteria set forth in Section 
7(c)(2)(B) of the Exchange Act \31\ and that have been approved by the 
SEC and, as applicable, the CFTC.\32\ Subsequent to the adoption of 
2002 Final Rules, and consistent with the exclusion, three SROs \33\ 
initiated

[[Page 36437]]

pilot programs for risk-based portfolio margining rules that permit a 
security futures intermediary to combine certain of a customer's 
securities and futures positions in a securities portfolio margin 
account to compute the customer's margin requirements based on the net 
market risk of all the customer's positions in the account.\34\ As 
discussed in more detail below, these SRO risk-based portfolio margin 
rules established a margin requirement for unhedged exchange-traded 
options and security futures of 15% (i.e., a valuation point range of 
+/- 15%).\35\ In proposed rule filings seeking to make the pilots 
permanent, the SROs noted that they did not encounter any problems or 
difficulties relating to such pilot programs.\36\ These SRO risk-based 
portfolio margining rules--originally adopted as a pilot program--
became permanent in 2008. These SRO rules require 15% margin (i.e., a 
valuation point range of +/- 15%) for an unhedged exchange-traded 
option on an equity security or narrow-based index.\37\
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    \31\ 15 U.S.C. 78g(c)(2)(B).
    \32\ See CFTC Rule 41.42(c)(2)(i), 17 CFR 41.42(c)(2)(i); SEC 
Rule 400(c)(2)(i), 17 CFR 242.400(c)(2)(i).
    \33\ The three SROs that proposed pilot programs are FINRA, the 
New York Stock Exchange LLC (``NYSE'') and CBOE (formerly known as 
Chicago Board Options Exchange, Inc.). The SEC has regulatory 
authority over all three SROs. In 2010, the CBOE conducted a 
restructuring transaction in which CBOE became a wholly-owned 
subsidiary of CBOE Holdings, Inc. The CFTC regulates the Cboe 
Futures Exchange, LLC (a wholly-owned subsidiary of CBOE Holdings, 
Inc.) as a designated contract market under Section 5 of the CEA.
    \34\ See Exchange Act Release No. 55471 (Mar. 14, 2007), 72 FR 
13149 (Mar. 20, 2007) (SR-NASD-2007-013, relating to the National 
Association of Securities Dealers' (now known as FINRA) rule change 
to permit members to adopt a portfolio margin methodology on a pilot 
basis); Exchange Act Release No. 54918 (Dec. 12, 2006), 71 FR 75790 
(Dec. 18, 2006) (SR-NYSE-2006-13, relating to further amendments to 
the NYSE's portfolio margin pilot program); Exchange Act Release No. 
54919 (Dec. 12, 2006), 71 FR 75781 (Dec. 18, 2006) (SR-CBOE 2006-14, 
relating to amendments to CBOE's portfolio margin pilot program to 
include security futures); Exchange Act Release No. 54125 (Jul. 11, 
2006), 71 FR 40766 (Jul. 18, 2006) (SR-NYSE-2005-93, relating to 
amendments to the NYSE's portfolio margin pilot program to include 
security futures); Exchange Act Release No. 52031 (Jul. 14, 2005), 
70 FR 42130 (Jul. 21, 2005) (SR-NYSE-2002-19, relating to the NYSE's 
original portfolio margin pilot proposal); Exchange Act Release No. 
52032 (Jul. 14, 2005), 70 FR 42118 (Jul. 21, 2005) (SR-CBOE-2002-03, 
relating to the CBOE's original portfolio margin pilot proposal).
    \35\ See discussion in section I.C. below.
    \36\ See Exchange Act Release No. 58251 (Jul. 30, 2008), 73 FR 
45506 (Aug. 5, 2008) (SR-FINRA-2008-041, relating to the FINRA's 
proposal to make the portfolio margin pilot program permanent under 
NASD Rule 2520(g) and Incorporated NYSE Rule 431(g)); Exchange Act 
Release No. 58243 (Jul. 29, 2008), 73 FR 45505 (Aug. 5, 2008) (SR-
CBOE-2008-73, relating to the CBOE's proposal to make the portfolio 
margin pilot program permanent); and Exchange Act Release No. 58261 
(Jul. 30, 2008), 73 FR 46116 (Aug. 7, 2008) (SR-NYSE-2008-66, 
relating to the NYSE's proposal to make the portfolio margin pilot 
program permanent). FINRA Rule 4210 (Margin Requirements) became 
effective December 2, 2010. See Exchange Act Release No. 62482 (July 
12, 2010) 75 FR 41562 (July 16, 2010) (SR-FINRA-2010-024, relating 
to FINRA's proposal to adopt FINRA Rule 4210 (Margin Requirements) 
as part of the process of developing a consolidated FINRA rulebook) 
and FINRA Regulatory Notice 10-45. As of February 14, 2019, of the 
3,777 broker-dealers registered with the SEC, FINRA is the 
designated examining authority for 3,654 firms (96.7%).
    \37\ Id.
---------------------------------------------------------------------------

    Subsequent to the adoption of 2002 Final Rules, each Commission 
adopted rules to enhance core principles and standards for the 
operation and governance of DCOs and covered clearing agencies that, as 
discussed below, also are generally applicable to the clearance and 
settlement of security futures. In 2011, the CFTC issued regulations 
applicable to DCOs, including CFTC Rule 39.13, which concerns margin--
both initial and variation margin--that is required to be collected by 
a DCO from its clearing members.\38\ Any DCO clearing security futures 
is subject to CFTC Rule 39.13,\39\ and most of the requirements under 
CFTC Rule 39.13 apply broadly to all transactions cleared by the DCO, 
but in some cases security futures transactions are excluded.\40\ Any 
of a DCO's clearing members that are FCMs and that are clearing 
security futures on behalf of customers would be subject to CFTC Rule 
41.45(b)(1).\41\
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    \38\ See DCO General Provisions and Core Principles, 76 FR 
69334, 69364-69379 (Nov. 8, 2011).
    \39\ The CFTC adopted enhanced risk management requirements for 
all registered DCOs in 2011. See id.
    \40\ For example, CFTC Rule 39.13(g)(8)(ii) (requiring DCOs to 
collect customer initial margin, for non-hedge positions, at a level 
that is greater than 100% of the DCO's initial margin requirements) 
does not apply to initial margin collected for security futures 
positions. In September 2012, the CFTC's Division of Clearing and 
Risk issued an interpretive letter regarding CFTC Rule 
39.13(g)(8)(ii) to provide clarifications to DCOs complying with the 
rule. CFTC Letter No. 12-08 (Sept. 14, 2012). CFTC Letter No. 12-08 
states that the customer margin rule under CFTC Rule 39.13(g)(8)(ii) 
``does not apply to customer initial margin collected as performance 
bond for customer security futures positions.'' CFTC Letter No. 12-
08 is limited in its discussion to CFTC Rule 39.13(g)(8)(ii) only 
and, accordingly, the remaining provisions of CFTC Rule 39.13 
continue to apply to DCOs clearing security futures.
    \41\ Currently, the OCC is the only clearinghouse in the United 
States that clears security futures. OCC is registered with the SEC 
as a clearing agency pursuant to Section 17A of the Exchange Act and 
registered with the CFTC as a DCO pursuant to Section 5b of the CEA.
---------------------------------------------------------------------------

    In 2016, the SEC adopted final rules applicable to clearing 
agencies registered with the SEC, including SEC Rule 17Ad-22(e)(6), to 
establish enhanced standards for the operation and governance of 
registered clearing agencies that meet the definition of ``covered 
clearing agency.\42\ This rule requires a covered clearing agency that 
provides central clearing services to establish, implement, maintain, 
and enforce written policies and procedures reasonably designed to, as 
applicable, cover its credit exposures to its participants by 
establishing a risk-based margin system that meets certain minimum 
standards prescribed in the rule.\43\ OCC, as a covered clearing 
agency, is subject to these rules, and its broker-dealer clearing 
members that clear security futures are subject to SEC Rule 
403(b)(1).\44\
---------------------------------------------------------------------------

    \42\ See Standards for Covered Clearing Agencies, Exchange Act 
Release No. 78961 (Sept. 28, 2016), 81 FR 70786 (Oct. 13, 2016).
    \43\ 17 CFR 240.17Ad-22(e)(6).
    \44\ 17 CFR 242.403(b)(1).
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C. Consideration of SROs' Risk-Based Portfolio Margining Approaches

    As discussed below, the Commissions are proposing to amend the 
customer margin requirements for security futures that are held outside 
of risk-based portfolio margining accounts. This amended margin 
requirement would equal the level of margin required to be collected 
for security futures under risk-based portfolio margining 
methodologies. The amended margin requirement also would equal the 
margin requirement for an unhedged exchange-traded option held in a 
securities portfolio margin account. Security futures and exchange-
traded options held in securities accounts are permitted to take 
advantage of SRO risk-based portfolio margining, and the Commissions 
are seeking to align the margin requirement for security futures not 
held in portfolio margin accounts (by lowering their overall margin 
rate) with security futures and exchanged-traded options held in these 
securities accounts.
    Under the SRO risk-based portfolio margining rules, the minimum 
initial and maintenance margin on a customer's entire portfolio, 
including an unhedged position in a security future or exchange-traded 
option, shall be the greater of: (i) The amount of any of the ten 
equidistant valuation points representing the largest theoretical loss 
in the portfolio as calculated under the rule,\45\ or (ii) the total 
calculated by multiplying $0.375 for each position by the instrument's 
multiplier, not to

[[Page 36438]]

exceed the market value in the case of long positions.\46\
---------------------------------------------------------------------------

    \45\ The actual percentage used to stress a financial instrument 
will depend on the financial instrument. For example, the up/down 
market move (high and low valuation points) is +6%/-8% for high 
capitalization, broad-based market indexes; +/-10% for non-high 
capitalization, broad-based market indexes; and +/-15% for any other 
eligible product that is, or is based on, an equity security or a 
narrow-based index. See FINRA Rule 4210(g)(2)(F) and CBOE Rule 
12.4(a)(11). Portfolio types containing volatility indexes are 
subject to market moves of +/-20% for 30-day implied volatility, and 
+/-40% for 9-day implied volatility. See CBOE Rule 12.4(a)(11).
    \46\ See FINRA Rule 4210(g)(7) and CBOE Rule 12.4(e).
---------------------------------------------------------------------------

    The SRO risk-based portfolio margining system approved by the SEC 
is a methodology for determining a customer's margin requirement by 
calculating the greatest theoretical loss on a portfolio of financial 
instruments at ten equidistant points along a range representing a 
potential percentage increase and decrease in the value of the 
instrument or underlying instrument in the case of a derivative. 
Theoretical gains and losses for each instrument in the portfolio are 
netted at each valuation point along the range to derive a potential 
portfolio-wide gain or loss for the point. Under current SRO risk-based 
portfolio margining rules, the range of theoretical gains and losses 
for portfolios of security futures and exchange-traded options that are 
based on a single equity security or narrow-based index is a market 
increase of 15% and a decrease of 15% (i.e., the valuation points would 
be +/- 3%, 6%, 9%, 12%, and 15%).\47\
---------------------------------------------------------------------------

    \47\ A theoretical options pricing model is used to derive 
position values at each valuation point for the purpose of 
determining the gain or loss. See FINRA Rule 4210(g)(2)(F) (defining 
the term ``theoretical gains and losses''). For example, assuming 
that the 15% market move creates the largest theoretical loss in the 
portfolio and that security futures have a linear function (i.e., a 
price movement in the underlying instrument will translate into a 
specific dollar value change in the security future), the initial 
and maintenance margin for a security future will equal close to 15% 
of the overall unhedged security futures portfolio.
---------------------------------------------------------------------------

    In addition to requiring a 15% margin for unhedged security futures 
and exchange-traded options, as a pre-condition to offering portfolio 
margining to customers under the SRO risk-based portfolio margining 
system, security futures intermediaries are required to establish a 
comprehensive, written risk analysis methodology to assess the 
potential risk to the security futures intermediary's capital over a 
specified range of possible market movements for positions held in a 
securities portfolio margin account.\48\
---------------------------------------------------------------------------

    \48\ See FINRA Rule 4210(g)(1) and CBOE Rule 15.8A. See also 
CFTC Rule 1.11 (requiring FCMs to establish risk management programs 
that address market, credit, liquidity, capital and other applicable 
risks, regardless of the type of margining offered).
---------------------------------------------------------------------------

D. Consideration of Statutory Requirements

    As noted above, in Section 7(c)(2)(B)(iii) of the Exchange Act \49\ 
Congress provided that the margin requirements for security futures 
must be consistent with the margin requirements for comparable 
exchange-traded options, and that the initial and maintenance margin 
levels for security futures may not be lower than the lowest level of 
margin, exclusive of premium, required for any comparable exchange-
traded option.
---------------------------------------------------------------------------

    \49\ 15 U.S.C. 78g(c)(2)(B)(iii).
---------------------------------------------------------------------------

    As noted above, despite some distinct economic uses for exchange-
traded options and security futures, both products share similar risk 
profiles. Accordingly, the Commissions are proposing to apply margin 
requirements to security futures that are consistent with the margin 
requirements for comparable exchange-traded options.
    In summary, as discussed in detail below, because unhedged 
exchange-traded options and security futures in SRO risk-based 
portfolio margining programs were permitted to be margined at a lower 
15% rate as early as 2008, when the SRO risk-based portfolio margining 
programs became permanent,\50\ the Commissions are proposing to amend 
their joint margin rules relating to security futures to reduce the 
minimum required margin for unhedged security futures from 20% to 15%, 
reflecting the current margin requirements available for comparable 
exchange-traded options.\51\
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    \50\ See supra note 36.
    \51\ See 2001 Proposed Rules, 66 FR at 50726 (``Pending adoption 
of such [portfolio margin] systems by regulatory authorities, 
however, the 20 percent level is consistent with the current 
requirements for comparable equity options.'').
---------------------------------------------------------------------------

    With regard to the other three statutory requirements, the 
Commissions preliminarily believe this proposed action is consistent 
with preserving the financial integrity of the security futures market, 
is unlikely to lead to systemic risk, and is consistent with the margin 
requirements established by the Federal Reserve Board under Regulation 
T.\52\
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    \52\ As discussed in the CFTC's Consideration of Costs and 
Benefits and the SEC's Economic Analysis, in sections IV.A and B, 
respectively, the Commissions believe that margin coverage is 
sufficient and tailored to preserve financial integrity and prevent 
systemic risk in the security futures market.
---------------------------------------------------------------------------

II. DISCUSSION

A. Minimum Margin for Unhedged Positions

1. Current Security Futures Margin Rules
    Under existing CFTC and SEC regulations, the current minimum 
initial and maintenance margin levels required of customers for each 
unhedged long or short position in security futures is 20% of the 
current market value of such a security future.\53\ This margin level 
was based on the margin requirements for an unhedged short, at-the-
money exchange-traded option in 2002.\54\ Currently, the margin 
requirement for an unhedged short, at-the-money exchange-traded option 
held in a customer account that is not subject to SRO risk-based 
portfolio margining, where the underlying instrument is either an 
equity security or a narrow-based index of equity securities, is 100% 
of the exchange-traded option proceeds, plus 20% of the value of the 
underlying security or narrow-based index.\55\
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    \53\ See CFTC Rule 41.45(b), 17 CFR 41.45(b); SEC Rule 403(b), 
17 CFR 242.403(b).
    \54\ See 2002 Final Rules, 67 FR at 53157.
    \55\ See generally FINRA Rule 4210 and CBOE Rule 12.3. For long, 
exchange-traded options, the purchaser is generally required to pay 
the full amount of the contract.
---------------------------------------------------------------------------

2. SRO Risk-Based Portfolio Margin Accounts May Hold Comparable 
Exchange-Traded Options
    When the Commissions adopted the 2002 Final Rules, market 
participants had no opportunity to margin short exchange-traded options 
on an equity security or a narrow-based index, at a rate lower than 
20%. Therefore, according to Section 7(c)(2)(B)(iii)(II) of the 
Exchange Act, the Commissions could not establish a margin level for 
security futures that was lower than the 20% margin level applicable to 
exchange-traded options. Now, after the adoption of the SRO risk-based 
portfolio margining for securities customer accounts, market 
participants may choose to hold their exchange-traded options in 
accounts that are margined at levels of 15% or lower.\56\
---------------------------------------------------------------------------

    \56\ As stated above, SRO risk-based portfolio margin rules 
permit a security futures intermediary to combine certain of a 
customer's securities positions to compute margin requirements. In 
cases where a customer holds hedged positions (such as options) on 
the same underlying security, the portfolio margin requirement may 
be less than 15%. For purposes of the analysis of the proposed rule 
amendments, however, the Commissions are determining whether the 
proposed 15% margin requirement for an unhedged security future held 
outside a securities portfolio margin account is comparable to a 15% 
margin requirement for unhedged exchanged-traded options held in a 
securities portfolio margin account.
---------------------------------------------------------------------------

    At the time of the 2002 Final Rules, the SROs had not yet proposed 
portfolio margining rules for exchange-traded options. As of the 
publication of the 2002 Final Rules, all short exchange-traded options 
on an equity security or a narrow-based index were required to satisfy 
a 20% margin rate and it was the Commissions' view that security 
futures should be subject to the same margin rate for those comparable 
exchange-traded options.
    Today, there is an alternative margin methodology for exchange-
traded options that are held in a securities

[[Page 36439]]

margin account and subject to permanent portfolio margin requirements 
implemented successfully by market participants. The Commissions 
preliminarily believe that they have satisfied the third prong of the 
Exchange Act's margin requirements to determine that the margin rate 
for security futures should be consistent with the margin rate for 
those exchange-traded options. The Commissions preliminarily believe 
there is sufficient basis to make that determination at this time, and 
are proposing that the margin rate for unhedged security futures be 
consistent with, and the same as, the margin rate for unhedged 
exchange-traded options held in a risk-based portfolio margining 
account.
3. Minimum Levels of Margin Required for Security Futures
    Congress stated explicitly that the margin level for a security 
future should not be lower than the lowest level of margin for any 
comparable exchange-traded option,\57\ but it did not state a specific 
amount that the Commissions would be required to set as a minimum 
margin requirement. Today, there are exchange-traded options based on 
an equity security or narrow-based index that are margined at 15%, or 
lower, as a result of portfolio margining that is now being offered by 
a number of SROs. Congress intended for the Commissions to set a margin 
level for a security future that was not lower than the margin rate 
required for comparable exchange-traded options, which is to say that 
the Commissions cannot set a margin rate for security futures lower 
than 15%. The margin required for an unhedged exchange-traded option in 
a risk-based portfolio margin account, calculated using the SROs' 
current rules, will equal 15% or less of the underlying equity 
security's value, because the largest theoretical loss produced by 
shocking the portfolio will not be more than 15%.
---------------------------------------------------------------------------

    \57\ 15 U.S.C. 78g(c)(2)(B)(iii)(II).
---------------------------------------------------------------------------

    Because the current SRO required margin levels for unhedged 
exchange-traded options held in a portfolio margin account are set at a 
level based on shocking the portfolio at 15% price movements, the 
Commissions preliminarily believe that the unhedged security futures 
margin rate should not be lower than 15%. Therefore, the Commissions' 
proposal to lower the margin requirement for security futures complies 
with the statutory requirement that the margin level for a security 
future be consistent with the margin for any comparable exchange-traded 
option.
4. The Commissions Have Authority to Determine Which Exchange-Traded 
Options Are Comparable to Security Futures
    In this proposal, the Commissions seek to align the margin rate for 
security futures with the lower portfolio-based margin rate for 
exchange-traded options because the Commissions view exchange-traded 
options held in portfolio margin accounts as comparable to security 
futures that may be held alongside the exchange-traded options.
    Congress did not instruct the Commissions to set the margin 
requirement for security futures at the same exact level as the margin 
requirements for exchange-traded options. The Commissions are required 
to establish a margin requirement that is ``consistent'' with the 
margin requirements for ``comparable'' exchange-traded options. Because 
the Commissions have some flexibility in establishing the margin rate 
for security futures, the Commissions are making the determination that 
establishing the margin rate for unhedged security futures at the same 
rate as the margin rate for exchange-traded options that are held 
alongside security futures inside a portfolio margin account subject to 
an SRO's portfolio margining rules will provide the most consistent 
result for security futures.
    The Commissions are proposing to decrease the margin requirement 
for unhedged security futures from 20% to 15% in order to reflect the 
comparability between unhedged security futures and exchange-traded 
options that are held in risk-based portfolio margin accounts. The SRO 
portfolio margining rules, upon which this change is based, are 
discussed in more detail below.
    The Commissions explained in the 2001 proposing release for 
customer margin for security futures that ``the Federal Reserve Board 
has expressed the view that `more risk-sensitive, portfolio-based 
approaches to margining security futures products' should be adopted 
[citing the FRB Letter]. Pending adoption of such systems by regulatory 
authorities, however, the 20% level is consistent with the current 
requirements for comparable equity options.'' \58\
---------------------------------------------------------------------------

    \58\ See 2001 Proposed Rules, 66 FR at 50726.
---------------------------------------------------------------------------

    With the adoption of the SRO securities risk-based portfolio 
margining rules--including portfolio margining for security futures--
the Commissions have preliminarily determined that a proposed minimum 
margin level of 15% meets the comparability standard of Section 7(c)(2) 
of the Exchange Act.\59\ Under the SROs' securities risk-based 
portfolio margining rules, a security futures intermediary may combine 
a customer's related products and calculate margin for a group of 
similar products on a portfolio margin basis. Each group of products 
may be subject to a different margin calculation, depending on its risk 
profile.\60\ Portfolios containing exchange-traded options and security 
futures based on the same underlying security, such as an individual 
equity or narrow-based index are grouped together.\61\ SRO rules 
calculate the margin requirement for these exchange-traded options and 
security futures by exposing the instruments to market moves that are 
+/-15%. The Commissions are proposing to allow security futures 
intermediaries to margin security futures held outside of these 
portfolios the same as security futures held inside of the portfolios 
with other instruments. As a result of this change, security futures 
held in futures accounts and strategy-based securities margin accounts 
would be subject to the same margin requirements as unhedged security 
futures held in securities portfolio margin accounts. The Commissions 
are proposing to require 15% margin for unhedged security futures 
because it would bring security futures held outside of a securities 
portfolio margin account into alignment with the margin requirements 
for unhedged security futures held within a securities account using 
risk-based portfolio margining.
---------------------------------------------------------------------------

    \59\ See 15 U.S.C. 78g(c)(2).
    \60\ Each of the SROs has different portfolio types that will be 
margined according to the portfolio's risk profile. These portfolio 
types include: (i) High capitalization, broad-based market index 
(margin required is calculated using +6/-8% market moves), (ii) non-
high capitalization, broad-based market index (margin required is 
calculated using +/-10% market moves), (iii) narrow-based index 
(margin required is calculated using +/-15% market moves), (iv) 
individual equity (margin required is calculated using +/-15% market 
moves), (v) volatility index (30-day implied) (margin required is 
calculated using +/-20% market moves), and (vi) volatility index (9-
day implied) (margin required is calculated using +/-40% market 
moves). See, e.g., FINRA Rule 4210(g)(2)(F) and CBOE Rule 
12.4(a)(11).
    \61\ Certain portfolios are allowed offsets such that, at the 
same valuation point, for example, 90% of a gain in one portfolio 
may reduce or offset a loss in another portfolio. These offsets 
would be allowed between portfolios within the narrow-based index 
group, but not for class groups containing different individual 
equity securities or eligible products (such as options and security 
futures) as the underlying security.
---------------------------------------------------------------------------

5. The Margin Requirements Are Consistent for Comparable Exchange-
Traded Options
    Under the statutory requirement, customer margin requirements,

[[Page 36440]]

including the establishment of levels of margin (initial and 
maintenance) for security futures must be consistent with the margin 
requirements for comparable options traded on any exchange registered 
pursuant to Section 6(a) of the Exchange Act. As noted above, the 
Commissions believe that certain types of exchange-traded options, no 
matter what type of an account they are in, are comparable to security 
futures. The margin requirements for comparable exchange-traded options 
and security futures must be consistent.
    Under this proposal, the Commissions are using a stress level 
percentage set out for unhedged exchange-traded options based on an 
equity security or narrow-based index in a portfolio margin account 
(e.g., +/-15%) to establish a consistent margin level for security 
futures held outside of a securities portfolio margin account, which 
use a fixed-rate percentage of market value to set margin.\62\ While 
these two regimes reflect certain differences (in that portfolio margin 
calculates margin on a portfolio or net basis for securities with the 
same underlying position, and outside a securities portfolio margin 
account, margin is calculated on a position-by-position basis), the 
Commissions believe that these two regimes are consistent when 
comparing unhedged security futures with comparable exchange-traded 
options.
---------------------------------------------------------------------------

    \62\ While the Commissions are using a single unhedged option 
for comparison, the Commissions note that a long (short) security 
future position can be replicated by a portfolio containing one long 
(short) at-the-money call and one short (long) at-the-money put. 
This options portfolio creates a synthetic security futures 
position. The margin requirement applicable to the options 
portfolio, under approved SRO portfolio margin system rules, is also 
15%. In addition, a very deep-in-the-money call or put on the same 
security (with a delta of one) is an option contract comparable to a 
security futures contract that will also result in a consistent 15% 
margin level.
---------------------------------------------------------------------------

    As stated above, the Commissions noted in the 2001 Proposed Rules 
that ``[p]ending adoption of such [portfolio margining] systems by 
regulatory authorities, however, the 20% level is consistent with the 
current requirements for comparable equity options.'' \63\ Since the 
adoption of the SRO risk-based portfolio margin rules, subsequent to 
the adoption of the 2002 Final Rules, unhedged exchanged-traded options 
based on an equity security or a narrow-based index and unhedged 
security futures held in a securities portfolio margin account may be 
margined at 15%. As a result of these developments, the Commissions are 
proposing to reduce the margin requirement for an unhedged security 
future held outside of a securities portfolio margin account from 20% 
to 15%. Consequently, the Commissions preliminarily believe that the 
proposed level of margin is consistent with the margin requirements for 
comparable options traded on any exchange registered pursuant to 
Section 6(a) of the Exchange Act.
---------------------------------------------------------------------------

    \63\ 2001 Proposed Rules, 66 FR at 50726.
---------------------------------------------------------------------------

6. The Proposed Margin Rule Is Consistent With the Federal Reserve's 
Regulation T
    Section 7(c)(2)(B)(iv) of the Exchange Act requires that margin 
requirements for security futures (other than levels of margin), 
including the type, form, and use of collateral, must be consistent 
with the requirements of Regulation T.\64\ In the 2002 Final Rules, 
while the Commissions determined not to apply Regulation T in its 
entirety to margin requirements for security futures, the Commissions 
adopted final rules which included certain provisions that govern 
account administration, type, form, and use of collateral, calculation 
of equity, withdrawals from accounts, and the treatment of 
undermargined accounts. In the 2002 Final Rules, the Commissions stated 
that ``the inclusion of these provisions in the Final Rules satisfies 
the statutory requirement that the margin rules for security futures be 
consistent with Regulation T.'' \65\ Because the proposed amendments 
today solely relate to a reduction in the ``levels of margin'' for 
security futures, which are not required under the Exchange Act to be 
consistent with Regulation T, the Commissions preliminarily believe 
that the margin requirements for security futures as proposed to be 
amended would continue to be consistent with Regulation T.
---------------------------------------------------------------------------

    \64\ 15 U.S.C. 78g(c)(2)(B)(iv).
    \65\ 2002 Final Rules, 67 FR at 53155.
---------------------------------------------------------------------------

7. The Proposed Margin Rule Permits Higher Margin Requirements
    Again, under this proposal, the joint margin regulations will 
continue to permit SROs and security futures intermediaries to 
establish higher margin levels and to take appropriate action to 
preserve their own financial integrity.\66\ The proposed minimum margin 
requirement of 15% would apply to an unhedged position in a security 
future, whether the position is held in a securities account or a 
futures account.\67\ The 15% margin requirement for unhedged security 
futures would not preclude the use of an existing portfolio margining 
system, such as SPAN, by an FCM for security futures held in a futures 
account, so long as the portfolio margining system is modified to 
produce results that comply with the margin requirements for security 
futures.\68\
---------------------------------------------------------------------------

    \66\ See CFTC Rule 41.42(c)(1), 17 CFR 41.42(c)(1); SEC Rule 
400(c)(1), 17 CFR 242.400(c)(1).
    \67\ In its petition, OCX stated that ``because of operational 
issues at the securities firms, almost all security futures 
positions are carried in a futures account regulated by the CFTC and 
not in a securities account. The proposed joint rulemaking would 
permit customers carrying security futures in futures accounts to 
receive margin treatment consistent with that permitted under the 
[portfolio] margining provisions of CBOE.'' See OCX Petition at 2.
    \68\ For example, a SPAN risk-based portfolio margining 
methodology can be used to compute required initial or maintenance 
margin that results in margin levels that are equal to or higher 
than the margin levels required by the proposed rules. In this 
regard, for example, the minimum margin requirement for unhedged 
security futures under the proposed rules would be 15%, and SPAN 
could not recognize any offset for combination positions that is not 
permitted under SRO rules, as provided in CFTC Rule 41.45(b)(2), 17 
CFR 41.45(b)(2); SEC Rule 403(b)(2), 17 CFR 242.403(b)(2). See also 
note 27 in the 2002 Final Rules, 67 FR at 53148.
---------------------------------------------------------------------------

8. Request for Comments
    In summary, the Commissions propose that the required minimum 
margin for each long or short position in a security future shall be 
15% of the current market value of such security future. The 
Commissions request comment on all aspects of the proposed amendment to 
reduce the margin requirement to 15%. In addition, the Commissions 
request comment, including empirical data in support of the comments, 
on the following questions related to the proposal:
     As discussed above, the Commissions believe that because 
the margin requirement for a comparable option held in a portfolio 
margin account is calculated by exposing the option to market moves 
that are + /-15%, the margin methodologies for security futures and 
comparable exchange-traded options are consistent. Is the Commissions' 
belief correct? If not, why not?
     Is the proposed reduction in margin for security futures 
to 15% consistent with the margin requirements for comparable exchange-
traded option contracts based on an equity security or narrow-based 
index held in a securities portfolio margin account? Is it appropriate 
to compare the proposed margin requirement for an unhedged security 
futures position held outside a portfolio margin account to an unhedged 
exchange-traded option held in a securities portfolio margin account 
for purposes of the comparability standard in Section 
7(c)(2)(B)(iii)(I) of the Exchange Act?

[[Page 36441]]

     Are there any other comparisons or methodologies for 
comparison that the Commissions should consider in determining whether 
the proposed reduction in margin to 15% for security futures meets the 
standards in Section 7(c)(2)(B)(iii) of the Exchange Act with respect 
to comparing the margin requirements for security futures with the 
margin requirements for comparable exchange-traded options? For 
example, should the comparison or methodologies for comparable options 
be based on a specific option position (or positions) held in a 
securities portfolio margin account, such as a deep in-the-money 
options position or matched pairs of long-short options positions? If 
so, please identify the position or positions and explain how they 
would meet the comparability standards under the Exchange Act.
     Are there any other risk-based margin methodologies that 
could be used to prescribe margin requirements for security futures? If 
so, please identify the margin methodologies and explain how they would 
meet the comparability standards under the Exchange Act.

B. Margin Offsets

    The Commissions' joint margin rules permit SROs \69\ to establish 
margin levels for offsetting positions involving security futures, 
which are lower than the required margin levels for unhedged 
positions.\70\ Thus, an SRO may adopt rules that set the required 
initial or maintenance margin level for an offsetting position 
involving security futures and related positions at a level lower than 
the level that would be required if the positions were margined 
separately. Such rules must meet the criteria set forth in Section 
7(c)(2)(B) of the Exchange Act \71\ and must be effective in accordance 
with Section 19(b)(2) of the Exchange Act \72\ and, as applicable, 
Section 5c(c) of the CEA.\73\
---------------------------------------------------------------------------

    \69\ As noted above, for the sake of clarity and consistency, 
the defined term ``SRO'' is used to describe both self-regulatory 
organizations and self-regulatory authorities throughout this 
proposal.
    \70\ See CFTC Rule 41.45(b)(2), 17 CFR 41.45(b)(2); SEC Rule 
403(b)(2), 17 CFR 242.403(b)(2).
    \71\ 15 U.S.C. 78g(c)(2)(B).
    \72\ 15 U.S.C. 78s(b)(2).
    \73\ 7 U.S.C. 7a-2(c).
---------------------------------------------------------------------------

    In issuing the 2002 Final Rules, the Commissions published a table 
of offsets for security futures that the Commissions had identified as 
consistent with those permitted for similar offsetting positions 
involving exchange-traded options and that would qualify for reduced 
margin levels.\74\ The Commissions are proposing to re-publish the 
table of offsets to reflect the proposed 15% minimum margin 
requirement.
---------------------------------------------------------------------------

    \74\ See 2002 Final Rules, 67 FR at 53159. The offset table was 
published in the 2002 Final Rules. It is not part of the Code of 
Federal Regulations. See also FINRA Rule 4210(f)(10)(B)(iii), CBOE 
Rule 12.3(k)(6), OCX Rule 515(m), and Schedule A to Chapter 5 of the 
OneChicago Exchange Rulebook.
---------------------------------------------------------------------------

    As compared to the offsets identified at the time of the adoption 
of the joint margin rules, certain offsets would reflect a 15% minimum 
margin requirement for certain offsetting positions (as opposed to the 
current 20% requirement) and would retain the same percentages for all 
other offsets.\75\ There are no additional adjustments to the offsets 
table, other than minor footnote edits.
---------------------------------------------------------------------------

    \75\ The offset table lists the margin percentages for a long 
security future and a short security future. These percentages are 
the baseline, not offsets, but they are included in the table to 
preserve consistency with the earlier offset table.
---------------------------------------------------------------------------

    The Commissions preliminarily believe that the offsets identified 
in the following re-stated table are consistent with the strategy-based 
offsets permitted for comparable offset positions involving exchange-
traded options. SROs seeking to permit trading in security futures 
generally should modify their rules that impose levels of required 
margin for offsetting positions involving security futures in 
accordance with the margin percentages identified in the following 
table of offsets.

----------------------------------------------------------------------------------------------------------------
                                      Security underlying the       Initial margin          Maintenance margin
        Description of offset              security future            requirement              requirement
----------------------------------------------------------------------------------------------------------------
1. Long security future or short      Individual stock or      15% of the current        15% of the current
 security future.                      narrow-based security    market value of the       market value of the
                                       index.                   security future.          security future.
2. Long security future (or basket    Individual stock or      15% of the current        The lower of: (1) 10%
 of security futures representing      narrow-based security    market value of the       of the aggregate
 each component of a narrow-based      index.                   long security future,     exercise price \3\ of
 securities index \1\) and long put                             plus pay for the long     the put plus the
 option \2\ on the same underlying                              put in full.              aggregate put out-of-
 security (or index).                                                                     the-money \4\ amount,
                                                                                          if any; or (2) 15% of
                                                                                          the current market
                                                                                          value of the long
                                                                                          security future.
3. Short security future (or basket   Individual stock or      15% of the current        15% of the current
 of security futures representing      narrow-based security    market value of the       market value of the
 each component of a narrow-based      index.                   short security future,    short security future,
 securities index \1\) and short put                            plus the aggregate put    plus the aggregate put
 option on the same underlying                                  in-the-money amount, if   in-the-money amount,
 security (or index).                                           any. Proceeds from the    if any. \5\
                                                                put sale may be
                                                                applied.
4. Long security future and short     Individual stock or      The initial margin        5% of the current
 position in the same security (or     narrow-based security    required under            market value as
 securities basket \1\) underlying     index.                   Regulation T for the      defined in Regulation
 the security future.                                           short stock or stocks.    T of the stock or
                                                                                          stocks underlying the
                                                                                          security future.
5. Long security future (or basket    Individual stock or      15% of the current        15% of the current
 of security futures representing      narrow-based security    market value of the       market value of the
 each component of a narrow-based      index.                   long security future,     long security future,
 securities index \1\) and short                                plus the aggregate call   plus the aggregate
 call option on the same underlying                             in-the-money amount, if   call in-the-money
 security (or index).                                           any. Proceeds from the    amount, if any.
                                                                call sale may be
                                                                applied.
6. Long a basket of narrow-based      Narrow-based security    15% of the current        15% of the current
 security futures that together        index.                   market value of the       market value of the
 tracks a broad based index \1\ and                             long basket of narrow-    long basket of narrow-
 short a broad-based security index                             based security futures,   based security
 call option contract on the same                               plus the aggregate call   futures, plus the
 index.                                                         in-the-money amount, if   aggregate call in-the-
                                                                any. Proceeds from the    money amount, if any.
                                                                call sale may be
                                                                applied.

[[Page 36442]]

 
7. Short a basket of narrow-based     Narrow-based security    15% of the current        15% of the current
 security futures that together        index.                   market value of the       market value of the
 tracks a broad-based security                                  short basket of narrow-   short basket of narrow-
 index\1\ and short a broad-based                               based security futures,   based security
 security index put option contract                             plus the aggregate put    futures, plus the
 on the same index.                                             in-the-money amount, if   aggregate put in-the-
                                                                any. Proceeds from the    money amount, if any.
                                                                put sale may be
                                                                applied.
8. Long a basket of narrow-based      Narrow-based security    15% of the current        The lower of: (1) 10%
 security futures that together        index.                   market value of the       of the aggregate
 tracks a broad-based security index                            long basket of narrow-    exercise price of the
 \1\ and long a broad-based security                            based security futures,   put, plus the
 index put option contract on the                               plus pay for the long     aggregate put out-of-
 same index.                                                    put in full.              the-money amount, if
                                                                                          any; or (2) 15% of the
                                                                                          current market value
                                                                                          of the long basket of
                                                                                          security futures.
9. Short a basket of narrow-based     Narrow-based security    15% of the current        The lower of: (1) 10%
 security futures that together        index.                   market value of the       of the aggregate
 tracks a broad-based security index                            short basket of narrow-   exercise price of the
 \1\ and long a broad-based security                            based security futures,   call, plus the
 index call option contract on the                              plus pay for the long     aggregate call out-of-
 same index.                                                    call in full.             the-money amount, if
                                                                                          any; or (2) 15% of the
                                                                                          current market value
                                                                                          of the short basket of
                                                                                          security futures.
10. Long security future and short    Individual stock or      The greater of: 5% of     The greater of: (1) 5%
 security future on the same           narrow-based security    the current market        of the current market
 underlying security (or index).       index.                   value of the long         value of the long
                                                                security future; or (2)   security future; or
                                                                5% of the current         (2) 5% of the current
                                                                market value of the       market value of the
                                                                short security future.    short security future.
11. Long security future, long put    Individual stock or      15% of the current        10% of the aggregate
 option and short call option. The     narrow-based security    market value of the       exercise price, plus
 long security future, long put and    index.                   long security future,     the aggregate call in
 short call must be on the same                                 plus the aggregate call   the money amount, if
 underlying security and the put and                            in-the-money amount, if   any.
 call must have the same exercise                               any, plus pay for the
 price. (Conversion)                                            put in full. Proceeds
                                                                from the call sale may
                                                                be applied.
12. Long security future, long put    Individual stock or      15% of the current        The lower of: (1) 10%
 option and short call option. The     narrow-based security    market value of the       of the aggregate
 long security future, long put and    index.                   long security future,     exercise price of the
 short call must be on the same                                 plus the aggregate call   put plus the aggregate
 underlying security and the put                                in-the-money amount, if   put out-of-the-money
 exercise price must be below the                               any, plus pay for the     amount, if any; or (2)
 call exercise price. (Collar).                                 put in full. Proceeds     15% of the aggregate
                                                                from call sale may be     exercise price of the
                                                                applied.                  call, plus the
                                                                                          aggregate call in-the-
                                                                                          money amount, if any.
13. Short security future and long    Individual stock or      The initial margin        5% of the current
 position in the same security (or     narrow-based security    required under            market value, as
 securities basket \1\) underlying     index.                   Regulation T for the      defined in Regulation
 the security future.                                           long stock or stocks.     T, of the long stock
                                                                                          or stocks.
14. Short security future and long    Individual stock or      The initial margin        10% of the current
 position in a security immediately    narrow-based security    required under            market value, as
 convertible into the same security    index.                   Regulation T for the      defined in Regulation
 underlying the security future,                                long security.            T, of the long
 without restriction, including the                                                       security.
 payment of money.
15. Short security future (or basket  Individual stock or      15% of the current        The lower of: (1) 10%
 of security futures representing      narrow-based security    market value of the       of the aggregate
 each component of a narrow-based      index.                   short security future,    exercise price of the
 securities index \1\) and long call                            plus pay for the call     call, plus the
 option or warrant on the same                                  in full.                  aggregate call out-of-
 underlying security (or index).                                                          the-money amount, if
                                                                                          any; or (2) 15% of the
                                                                                          current market value
                                                                                          of the short security
                                                                                          future.
16. Short security future, Short put  Individual stock or      15% of the current        10% of the aggregate
 option and long call option. The      narrow-based security    market value of the       exercise price, plus
 short security future, short put      index.                   short security future,    the aggregate put in-
 and long call must be on the same                              plus the aggregate put    the-money amount, if
 underlying security and the put and                            in-the-money amount, if   any.
 call must have the same exercise                               any, plus pay for the
 price. (Reverse Conversion)                                    call in full. Proceeds
                                                                from put sale may be
                                                                applied.
17. Long (short) a basket of          Narrow-based security    5% of the current market  5% of the current
 security futures, each based on a     index.                   value of the long         market value of the
 narrow-based security index that                               (short) basket of         long (short) basket of
 together tracks the broad-based                                security futures.         security futures.
 index \1\ and short (long) a broad
 based-index future.

[[Page 36443]]

 
18. Long (short) a basket of          Individual stock and     The greater of: (1) 5%    The greater of: (1) 5%
 security futures that together        narrow-based security    of the current market     of the current market
 tracks a narrow-based index \1\ and   index.                   value of the long         value of the long
 short (long) a narrow based-index                              security future(s); or    security future(s); or
 future.                                                        (2) 5% of the current     (2) 5% of the current
                                                                market value of the       market value of the
                                                                short security            short security
                                                                future(s).                future(s).
19. Long (short) a security future    Individual stock and     The greater of: (1) 3%    The greater of: (1) 3%
 and short (long) an identical         narrow-based security    of the current market     of the current market
 security future traded on a           index.                   value of the long         value of the long
 different market \6\.                                          security future(s); or    security future(s); or
                                                                (2) 3% of the current     (2) 3% of the current
                                                                market value of the       market value of the
                                                                short security            short security
                                                                future(s).                future(s).
----------------------------------------------------------------------------------------------------------------
\1\ Baskets of securities or security futures contracts replicate the securities that compose the index, and in
  the same proportion.
\2\ Generally, unless otherwise specified, stock index warrants are treated as if they were index options.
\3\ ``Aggregate exercise price,'' with respect to an option or warrant based on an underlying security, means
  the exercise price of an option or warrant contract multiplied by the numbers of units of the underlying
  security covered by the option contract or warrant. ``Aggregate exercise price'' with respect to an index
  option means the exercise price multiplied by the index multiplier.
\4\ ``Out-of-the-money'' amounts are determined as follows:
(1) for stock call options and warrants, any excess of the aggregate exercise price of the option or warrant
  over the current market value of the equivalent number of shares of the underlying security;
(2) for stock put options or warrants, any excess of the current market value of the equivalent number of shares
  of the underlying security over the aggregate exercise price of the option or warrant;
(3) for stock index call options and warrants, any excess of the aggregate exercise price of the option or
  warrant over the product of the current index value and the applicable index multiplier; and
(4) for stock index put options and warrants, any excess of the product of the current index value and the
  applicable index multiplier over the aggregate exercise price of the option or warrant.
\5\ ``In the-money'' amounts are determined as follows:
(1) for stock call options and warrants, any excess of the current market value of the equivalent number of
  shares of the underlying security over the aggregate exercise price of the option or warrant;
(2) for stock put options or warrants, any excess of the aggregate exercise price of the option or warrant over
  the current market value of the equivalent number of shares of the underlying security;
(3) for stock index call options and warrants, any excess of the product of the current index value and the
  applicable index multiplier over the aggregate exercise price of the option or warrant; and
(4) for stock index put options and warrants, any excess of the aggregate exercise price of the option or
  warrant over the product of the current index value and the applicable index multiplier.
\6\ Two security futures are considered ``identical'' for this purpose if they are issued by the same clearing
  agency or cleared and guaranteed by the same derivatives clearing organization, have identical contract
  specifications, and would offset each other at the clearing level.

    The Commissions request comment on the re-stated table of offsets 
to reflect the proposed 15% minimum margin requirement. In addition, 
the Commissions request comment, including empirical data in support of 
the comments, on the following questions related to the re-stated table 
of offsets:
     In light of the proposed reduction in margin requirements 
for unhedged security futures from 20% to 15%, should any of the other 
percentages in the offsets table also be reduced? If so, would those 
percentages still be consistent with the margin requirements for 
comparable exchange-traded options?
     Are there offset positions in addition to those enumerated 
in the above chart that are consistent with the margin requirements for 
comparable exchange-traded options, and which the Commissions should 
consider adding to the list of offsets?
     Are there offset positions included in the above chart 
which the Commissions should delete from the list of offsets?

III. Paperwork Reduction Act

A. CFTC

    The Paperwork Reduction Act of 1995 (``PRA'') \76\ imposes certain 
requirements on federal agencies (including the CFTC and the SEC) in 
connection with their conducting or sponsoring any collection of 
information as defined by the PRA. The proposed rules do not require a 
new collection of information on the part of any entities subject to 
these rules. Accordingly, the requirements imposed by the PRA are not 
applicable to these rules.
---------------------------------------------------------------------------

    \76\ 44 U.S.C. 3501 et seq.
---------------------------------------------------------------------------

B. SEC

    The PRA\77\ imposes certain requirements on federal agencies 
(including the CFTC and the SEC) in connection with their conducting or 
sponsoring any collection of information as defined by the PRA. The 
proposed amendments do not contain a ``collection of information'' 
requirement within the meaning of the PRA. Accordingly, the PRA is not 
applicable.
---------------------------------------------------------------------------

    \77\ Id.
---------------------------------------------------------------------------

IV. Consideration of Costs and Benefits (CFTC) and Economic Analysis 
(SEC) of the Proposed Amendments

A. CFTC

1. Introduction
    Section 15(a) of the CEA requires the CFTC to consider the costs 
and benefits of its actions before promulgating a regulation under the 
CEA or issuing certain orders.\78\ Section 15(a) further specifies that 
the costs and benefits shall be evaluated in light of five broad areas 
of market and public concern: (1) Protection of market participants and 
the public; (2) efficiency, competitiveness, and financial integrity of 
futures markets; (3) price discovery; (4) sound risk management 
practices; and (5) other public interest considerations. The CFTC 
considers the costs and benefits resulting from its discretionary 
determinations with respect to the Section 15(a) factors below. Where 
reasonably feasible, the CFTC has endeavored to estimate quantifiable 
costs and benefits. Where quantification is not feasible, the CFTC 
identifies and describes costs and benefits qualitatively.
---------------------------------------------------------------------------

    \78\ 7 U.S.C. 19(a).

---------------------------------------------------------------------------

[[Page 36444]]

2. Economic Baseline
    The CFTC's economic baseline for purposes of considering the 
proposed amendment is the security futures margin rule that exists 
today. In the 2002 Final Rules, the Commissions adopted security 
futures margin rules that complied with the statutory requirements 
under Section 7(c)(2)(B) of the Exchange Act. The rules state that, 
``the required margin for each long or short position in a security 
future shall be twenty (20) percent of the current market value of such 
security future.'' \79\ The 2002 Final Rules also allow SROs to set 
margin levels lower than the 20% minimum requirement for customers with 
``an offsetting position involving security futures and related 
positions.'' \80\ In addition, the 2002 Final Rules permit certain 
customers to take advantage of exclusions to the minimum margin 
requirement for security futures.
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    \79\ CFTC Rule 41.45(b)(1), 17 CFR 41.45(b)(1). See CFTC Rule 
41.43(a)(4), 17 CFR 41.43(a)(4) (defining the term ``current market 
value.'').
    \80\ CFTC Rule 41.45(b)(2), 17 CFR 41.45(b)(2).
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    The CFTC will consider the costs and benefits of this rule proposal 
as compared with the baseline of the current minimum initial and 
maintenance margin levels for unhedged security futures, which is set 
at 20% of the current market value of such security future.
3. Summary of Proposed Amendment
    The proposed amendment would lower the minimum margin level for an 
unhedged position in a security future from 20% of its current market 
value to 15% of its current market value. In connection with this 
change, the security futures margin offsets table would be restated so 
that it is consistent with the proposed reduction in margin.
4. Description of Possible Costs
    The CFTC has preliminarily determined that, to the extent that 
there are operational or technology costs associated with modifying 
operational and administrative systems for calculating security futures 
customer margin, such costs are not likely to be significant given that 
the infrastructure for calculating such margin already exists and is 
not likely to require major reprogramming.
i. Risk-Related Costs for Security Futures Intermediaries and Customers
    There are three types of risk-related costs that could result from 
the adoption of the proposed amendment. The first risk-related cost is 
reducing margin requirements for security futures that could expose 
security futures intermediaries and their customers to losses in the 
event that margin collected is insufficient to protect against market 
moves and there is a default of a security futures intermediary or its 
customer. Pursuant to OCC's bylaws, any security futures intermediary 
that is a clearing member of OCC grants a security interest in any 
account it establishes and maintains to OCC, and therefore a customer's 
assets may be obligated to OCC upon default.\81\ As a result, FCMs 
could be exposed to a loss if the 15% margin rate for security futures 
is insufficient. However, this risk is mitigated by the fact that if a 
15% margin level is determined to be insufficient, the security futures 
intermediary has the authority to collect margin in an amount that 
exceeds the minimum requirement in order to protect its financial 
integrity.\82\
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    \81\ See OCC Bylaws, Maintenance of Accounts, Section 3, 
Interpretations and Policies .07, adopted September 22, 2003, last 
accessed on January 3, 2018, available at https://www.theocc.com/components/docs/legal/rules_and_bylaws/occ_bylaws.pdf.
    \82\ See CFTC Rule 41.42(c)(1), 17 CFR 41.42(c)(1); SEC Rule 
400(c)(1), 17 CFR 242.400(c)(1).
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    A second type of risk-related cost might arise where an FCM 
collects the minimum margin required from customers in order to 
maintain or expand its customer business. Lower margin requirements 
might facilitate an FCM permitting its customers to take on additional 
risk in their positions in order to increase business for the FCM. Such 
additional risks could put the FCM at risk if the customer were to 
default, and other customers at the FCM could risk losses if the FCM or 
one of its customers defaulted. A related third type of risk-related 
cost stems from the possibility of increased leverage among security 
futures customers. Customers posting less margin to cover security 
futures positions might be able to increase their overall market 
exposure and thereby increase their leverage.
    The second and third risk-related costs are mitigated, to some 
degree, by regulations that apply to security futures intermediaries 
that are registered as FCMs. For example, FCMs are subject to capital 
requirements under CFTC regulations,\83\ and in instances where the 
security futures intermediary is jointly registered as a broker-dealer 
FCM, the SEC's capital rules also apply.\84\ In addition, FCMs are 
required to establish a system of risk management policies and 
procedures pursuant to CFTC Rule 1.11. This risk management program is 
designed to protect the FCM and its customers against a variety of 
risks, including the potential future exposure of a security futures 
position that initial and maintenance margin is designed to address.
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    \83\ See CFTC Rule 1.17, 17 CFR 1.17.
    \84\ See SEC Rule 240.15c3-1, 17 CFR 240.15c3-1.
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    Lastly, risk-related costs to the security futures intermediary are 
further mitigated by the fact that OCX represents that the vast 
majority of its open interest is held by eligible contract participants 
(``ECPs'') as defined in Section 1a(18) of the CEA.\85\ Generally 
speaking, ECPs are financial entities or individuals with significant 
financial resources or other qualifications, that make them appropriate 
persons for certain investments.\86\ According to data provided by OCX, 
over 99% of the notional value of OCX's products was held by ECPs as of 
March 1, 2016 and March 1, 2017.
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    \85\ See also CFTC Rule 1.3, 17 CFR 1.3.
    \86\ For example, an individual can qualify as an ECP if the 
individual has amounts invested on a discretionary basis, the 
aggregate of which is in excess of: (i) $10,000,000; or (ii) 
$5,000,000 if the individual also enters into an agreement, 
contract, or transaction in order to manage the risk associated with 
an asset owned or liability incurred, or reasonably likely to be 
owned or incurred, by the individual.
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ii. Appropriateness of Margin Requirements
    A possible risk-related cost of lowering margin requirements for 
security futures is that a DCO may not have sufficient margin on 
deposit to cover the potential future exposure of cleared security 
futures positions. However, as explained above, a review of margin 
coverage data for related options on futures supports the view that 
decreasing margin requirements from 20% to 15% margin will not have a 
significant effect on the safety and soundness of the security futures 
intermediaries and DCOs. Moreover, the risk management expertise at 
security futures intermediaries and DCOs, as well as the general 
applicability of CFTC Rule 39.13 to security futures, supports a view 
that DCOs and security futures intermediaries will continue to manage 
the risks of these products effectively even with lower margin 
requirements.\87\
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    \87\ As discussed above, security futures intermediaries are 
authorized to collect margin above the amounts required by the 
Commissions. However, as for-profit entities, security futures 
intermediaries may be incentivized to lower their margin rates in 
order to compete for customer business. If security futures 
intermediaries engage in competition for business based on margin 
pricing, it is possible that security futures intermediaries will 
collect only the required level of margin (i.e., 15% under the 
proposed rule change), regardless of the market conditions, which 
could impair their ability to protect against market risk and 
losses.
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    The CFTC has reviewed the security futures markets under normal 
market

[[Page 36445]]

conditions and observed that a 15% level of margin would be sufficient 
to cover daily price moves in most instances (i.e., more than 
99.5%).\88\ Therefore, the CFTC preliminarily believes that the 
proposed amendment will not have a substantial negative impact on (1) 
the protection of market participants or the public, (2) the financial 
integrity of security futures markets, or (3) sound risk management 
practices of DCOs or security futures intermediaries.
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    \88\ Conducting a value-at-risk analysis of 74 of the most 
liquid security futures contracts during a limited time-frame 
(November 2002-June 2010), CFTC staff found that there were 195 
instances where a 15% margin was insufficient and 99 instances where 
a 20% margin was insufficient. For all observations, a 15% margin 
was sufficient for 99.81% of all observations while a 20% margin was 
sufficient for 99.91% of all observations. CFTC staff notes that 
this period covers the fall of 2008, one of the most volatile 
quarters in history. The CFTC staff also notes that since 2010, 
volatility in the equity markets has typically been lower (e.g., as 
measured by the Chicago Board Options Exchange Volatility Index 
(``VIX'')) than in the 2002 to 2010 period. In particular, the VIX, 
which measures market expectations of near term volatility as 
conveyed by stock index option prices, has, at its highest levels 
since June 2010, never reached levels higher than 48 (as compared to 
almost 90 at the peak during the financial crisis). It is therefore 
reasonable to conclude that a 15% margin would be sufficient for 
almost all days since 2010. See, e.g., VIX data available from the 
Federal Reserve Bank of Saint Louis at https://fred.stlouisfed.org/series/VIXCLS.
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    The risk customers and/or intermediaries face from reducing margin 
for security futures is addressed at the clearinghouse level because 
there are additional protections under CFTC regulations. For example, 
CFTC Rule 39.13 requires a DCO to establish initial margin requirements 
that are commensurate with the risks of each product and portfolio. In 
addition, CFTC Rule 39.13 requires that initial margin models meet set 
liquidation time horizons and have established confidence levels of at 
least 99%. These DCO initial margin requirements are distinct from the 
margin requirements that are the subject of this proposal and serve to 
mitigate the possibility that a DCO may default (resulting in a 
systemic event). In the event that a DCO determined that a 15% margin 
level for security futures is insufficient to satisfy a DCO's 
obligation under CFTC Rule 39.13, the DCO would be required to collect 
additional margin from its clearing members.\89\
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    \89\ The CFTC expects that any difference between the margin 
charged at the DCO and the margin charged by the security futures 
intermediary will be addressed by additional margin calls, if 
necessary. The DCO can require additional margin from its clearing 
members (which in some cases will be the security futures 
intermediary), to cover changes in market positions. DCOs and 
clearing members are familiar with margin call procedures and have 
established rules and policies to efficiently transfer funds when 
needed. If a customer's account has insufficient funds to meet the 
margin call, its clearing member may provide the amount to the DCO 
and collect it from the customer at a later time. In this scenario, 
the clearing member may take on a liability or additional risk on 
the customer's behalf for a short period of time. The CFTC notes 
that this practice is the same for security futures as it is for 
other products subject to clearing and it does not view this 
temporary shifting of risk between the clearing member and the 
customer as a unique source of risk to security futures. 
Furthermore, this proposed change in required margin from 20% to 15% 
would not alter the relationship between DCOs and their clearing 
members, or between clearing members and their customers. The CFTC 
acknowledges that it is possible that DCOs and security futures 
intermediaries will collect different levels of margin, but it is 
not necessarily a result of this proposed rule change. Moreover, the 
difference in margin collected is not an unmitigated source of risk 
for the security futures intermediaries because they have the 
authority to collect additional funds from their customers in the 
event of a margin call and can choose to set margin levels higher 
than the minimum level required by the Commissions.
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    The CFTC observes that the current and proposed margin requirements 
for security futures are materially distinct from initial margin 
requirements for DCOs. The initial margin requirements for DCOs are 
risk-based and designed to permit DCOs to use risk-based margin models 
to determine the appropriate level of margin to be collected, subject 
to the CFTC's minimum requirements under CFTC regulations in Part 39. 
The current and proposed margin requirements for security futures do 
not incorporate risk-based strategies or calculations. Despite 
proposing a non-risk-based margin requirement for security futures, the 
CFTC continues to support the use of risk-based margin models for all 
derivatives because use of such models are a sound way for DCOs to 
manage their clearing risks appropriately.
iii. Costs Associated With Margin Offsets Table
    The Commissions are proposing to restate the table of offsets for 
security futures to reflect the proposed 15% minimum margin 
requirement. The CFTC does not believe that lowering the margin 
requirements for certain offsets will increase costs to customers, 
security futures intermediaries, or DCOs. The categories of permissible 
offsets will remain the same and there will be no change to the inputs 
used to calculate the offset, other than to decrease the initial and 
maintenance margin on all security futures from 20 to 15%. Moreover, 
the same risk to the customers and security futures intermediaries will 
exist if the Commissions decrease the margin required for security 
futures trading combinations eligible for offsets as it will with 
security futures without an offset.
    Finally, the CFTC notes that security futures intermediaries and 
customers will continue to be required to comply with daily mark-to-
market and variation settlement procedures applied to security futures, 
as well as the large trader reporting regime that applies to futures 
accounts.
5. Description of Possible Benefits
    The CFTC has preliminarily determined that there are significant 
benefits associated with the proposed amendment. The proposed 
amendments would align customer margin requirements for security 
futures held in a futures or securities account with those that are 
held in a securities risk-based portfolio margin account. The CFTC 
believes that it would increase competition by establishing a level 
playing field between security futures carried in the SRO securities 
risk-based portfolio margining account and security futures carried in 
a futures account or a securities account.
    Additionally, the reduced minimum margin level could facilitate 
more trading in security futures, which would increase market liquidity 
to the benefit of market participants and the public. Increased 
liquidity could contribute to the financial integrity of security 
futures markets, particularly in the event an FCM finds that it must 
manage the default of a customer's security futures positions.
    The lower minimum margin requirement also might decrease the direct 
cost of trading in security futures and increase capital efficiency 
because more funds would be available for other uses. Lowering the 
minimum margin requirement also could enable the one U.S. security 
futures exchange to better compete in the global marketplace, where 
security futures traded on foreign exchanges are subject to risk-based 
margin requirements that are generally lower than those applied to 
security futures traded in the U.S.
    The proposal restates the table of offsets for security futures to 
reflect the proposed 15% minimum margin requirement. These offsets 
would continue to provide the benefits of capital efficiency to 
customers because offsets recognize the unique features of certain 
specified combined strategies and would permit margin requirements that 
better reflect the risk of these strategies. Moreover, the same 
benefits of lowering margin costs for customers and increasing business 
in security futures could result from lowering margin requirements for 
offsetting security futures positions.

[[Page 36446]]

6. Consideration of Section 15(a) Factors
    This section will discuss the expected results of the proposal to 
amend CFTC Rule 41.45(b)(1) to reduce the minimum initial and 
maintenance margin levels for each security future to 15% of the 
current market value of such contract from the current requirement of 
20% in light of the five factors under Section 15(a) of the CEA, as 
itemized above.
i. Protection of Market Participants and the Public
    The proposed amendment continues to protect market participants and 
the public from the risks of a default in the security futures market. 
As discussed above, the CFTC believes that a 15% minimum initial and 
maintenance margin requirement in combination with other protections, 
such as the general applicability of CFTC Rule 39.13 to DCOs that offer 
to clear security futures products, will protect U.S. market 
participants, including security futures customers and security futures 
intermediaries, from the risk of a default in security futures. In 
addition, security futures intermediaries, such as FCMs, are authorized 
to collect additional margin from their customer if the FCM believes a 
customer's positions may pose excessive risk.
    The existence of separate margin requirements at the DCO level 
provides assurance to the CFTC that lowering the minimum margin level 
for security futures will not present a risk to the financial 
system.\90\ In cases where the 15% margin level as determined by the 
security futures intermediary is insufficient to satisfy a DCO's 
obligation under CFTC Rule 39.13, the DCO would be required to collect 
additional margin from its clearing members. As a result, DCOs will 
always have adequate margin to manage risks presented by security 
futures.
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    \90\ See CFTC Rule 39.13, 17 CFR 39.13.
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    Finally, the CFTC staff has reviewed market activity in security 
futures and found that a 15% level of margin would be sufficient to 
cover daily price moves in a significant number of instances (i.e., 
more than 99.5%).\91\
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    \91\ See supra note 88.
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ii. The Efficiency, Competitiveness and Financial Integrity of the 
Markets
    This proposal is intended to enhance the efficiency and 
competitiveness of the security futures market in the U.S. by bringing 
the initial and maintenance margin requirements for security futures in 
line with requirements for security futures subject to an SRO risk-
based portfolio margining program.\92\ Market participants trading in 
security futures will benefit from lower margin requirements, that more 
accurately reflect their risk exposures, and they will be able to use 
their capital more efficiently in other investment opportunities. 
Furthermore, a decrease in initial and maintenance margin requirements 
from 20% to 15% of the current market value of each security futures 
contract may increase the attractiveness of the U.S. security futures 
market and may increase the competitiveness of the U.S. security 
futures market with international markets. The proposal also improves 
the competitiveness of security futures as compared to exchange-traded 
options. For example, it would help to re-establish a level playing 
field between options exchanges and the security futures exchange, and 
between broker-dealers/securities accounts and FCMs/futures accounts. 
Overall, the CFTC preliminarily believes that this proposal will have a 
positive effect on competition in the U.S. security futures market.\93\
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    \92\ The CFTC preliminarily believes that this proposal 
effectively balances the need for greater efficiency with the 
statutory requirements under Section 7(c)(2)(B)(iii) of the Exchange 
Act, which prevents the CFTC from considering any alternatives to 
this proposal that would reduce the minimum initial margin and 
maintenance margin levels for unhedged security futures below 15%. 
The CFTC worked to identify alternatives, but it does not believe 
that there are any reasonable alternatives to this proposal.
    \93\ See also the CFTC's analysis of anti-trust considerations 
in section VII. below. The CFTC has preliminarily identified no 
anticompetitive effects of this proposal.
---------------------------------------------------------------------------

    Furthermore, this proposal could enhance the financial integrity of 
the security futures market in the U.S. Lowering the amount of initial 
and maintenance margin required for customers trading in security 
futures may increase the number of customers trading in security 
futures and/or increase the amount of trading. Either an increase in 
the number of customers or trades in security futures market would 
strengthen the financial integrity of the security futures market by 
enhancing its liquidity.
    The CFTC preliminarily believes that a 15% margin requirement will 
be sufficient to protect against the risk of default in greater than 
99% of cases. After examining the economic data, the CFTC believes that 
a 15% margin requirement for security futures will protect other 
customers and DCOs against most risks of default.
    Again, the CFTC notes that the DCOs clearing security futures are 
subject to CFTC regulations requiring the DCO to maintain adequate risk 
management policies, including initial margin requirements. DCOs may 
require additional margin, in an amount that is greater than 15%, on 
certain security futures positions or portfolios if the DCO notes 
particular risks associated with the products or portfolios. 
Accordingly, the proposed rule amendment would maintain or possibly 
improve the financial integrity of the security futures markets in the 
U.S.
iii. Price Discovery
    As discussed above, the CFTC preliminarily believes that the 
proposed amendment is expected to have a positive effect on 
competition, which may result in some new customers entering the 
security futures market and increased trading by existing customers. In 
addition, trading from foreign markets may shift to the U.S. security 
futures market. This increased activity in the U.S. security futures 
market may have a positive effect on price discovery in the security 
futures market. While changes in price discovery may be difficult to 
measure, this proposal is unlikely to harm price discovery and indeed 
may improve price discovery in the security futures market in the U.S.
iv. Risk Management
    As discussed further above, margin requirements are a critical 
component of any risk management program for cleared financial 
products. Security futures have been risk-managed through central 
clearing and initial and maintenance margin requirements for over 
fifteen years. The CFTC recognizes the necessity of sound initial and 
maintenance margin requirements for DCO and FCM risk management 
programs. Initial and maintenance margin collected addresses potential 
future exposure, and in the event of a default, such margin protects 
non-defaulting parties from losses.
v. Other Public Interest Considerations
    The CFTC has not identified any additional public interest 
considerations related to the costs and benefits of this proposal.
7. Request for Comment
    The CFTC requests comment on all aspects of the costs and benefits 
associated with the proposed rule amendments, specifically, with regard 
to all Section 15(a) risk factors. In particular, the CFTC requests 
that commenters provide data and any other information or data upon 
which the commenters relied to reach any conclusions regarding the 
proposal. Finally, the CFTC seeks estimates and

[[Page 36447]]

views regarding the specific costs and benefits for a security futures 
clearing organization, exchange, intermediary, or trader that may 
result from the adoption of the proposed rule amendment.
    The CFTC seeks estimates of the costs and benefits that may result 
from the adoption of the proposed rule amendments to reduce the minimum 
margin requirement to 15% of current market value or the application of 
permitted margin offsets.

B. SEC

1. Introduction
    In the following economic analysis, the SEC considers the benefits 
and costs, as well as the effects on efficiency, competition, and 
capital formation that would result from the SEC's proposed amendments. 
\94\ The SEC evaluates these benefits, costs, and other economic 
effects relative to a baseline, which the SEC takes to be the state of 
the markets for security futures products and the regulations 
applicable to those markets at the time of this proposal.
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    \94\ The Exchange Act states that when the SEC is engaging in 
rulemaking under the Exchange Act and is required to consider or 
determine whether an action is necessary or appropriate in the 
public interest, the SEC shall consider, in addition to the 
protection of investors, whether the action will promote efficiency, 
competition, and capital formation. 15 U.S.C. 78c(f). In addition, 
Exchange Act Section 23(a)(2) requires the SEC, when making rules or 
regulations under the Exchange Act, to consider, among other 
matters, the impact that any such rule or regulation would have on 
competition and states that the SEC shall not adopt any such rule or 
regulation which would impose a burden on competition that is not 
necessary or appropriate in furtherance of the Exchange Act. See 15 
U.S.C. 78w(a)(2).
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    The amendments that the SEC is proposing would reduce minimum 
margin requirements for security futures positions held in customer 
accounts of broker-dealers \95\ not subject to an approved portfolio 
margining system. As a result of the SEC's proposed amendments, the 
minimum margin requirements on customers' unhedged security futures 
positions would be lowered to 15%.\96\ Similarly, the SEC's guidance on 
minimum margin requirements for certain hedged security futures 
positions would also be lowered in a conforming manner.\97\ The SEC's 
proposed amendments would make minimum margin requirements on security 
futures positions held in securities accounts not eligible for 
portfolio margining consistent with the minimum margin requirements 
that would currently apply to those positions were they to be held in 
separate \98\ accounts eligible for portfolio margining.\99\
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    \95\ The 2002 Final Rules established margin requirements for 
customers' security futures accounts held through ``security futures 
intermediaries'', including registered entities such as brokers, 
dealers, and FCMs. The SEC's proposed amendments affect broker-
dealers. See supra note 22 and accompanying text.
    \96\ See proposed SEC Rule 403(b)(1).
    \97\ Conforming reductions to minimum margin percentages on 
hedged security futures positions would be reflected in a 
restatement of the table of offsets published in the 2002 Final 
Rules. This table of offsets is not part of the Code of Federal 
Regulations. See 2002 Final Rules, 67 FR at 53159.
    \98\ The presence of other (related) securities in the portfolio 
margin account (e.g., positions in the underlying) could affect the 
required margin for the security futures position.
    \99\ See supra note 47 and accompanying text.
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    As discussed below, the SEC believes that the proposed rule 
amendments will primarily benefit broker-dealers offering security 
futures trading accounts that are not eligible for portfolio margining, 
their customers who trade (or wish to trade) security futures at higher 
levels of leverage than currently permitted, and exchanges that offer 
trading in security futures products.\100\ The SEC does not believe 
that the proposed rule amendments will impose any direct costs on 
market participants.
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    \100\ See infra sections IV.B.3.i. and ii.
---------------------------------------------------------------------------

    Although the SEC believes that the proposed rule amendments will 
not impose any direct costs, they could nonetheless impose various 
indirect costs. Most importantly, lower minimum margin requirements are 
likely to facilitate greater leverage, which can harm financial 
stability, imposing costs on the broader financial system. However, 
because of the very small size of the U.S. security futures markets and 
their insignificance to the broader U.S. financial markets, the SEC 
does not believe the proposed amendments will have material impact on 
financial stability.\101\ In addition, the greater leverage permitted 
under the proposed rule amendments may result in customers taking on 
additional risk. Customers who are not aware of these risks may suffer 
unexpected losses as a result.\102\
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    \101\ See infra section IV.B.2.
    \102\ See infra sections IV.B.3.i. and ii.
---------------------------------------------------------------------------

    The SEC believes that the proposed rule amendments will improve 
competition among providers of customer security futures accounts 
(i.e., FCMs and broker-dealers), and increase the potential for 
competition across security futures, options, and other related 
markets. The SEC also believes that their impact on economic efficiency 
and capital formation will be minimal.\103\
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    \103\ See infra section IV.B.3.iii.
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    Many of the costs, benefits, and other effects the SEC discusses 
are difficult to quantify. Therefore, much of the discussion is 
qualitative in nature. The SEC's inability to quantify certain costs, 
benefits, and effects does not imply that such costs, benefits, or 
effects are less significant. The lack of a quantitative analysis is 
largely due to the SEC's lack of data on the markets for security 
futures.\104\ The SEC requests that commenters provide relevant data 
and information to assist the SEC in analyzing the economic 
consequences of the proposed amendments. More generally, the SEC 
requests comment on all aspects of this initial economic analysis, 
including on whether the analysis has: (1) Identified all benefits and 
costs, including all effects on efficiency, competition, and capital 
formation; and (2) given due consideration to each benefit and cost, 
including each effect on efficiency, competition, and capital 
formation. The SEC also requests comment on any reasonable alternatives 
to the proposed rule amendments.
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    \104\ See infra sections IV.B.2. and IV.B.3.i.
---------------------------------------------------------------------------

2. Baseline
    The SEC evaluates the impact of rules relative to specific 
baselines. Here, the SEC takes the baseline to be the regulatory regime 
applicable to the markets for security futures as well as the state of 
these markets as of the end of 2017. As discussed above, the term 
``security futures'' refers to futures on a single security and futures 
on narrow-based security indexes.\105\ More generally, ``security 
futures product'' refers to security futures and options on security 
futures. Unlike futures markets on commodities or ``broad-based'' 
equity indexes, the U.S. market for security futures is currently small 
and does not play a significant role in the U.S. financial system.\106\ 
The limited role of security futures markets is likely due to their 
short history,\107\ uncertainty relating to tax treatment,\108\ and 
competition from the more developed equity and options markets.\109\ 
Incentives to participate in the security futures markets (rather than 
the markets

[[Page 36448]]

for the underlying or the options markets) arise either from reduced 
market frictions (e.g., short sale constraints, pin risk) or from a 
regulatory advantage (e.g., lower margin requirements).
---------------------------------------------------------------------------

    \105\ See supra section I.
    \106\ See infra section IV.B.2.i.
    \107\ Trading in security futures became possible only after the 
passage of CFMA in 2000. See supra notes 4 and 5, and accompanying 
text.
    \108\ Specifically, the proposition that exchange-for-physical 
single stock security futures qualify for the same tax treatment as 
stock loan transactions under Section 1058 of the Internal Revenue 
Code has not been tested. See e.g., Exchange Act Release No. 71505 
(Feb. 7, 2014).
    \109\ Security futures markets face competition from equity and 
options markets because in principle, the payoff from a security 
futures position is readily replicated using either the underlying 
security, or through options on the underlying security.
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    As with other types of futures, both the buyer and seller in a 
security futures transaction can potentially default on his or her 
respective obligation. Because of this, an intermediary to a security 
futures transaction will typically require a performance bond 
(``margin'') from both parties to the transaction. Higher margin levels 
imply lower leverage, which reduces risk. Private incentives encourage 
a counterparty that intermediates security futures transactions to 
require a level of margin that adequately protects its interests. 
However, in the presence of market failures, private incentives alone 
may lead to margin levels that are inefficient. For example, margin 
levels set by intermediaries may allow investors who do not fully 
understand the risk of security futures products to take highly 
leveraged positions that may result in unexpected losses. Moreover, 
even when all parties are fully aware of the risks of leverage, 
privately-negotiated margin arrangements may be too low. For example, 
the risk resulting from higher leverage levels can impose negative 
externalities on financial system stability, the costs of which would 
not be reflected in privately-negotiated margin arrangements. Such 
market failures provide an economic rationale for regulatory minimum 
margin requirements.\110\
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    \110\ Monetary authorities may also rely on regulatory margin 
requirements as a policy tool. The SEC does not consider such 
motives here.
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i. The Security Futures Market
    The security futures markets provide a convenient means of 
obtaining delta exposure to an underlying security.\111\ To effectively 
compete with other venues for obtaining similar exposures (i.e., equity 
and options markets), security futures markets must reduce market 
frictions or provide more favorable regulatory treatment.\112\ Security 
futures markets may reduce market frictions by providing lower cost 
means of financing equity exposures. They can simplify taking short 
positions by eliminating the need to ``locate'' borrowable 
securities.\113\ They can also provide an opportunity for customers to 
gain greater leverage through lower margin requirements (relative to 
margin in security or options transactions). The SEC does not currently 
have data on participants in the security futures markets or their 
trading motives.
---------------------------------------------------------------------------

    \111\ The derivative of the theoretical price of a futures 
contract with respect to the price of the underlying (i.e., the 
``delta'') is 1: For a $1 increase (decrease) in the price of an 
underlying security, the theoretical price of its security future 
increases (decreases) by $1.
    \112\ See supra note 109.
    \113\ In these respects, a security future functions like a 
cleared total return swap.
---------------------------------------------------------------------------

    Currently only one U.S. exchange, OCX, provides trading in security 
futures. OCX is a designated contract market regulated by the CFTC and 
a notice-registered national securities exchange.\114\ As of the end of 
2017, 13,652 security futures contracts on 1,759 names were traded on 
the exchange.\115\ Of these 13,652 contracts, 730 had open interest at 
the end of the year. Total open interest at the end of the year was 
476,430 contracts, with a gross notional value of $3 billion. Annual 
trading volume in 2017 was 15 million contracts, an increase of 39% 
from the prior year. Although growing, the security futures market is 
currently very small. For comparison, as of the end of 2017, open 
interest in equity options was 290 million contracts with annual 
trading volume of 3.7 billion contracts.\116\
---------------------------------------------------------------------------

    \114\ Section 6(g) of the Exchange Act permits a notice of 
registration to be filed by an exchange registering as a national 
securities exchange for the sole purpose of trading security futures 
products. 15 U.S.C. 78f(g). See also Rule 6a-4 (Notice of 
registration under Section 6(g) of the Act, amendment to such 
notice, and supplemental materials to be filed by exchanges 
registered under Section 6(g) of the Act). 17 CFR 240.6a-4.
    \115\ Security futures data from OCX, available at https://ftp.onechicago.com/market_data/.
    \116\ Options data from OCC, available at https://www.theocc.com/webapps/historical-volume-query.
---------------------------------------------------------------------------

    According to OCX, almost all security futures positions were 
carried in futures accounts of CFTC-regulated FCMs and introducing 
brokers (``IBs'').\117\ Consequently, the SEC believes only a small 
fraction of security futures accounts fall under the SEC's margin 
rules. The SEC believes that none of the accounts that are subject to 
the SEC's margin rules are currently using risk-based portfolio 
margining.\118\ Therefore, the SEC believes that all of the accounts 
falling under the SEC's margin rules are currently subject to the 
general margin requirement and the associated strategy-based 
offsets.\119\
---------------------------------------------------------------------------

    \117\ See OCX Petition.
    \118\ If security futures positions were held in accounts 
eligible for portfolio margining, they would be included in the 
risk-based portfolio margin calculation and thus effectively subject 
to a lower (i.e., 15%) margin requirement under the baseline. There 
are approximately 18 broker-dealers that have been approved by SROs 
to offer portfolio margining and are members of OCC to clear 
security futures. However, based on an analysis of FOCUS filings 
from year-end 2017, no broker-dealers had collected margin for 
security futures accounts subject to portfolio margining. See infra 
note 138. See also Exchange Act Release No. 54919 (Dec. 12, 2006), 
71 FR 75781 (Dec. 18, 2006) (SR-CBOE 2006-14, relating to amendments 
to CBOE's portfolio margin pilot program to include security 
futures); Exchange Act Release No. 54125 (Jul. 11, 2006), 71 FR 
40766 (Jul. 18, 2006) (SR-NYSE-2005-93, relating to amendments to 
the NYSE's portfolio margin pilot program to include security 
futures).
    \119\ See supra note 25 and accompanying text.
---------------------------------------------------------------------------

    The SEC is seeking comment on the characterization of the market 
for security futures:
     What are the principal motives for participants 
transacting in security futures? What are the advantages of these 
markets (vis-[agrave]-vis options or equity markets)? What are the 
disadvantages?
     Do customers transact in security futures through 
securities accounts ? Why or why not?
     To the extent that customers transact security futures 
transactions through securities accounts, are these accounts subject to 
portfolio margining? If not, why not?
ii. Regulation
    Under existing SEC rules the minimum margin requirement for a 
customer's unhedged security futures position not subject to an 
exemption is 20%.\120\ SROs may allow margin levels lower than 20%for 
accounts with ``strategy-based offsets'' (i.e., hedged positions).\121\ 
Strategy-based offsets can involve security futures as well as one or 
more related securities or futures positions. Accounts subject to an 
SRO's approved portfolio margining system are also exempt from the 
minimum margin requirement.\122\ Under currently approved SRO portfolio 
margining systems, the effective margin requirement for an unhedged 
exposure to a security futures position on a narrow-based index or an 
individual equity would be 15%.\123\ Under current rules, only customer 
securities accounts held through SEC-regulated broker-dealers could 
potentially be subject to portfolio margining; however, the SEC is not 
aware of any broker-dealers offering such accounts. Margin requirements 
for security futures positions of clearing members (i.e., their 
accounts at a clearing agency or DCO) are not subject to the 
aforementioned margin requirements.\124\
---------------------------------------------------------------------------

    \120\ See supra notes 20-23 and accompanying text.
    \121\ See supra note 25 and accompanying text.
    \122\ See CFTC Rule 41.42(c)(2)(i), 17 CFR 41.42(c)(2)(i); SEC 
Rule 400(c)(2)(i), 17 CFR 242.400(c)(2)(i).
    \123\ This follows from the methodology of current SRO risk-
based portfolio margining rules as applied to delta one securities. 
See supra notes 47 and 111.
    \124\ See SEC Rule 400(c)(2)(i)-(v). 17 CFR 242.400(c)(2)(i)-
(v). Clearing members are instead subject to margin rules of the 
clearing organization as approved by the SEC pursuant to Section 
19(b)(2) of the Exchange Act, 15 U.S.C. 78s(b)(2). See notes 42-44 
and accompanying text.

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[[Page 36449]]

3. Analysis of the Proposals
    The SEC is proposing to amend SEC Rule 403(b)(1) to reduce the 
minimum initial and maintenance margin levels for unhedged security 
futures to 15% from the current requirement of 20%.\125\ To the extent 
that the SROs file proposed rule changes and the SEC approves them, 
this would have the effect of reducing minimum margin on security 
futures positions held in customer securities accounts at broker-
dealers that are not currently authorized to use a portfolio margining 
system.\126\ As described in the previous section, the vast majority of 
security futures positions are held in futures accounts at CFTC-
regulated entities. Consequently, the proposed changes to the margin 
requirements are expected to have very limited effects.\127\
---------------------------------------------------------------------------

    \125\ 17 CFR 242.403(b)(1). In addition, the Commissions are 
proposing to publish a re-stated table of offsets to reflect the 
proposed reduction in margin. See section II.B. above. This table of 
offsets is not part of the Code of Federal Regulations. See 2002 
Final Rules, 67 FR at 53159. SROs seeking to permit trading in 
security futures may modify their rules to parallel the levels 
identified in the re-stated table of offsets.
    \126\ Specifically, the SEC expects broker-dealers that become 
subject to lower regulatory minimum customer margin requirements on 
security futures to reduce customer margin requirements on security 
futures positions that are currently set at the regulatory lower 
bound (i.e., 20%). See supra text accompanying note 100.
    \127\ Concurrently, the CFTC is proposing to similarly amend 
CFTC Rule 41.45(b), affecting security futures positions held in 
futures accounts at CFTC-regulated entities. See supra section II.A.
---------------------------------------------------------------------------

i. Benefits
    The SEC believes that the proposed amendment to SEC Rule 403(b)(1) 
\128\ would benefit customers currently trading security futures 
through securities accounts not subject to portfolio margining and 
whose house margin requirement is set (by the broker-dealer) to the 
current regulatory minimum. To the extent that customers with security 
futures accounts held at broker-dealers are currently subject to margin 
levels reflecting the regulatory minimums,\129\ the proposed reductions 
to margin requirements could reduce these customers' costs of engaging 
in security futures transactions, increase their liquidity, and provide 
an opportunity for greater leverage. The SEC believes that these 
benefits are likely to result in increased position-taking by 
customers, with attendant benefits to broker-dealers providing security 
futures trading accounts, and to security futures trading 
exchanges.\130\
---------------------------------------------------------------------------

    \128\ Throughout, the analysis of costs and benefits is limited 
to the effects of the SEC's rule change, and does not reflect costs 
and benefits resulting from corresponding changes to CFTC rules.
    \129\ Security futures accounts may be subject to ``house'' 
margin requirements that exceed the regulatory minimums.
    \130\ Increased position-taking by customers is expected to 
increase fees collected related to security futures transactions 
effected by broker-dealers and security futures exchanges.
---------------------------------------------------------------------------

    Based on data provided by OCX, at the end of 2017, open interest in 
the U.S. security futures markets was 476,430 contracts, with a gross 
notional value of $3 billion.\131\ SEC staff understands that 
approximately 2% of these contracts are believed to involve securities 
accounts subject to SEC margin requirements. None of these accounts are 
believed to be subject to portfolio margining.\132\ The SEC constructed 
an estimate of the upper bound of margin collected under SEC margin 
rules as the sum (across all contracts listed on OCX) of twice \133\ 
the product of: The contract settlement price, 20% (current margin 
requirement), the contract's open interest, and 2% (the fraction of 
accounts believed to be subject to SEC customer margin rules). Because 
some of the contracts held in securities accounts may be subject to 
strategy offsets (that would result in lower margin requirements), this 
represents an upper bound. The SEC estimates that the margin 
requirements on customers' security futures positions held in 
securities accounts was no more than $24 million. To the extent that 
the proposed reduction in regulatory minimums is passed on to 
customers, the SEC estimates that the amount of margin required to 
secure security futures transactions in securities accounts could be 
reduced by as much as $6 million. This reduction would benefit affected 
customers by improving their liquidity.\134\
---------------------------------------------------------------------------

    \131\ See supra note 115.
    \132\ See supra note 118.
    \133\ Both sides of a security futures contract may potentially 
be subject to SEC customer margin requirements.
    \134\ See Telser, Lester G., ``Why There Are Organized Futures 
Markets,'' The Journal of Law and Economics 24, no. 1 (Apr. 1, 
1981): 1-22.
---------------------------------------------------------------------------

    As part of this rulemaking, the Commissions are proposing to 
publish a restated table of offsets for hedged security futures 
positions.\135\ This restatement would make the table of offsets 
conform to the proposed 15% minimum margin requirement on unhedged 
positions.\136\ These revisions to the offset table would provide 
guidance consistent with the lower general margin levels on unhedged 
positions that the SEC is proposing. Because the SEC does not have data 
on specific hedged positions held in broker-dealers' customer accounts 
subject to SEC margin rules, the SEC is unable to further quantify the 
reductions in margin that would be attributable specifically to any 
potential SRO rules that follow the restatement of the offset table.
---------------------------------------------------------------------------

    \135\ See 2002 Final Rules, 67 FR at 53159.
    \136\ See 17 CFR 242.403(b)(2).
---------------------------------------------------------------------------

    The reductions to margin requirements the SEC is proposing will 
have the immediate effect of improving the liquidity of customers 
trading security futures through broker-dealer accounts. These 
improvements to liquidity could lead to increased participation in 
security futures markets with attendant benefits to broker-dealers 
providing security futures accounts, security futures exchanges, and 
clearing agencies.\137\
---------------------------------------------------------------------------

    \137\ See supra note 130.
---------------------------------------------------------------------------

    In addition, the SEC believes that the proposed rule amendments may 
reduce costs for participants in the security futures markets through 
improved operational efficiency. In particular, the customers of 
broker-dealers that do not offer portfolio margining may be able to 
avail themselves of lower margin requirements on security futures 
transactions without having to maintain separate accounts with broker-
dealers that do provide portfolio margining.
    It is not possible for the SEC to estimate broker-dealers' 
customers' sensitivity to margin requirements on security futures due 
to an absence of historical data. The SEC also does not possess data on 
current customer margin requirements (broker-dealers may set 
requirements above regulatory minimums),\138\ nor does the SEC possess 
data on broker-dealers',\139\ security futures exchanges',\140\ or 
clearing agencies' \141\ profits related to security futures 
transactions, as this information is not reported to the SEC. Because 
the SEC lacks these data, the SEC is currently unable to quantify the 
benefits to broker-dealers, security futures exchanges, and clearing 
agencies resulting from any reduction to minimum margin requirements.
---------------------------------------------------------------------------

    \138\ With respect to security futures, the SEC currently 
requires broker-dealers to provide only one item on quarterly 
regulatory filings: The amount of margin collected from accounts 
subject to portfolio margining rules (FOCUS item 4467). In the 
fourth quarter of 2017, no broker-dealer reported collecting any 
such margin; see also supra note 118.
    \139\ See id.
    \140\ OCX does not release financial statements.
    \141\ OCC's annual financial reports do not provide a breakdown 
of profits based on the type of product cleared.
---------------------------------------------------------------------------

ii. Costs
    Because broker-dealers may set customer margin levels higher than 
the proposed regulatory minimums, the proposed rule amendments do not

[[Page 36450]]

impose direct conduct costs on broker-dealers. The SEC believes that 
broker-dealers will weigh any additional private costs associated with 
lower margin requirements against the private benefits of lower margin 
requirements.\142\ In so doing they may opt to leave margins at a 
higher level than the regulatory minimum.\143\
---------------------------------------------------------------------------

    \142\ That is, in weighing the costs and benefits the SEC does 
not expect broker-dealers to consider externalities resulting from 
their choices.
    \143\ Under broker-dealer margin rules, broker-dealers also can 
establish ``house'' margin requirements as long as they are at least 
as restrictive as the Federal Reserve and SRO margin rules. See, 
e.g., FINRA Rule 4210(d).
---------------------------------------------------------------------------

    If the reduction to the minimum margin requirement on security 
futures is--as the SEC expects--passed on to customers, it will lower 
the costs of customer position taking and provide opportunities for 
greater leverage. As described above, the SEC believes this will 
generally benefit investors trading in security futures.\144\ However, 
to the extent that unsophisticated retail investors who trade security 
futures are not fully aware of the risks,\145\ reducing margin 
requirements would increase the potential for them to suffer unexpected 
losses.\146\ Thus, the proposed reduction in margin requirements could 
impose indirect costs on unsophisticated retail investors. Under the 
baseline, retail investors are believed to represent a very small 
fraction (less than 1%) of open interest in security futures. Thus, the 
SEC believes that the potential costs borne by unsophisticated retail 
investors will be low. Moreover, the ability of margin requirements to 
serve as an efficient instrument of customer protection is 
questionable.\147\
---------------------------------------------------------------------------

    \144\ To the extent that regulatory margin requirements serve a 
micro-prudential function, these benefits may be reduced or 
eliminated. However the SEC does not believe that micro-prudential 
effects are a major consideration here. See infra note 152.
    \145\ See FINRA, Security Futures--Know Your Risks, or Risk Your 
Future, available at https://www.finra.org/Investors/InvestmentChoices/P005912 and National Futures Association, Security 
Futures, An Introduction to Their Uses and Risks (2002), available 
at https://www.nfa.futures.org/members/member-resources/files/security-futures.pdf.
    \146\ The judgement of retail investors receives significant 
criticism in the academic literature. See e.g., Odean, Terrance. 
``Do Investors Trade Too Much?'' The American Economic Review 89, 
no. 5 (1999): 1279-98. See also Barber, Brad M, and Terrance Odean. 
``Trading Is Hazardous to Your Wealth: The Common Stock Investment 
Performance of Individual Investors.'' The Journal of Finance 55, 
no. 2 (April 1, 2000): 773-806. See also Heimer, Rawley Z, and Alp 
Simsek. ``Should Retail Investors' Leverage Be Limited?'' Working 
Paper. National Bureau of Economic Research, December 2017.
    \147\ Fixed margin requirements cannot differentiate between 
different types of customers (e.g., sophisticated vs. 
unsophisticated, financially constrained vs. unconstrained) or the 
risk of the position. See Figlewski Stephen, ``Margins and Market 
Integrity: Margin Setting for Stock Index Futures and Options,'' 
Journal of Futures Markets 4, no. 3 (1984): 385-416. See also FRB, A 
Review and Evaluation of Federal Margin Regulation: A Study (1984).
---------------------------------------------------------------------------

    In addition, to the extent that the proposed reductions in 
regulatory margin requirements lead broker-dealers to decrease customer 
margin requirements, they could increase the risk of the broker-dealer 
defaulting. Such a default may impose costs on the defaulting broker-
dealer's customers as well as its counterparties. However, broker-
dealers participating in security futures markets are subject to 
clearing organizations' prudential margin requirements and the SEC 
believes that such requirements are reasonably designed to mitigate the 
risk of a broker-dealers' default.\148\ In addition, the SEC believes 
that in the event of such a default, the SEC's customer protection rule 
would protect customers' assets held in a securities account.\149\
---------------------------------------------------------------------------

    \148\ See supra notes 42-44 and accompanying text.
    \149\ See Rule 15c3-3, 17 CFR 240.15c3-3. See also Applicability 
of CFTC and SEC Customer Protection, Recordkeeping, Reporting, and 
Bankruptcy Rules and the Securities Investor Protection Act of 1970 
to Accounts Holding Security Futures Products, Final Rule, Exchange 
Act Release No. 46473 (Sept. 9, 2002), 67 FR 58284 (Sept. 13, 2002).
---------------------------------------------------------------------------

    Because broker-dealers affected by the proposed amendments are 
already subject to a regulatory minimum level for customer margin 
requirements, and because they would be under no obligation to alter 
their existing customer margin requirements, the SEC believes that the 
compliance costs resulting from the proposed reduction to said minimum 
would be de minimis.\150\ In addition, the SEC does not believe that 
the affected entities would bear any additional compliance costs as a 
result of the proposed rule amendments.
---------------------------------------------------------------------------

    \150\ Under the proposed rule, broker-dealers could maintain 
existing customer margin requirements and avoid incurring any 
implementation costs.
---------------------------------------------------------------------------

    The SEC requests comments, data, and estimates on all aspects of 
the costs and benefits associated with the proposed calculations for 
margin on security futures. The SEC requests data to quantify the 
potential costs and benefits described above. The SEC seeks estimates 
of these costs and benefits, as well as any costs and benefits that the 
SEC has not identified that may result from the adoption of these 
proposed rule amendments. The SEC also requests qualitative feedback on 
the nature of the potential benefits and costs described above and any 
benefits and costs the SEC may have overlooked.
iii. Effects on Efficiency, Competition, and Capital Formation
    In addition to the specific costs and benefits discussed above, the 
reductions to margin requirements on security futures that the SEC is 
proposing may have broader effects on efficiency, competition, and 
capital formation. The SEC believes that these effects will generally 
be positive, but unlikely to be significant. The SEC discusses these 
effects in more detail in the remainder of this section. The SEC 
requests comment on all aspects of this analysis of the burden on 
competition and promotion of efficiency, competition, and capital 
formation.
a. Efficiency
    As discussed in the previous section, the SEC believes that broker-
dealers will weigh the costs associated with customer defaults against 
the benefits of lower margin requirements when setting margin 
requirements for their customers. Although private considerations would 
render market-determined margin levels optimal from a broker-dealer's 
perspective, market imperfections could lead broker-dealers to impose 
margin requirements that are not economically efficient.\151\ The 
relevant market imperfections in the context of margin requirements 
relate to externalities on financial stability arising from excessive 
leverage.\152\
---------------------------------------------------------------------------

    \151\ See supra note 142.
    \152\ The SEC acknowledges that other market imperfections 
(e.g., asymmetric information, adverse selection) may also play a 
role, although the SEC believes these to be less relevant to this 
context. Asymmetric information about market participants' quality 
can lead privately-negotiated margin levels to be inefficient. For 
example, competition among broker-dealers may lead to a ``race to 
the bottom'' in margin requirements when customers' ``quality'' is 
not perfectly observable. See e.g., Santos, Tano, and Jose A. 
Scheinkman, ``Competition among Exchanges,'' The Quarterly Journal 
of Economics 116, no. 3 (Aug. 1, 2001): 1027-61. Alternatively, 
problems of adverse selection (e.g., potential to re-invest customer 
margin in risky investments) or moral hazard (e.g., expectations of 
government rescue) may also create incentives for broker-dealers to 
offer margin requirements that are too low. Asymmetric information 
about broker-dealer quality may make it impossible for customers to 
provide sufficient market discipline, leading to a problem similar 
to that faced by bank depositors. See Dewatripont, Mathias, and Jean 
Tirole, ``Efficient Governance Structure: Implications for Banking 
Regulation,'' Capital Markets and Financial Intermediation, 1993, 
12-35.
---------------------------------------------------------------------------

    Historically, a key aspect of the rationale for regulatory margin 
requirements on securities transactions was the belief that such 
requirements could improve economic efficiency by limiting stock market 
volatility resulting from ``pyramiding credit.'' \153\ Leveraged

[[Page 36451]]

exposures built up during price run ups could lead to the collapse of 
prices when a small shock triggers margin calls and a cascade of de-
leveraging. The utility of margin requirements in limiting such 
``excess'' volatility and the contribution of derivative markets to 
such volatility have been a perennial topic of debate in the academic 
literature, rekindled periodically by crisis episodes.\154\ Most 
recently, the 2007-2008 financial crisis saw similar concerns (i.e., 
procyclical leverage, margin call-induced selling spirals) raised in 
the securitized debt markets.\155\ While the SEC believes that lower 
margin requirements can increase the risk and severity of market 
dislocations, the SEC does not believe--given the current limited scale 
of the security futures markets and the limited role played by SEC 
registrants in these markets--that the proposed reductions to minimum 
margin requirements present a material financial stability 
concern.\156\
---------------------------------------------------------------------------

    \153\ See Moore, Thomas Gale, ``Stock Market Margin 
Requirements,'' Journal of Political Economy 74, no. 2 (April 1, 
1966): 158-67.
    \154\ See id. See also Figlewski, Stephen, ``Futures Trading and 
Volatility in the GNMA Market,'' The Journal of Finance 36, no. 2 
(1981): 445-56. See also Edwards, Franklin R, ``Does Futures Trading 
Increase Stock Market Volatility?,'' Financial Analysts Journal 44, 
no. 1 (1988): 63-69. See also Kupiec, Paul H, ``Margin Requirements, 
Volatility, and Market Integrity: What Have We Learned Since the 
Crash?,'' Journal of Financial Services Research 13, no. 3 (June 1, 
1998): 231-55.
    \155\ See e.g., Adrian, Tobias, and Hyun Song Shin, ``Liquidity 
and Leverage,'' Journal of Financial Intermediation 19, no. 3 
(2010): 418-437.
    \156\ If the security futures market were to significantly 
increase in size as a result of these proposed changes or other 
factors, the impact of lower margin requirements on overall market 
stability would be greater than the minimal impact the SEC expects 
under current market conditions. However, for reasons described in 
notes 106-108 and accompanying text, above, the SEC does not believe 
this type of significant growth is likely in the foreseeable future.
---------------------------------------------------------------------------

b. Competition
    Under the baseline, risk-based portfolio margining is not available 
to customers holding security futures positions in futures accounts, 
and these positions are thus subject to the 20% margin requirement. The 
proposed reduction in margin would permit customers holding security 
futures in futures accounts to receive margin treatment consistent with 
margin treatment for customers holding security futures positions in a 
securities account permitted under the current SRO securities portfolio 
margining rules.\157\ This could establish a more level playing field 
between options exchanges and security futures exchanges, and between 
broker-dealers/securities accounts and FCMs/futures accounts.
---------------------------------------------------------------------------

    \157\ See OCX Petition.
---------------------------------------------------------------------------

    In principle, a more level playing field should enhance competition 
among broker-dealers and FCMs for security futures business. In 
practice however, the majority of security futures transactions are 
already conducted through futures accounts, and of those that are not, 
none are subject to portfolio margining.\158\ It is therefore unlikely 
that the proposed changes will have an immediate impact on competition 
among existing intermediaries of security futures transactions (i.e., 
broker-dealers and FCMs). However, it is likely that the reduction in 
margin levels will increase participation in the security futures 
markets. If sufficiently large, such increased participation may spur 
additional broker-dealers and FCMs to offer security futures trading.
---------------------------------------------------------------------------

    \158\ See supra note 118.
---------------------------------------------------------------------------

    More broadly, by aligning margin requirements applicable to a 
security futures position (which generally are not portfolio margined) 
with those applicable to equivalent options positions \159\ (which 
generally are subject to portfolio margining), the proposed amendment 
could be expected to encourage growth of the security futures market. 
The security futures market can provide a low-friction means of 
obtaining delta exposures, and relatively high margin requirements 
(vis-[agrave]-vis comparable options positions) which may have played a 
role in restraining its development. To the extent that reducing margin 
requirements leads to significant growth of this market, it may have 
additional--less direct--competitive implications. For example, 
increased liquidity in security futures may lead to increased use of 
this market to obtain short exposures, which could, in turn, adversely 
affect intermediaries' securities lending business.
---------------------------------------------------------------------------

    \159\ A long (short) security future position can be replicated 
by a portfolio containing one long (short) at-the-money call and one 
short (long) at-the-money put. The margin requirement applicable to 
the latter under approved portfolio margin systems is 15%.
---------------------------------------------------------------------------

c. Capital Formation
    The proposed rule changes are not expected to have an immediate 
material impact on capital formation. To the extent that the proposed 
reductions in margin requirements encourage significant growth in the 
security futures markets, it may, in time, improve price discovery for 
underlying securities. In particular, a more active security futures 
market can reduce the frictions associated with shorting equity 
exposures, making it easier for negative information about a firm's 
fundamentals to be incorporated into security prices. This could 
promote more efficient capital allocations by facilitating the flow of 
financial resources to their most productive uses.
    The SEC generally requests comment on all aspects of this analysis 
of the burden on competition and promotion of efficiency, competition, 
and capital formation.
iv. Alternatives Considered
    The SEC believes that reducing minimum customer margin requirements 
for security futures to a level between 15% and 20% would maintain 
inconsistencies in margin requirements across security futures and 
options, without providing significant benefits as compared to the 
proposed amendments. Accordingly, in light of the objectives of this 
particular rulemaking, and in the context of the statutory framework 
discussed above, the SEC does not believe that there are reasonable 
alternatives to the proposal to reduce the minimum initial and 
maintenance margin levels for unhedged security futures to 15%.

V. Regulatory Flexibility Act

A. CFTC

    The Regulatory Flexibility Act (``RFA'') requires that federal 
agencies, in promulgating rules, consider the impact of those rules on 
small entities.\160\ The proposed amendments will affect designated 
contract markets, FCMs, and customers who trade in security futures. 
The CFTC has previously established certain definitions of ``small 
entities'' to be used by the CFTC in evaluating the impact of its rules 
on small entities in accordance with the RFA.\161\
---------------------------------------------------------------------------

    \160\ 5 U.S.C. 601 et seq.
    \161\ Policy Statement and Establishment of Definitions of 
``Small Entities'' for Purposes of the Regulatory Flexibility Act, 
47 FR 18618, 18618-21 (Apr. 30, 1982).
---------------------------------------------------------------------------

    In its previous determinations, the CFTC has concluded that 
contract markets are not small entities for purposes of the RFA, based 
on the vital role contract markets play in the national economy and the 
significant amount of resources required to operate as SROs.\162\ The 
CFTC also has determined that notice-designated contract markets are 
not small entities for purposes of the RFA.\163\
---------------------------------------------------------------------------

    \162\ Id. at 18619.
    \163\ Designated Contract Markets in Security Futures Products: 
Notice-Designation Requirements, Continuing Obligations, 
Applications for Exemptive Orders, and Exempt Provisions, 66 FR 
44960, 44964 (Aug. 27, 2001).
---------------------------------------------------------------------------

    The CFTC has previously determined that FCMs are not small entities 
for purposes of the RFA, based on the fiduciary nature of FCM-customer

[[Page 36452]]

relationships as well as the requirements that FCMs meet certain 
minimum financial requirements.\164\ In addition, the CFTC has 
determined that notice-registered FCMs,\165\ for the reasons applicable 
to FCMs registered in accordance with Section 4f(a)(1) of the CEA,\166\ 
are not small entities for purposes of the RFA.\167\
---------------------------------------------------------------------------

    \164\ Supra note 159 at 18619.
    \165\ A broker or dealer that is registered with the SEC and 
that limits its futures activities to those involving security 
futures products may notice register with the CFTC as an FCM in 
accordance with Section 4f(a)(2) of the CEA (7 U.S.C. 6f(a)(2)).
    \166\ 7 U.S.C. 6f(a)(1).
    \167\ 2002 Final Rules, 67 FR at 53171.
---------------------------------------------------------------------------

    Finally, the CFTC notes that according to data from OCX, 99% of all 
customers transacting in security futures as of March 1, 2016 and March 
1, 2017 qualified as ECPs. The CFTC has found that ECPs should not be 
considered small entities for the purposes of the RFA.\168\ An 
overwhelming majority of the customers transacting in security futures 
currently are ECPs and are not small entities. Therefore, a change in 
the margin level for security futures is not anticipated to affect 
small entities.
---------------------------------------------------------------------------

    \168\ Opting Out of Segregation, 66 FR 20740, 20743 (Apr. 25, 
2001).
---------------------------------------------------------------------------

    Accordingly, the CFTC Chairman, on behalf of the CFTC, hereby 
certifies pursuant to 5 U.S.C. 605(b), that the proposed amendments 
will not have a significant economic impact on a substantial number of 
small entities. The CFTC invites public comments on this determination.

B. SEC

    The RFA requires that federal agencies, in promulgating rules, 
consider the impact of those rules on small entities.\169\ Section 3(a) 
\170\ of the RFA generally requires the SEC to undertake a regulatory 
flexibility analysis of all proposed rules to determine the impact of 
such rulemaking on small entities unless the SEC certifies that the 
rule amendments, if adopted, would not have a significant economic 
impact on a substantial number of small entities.\171\
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    \169\ 5 U.S.C. 601 et seq.
    \170\ 5 U.S.C. 603.
    \171\ 5 U.S.C. 605(b). The proposed amendments are discussed in 
detail in section II. above. The SEC discusses the potential 
economic consequences of the amendments in section IV. (Economic 
Analysis) above. As discussed in section III (Paperwork Reduction 
Act) above, the proposed amendments do not contain a ``collection of 
information'' requirement within the meaning of the Paperwork 
Reduction Act.
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    For purposes of SEC rulemaking in connection with the RFA,\172\ a 
small entity includes a broker-dealer that had total capital (net worth 
plus subordinated liabilities) of less than $500,000 on the date in the 
prior fiscal year as of which its audited financial statements were 
prepared pursuant to SEC Rule 17a-5(d) (under the Exchange Act),\173\ 
or, if not required to file such statements, a broker-dealer with total 
capital (net worth plus subordinated liabilities) of less than $500,000 
on the last day of the preceding fiscal year (or in the time that it 
has been in business, if shorter); and is not affiliated with any 
person (other than a natural person) that is not a small business or 
small organization.\174\ The proposed rule amendments would reduce the 
required margin for security futures from 20% to 15%. The proposed rule 
amendments would affect brokers, dealers, and members of national 
securities exchanges, including FCMs required to register as broker-
dealers under Section 15(b)(11) of the Exchange Act, relating to 
security futures.\175\
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    \172\ Although Section 601 of the RFA defines the term ``small 
entity,'' the statute permits agencies to formulate their own 
definitions. The SEC has adopted definitions for the term ``small 
entity'' for the purposes of SEC rulemaking in accordance with the 
RFA. Those definitions, as relevant to this proposed rulemaking, are 
set forth in SEC Rule 0-10 (under the Exchange Act), 17 CFR 240.0-
10. See Statement of Management on Internal Accounting Control, 
Exchange Act Release No. 18451 (Jan. 28, 1982), 47 FR 5215 (Feb. 4, 
1982).
    \173\ 17 CFR 240.17a-5(d).
    \174\ See 17 CFR 240.0-10(c).
    \175\ See SEC Rule 400(a), 17 CFR 242.400(a).
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    IBs and FCMs may register as broker-dealers by filing Form BD-
N.\176\ However, because such IBs may not collect customer margin they 
are not subject to these rules. In addition, the CFTC has concluded 
that FCMs are not considered small entities for purposes of the 
RFA.\177\ Accordingly, there are no IBs or FCMs that are small entities 
for purposes of the RFA that would be subject to the proposed rule 
amendments.
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    \176\ These notice-registered broker-dealers are not included in 
the 1,060 small broker-dealers discussed below, as they are not 
required to file FOCUS Reports with the SEC. See SEC Rule 17a-
5(m)(4), 17 CFR 240.17a-5(m)(4).
    \177\ See 47 FR 18618, 18618-21 (Apr. 30, 1982). See also 66 FR 
14262, 14268 (Mar. 9, 2001).
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    In addition, all members of national securities exchanges 
registered under Section 6(a) of the Exchange Act are registered 
broker-dealers.\178\ The SEC estimates that as of December 31, 2017, 
there were approximately 1,060 broker-dealers that were ``small'' for 
the purposes of SEC Rule 0-10. Of these, the SEC estimates that there 
are less than ten broker-dealers that are carrying broker-dealers 
(i.e., can carry customer margin accounts and extend credit). However, 
based on December 31, 2017 FOCUS Report data, none of these small 
carrying broker-dealers carried debit balances. This means these 
``small'' carrying firms are not extending margin credit to their 
customers, and therefore, the proposed rules likely would not apply to 
them. Therefore, while SEC believes that some small broker-dealers 
could be affected by the proposed amendments, the amendments will not 
have a significant impact on a substantial number of small broker-
dealers.
---------------------------------------------------------------------------

    \178\ National securities exchanges registered under Section 
6(g) of the Exchange Act--notice registration of security futures 
product exchanges--may have members who are floor brokers or floor 
traders who are not registered broker-dealers; however, these 
entities cannot clear securities transactions or collect customer 
margin, and, therefore, the proposed rules would not apply to them.
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    Accordingly, the SEC certifies that the proposed rule amendments 
would not have a significant economic impact on a substantial number of 
small entities for purposes of the RFA. The SEC encourages written 
comments regarding this certification. The SEC solicits comment as to 
whether the proposed rule amendments could have an effect on small 
entities that has not been considered. The SEC requests that commenters 
describe the nature of any impact on small entities and provide 
empirical data to support the extent of such impact.

VI. Small Business Regulatory Enforcement Fairness Act

    For purposes of the Small Business Regulatory Enforcement Fairness 
Act of 1996, or ``SBREFA,'' \179\ a rule is considered ``major'' where, 
if adopted, it results or is likely to result in:
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    \179\ Public Law 104-121, Title II, 110 Stat. 857 (1996) 
(codified in various Sections of 5 U.S.C., 15 U.S.C. and as a note 
to 5 U.S.C. 601).
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     An annual effect on the economy of $100 million or more 
(either in the form of an increase or a decrease);
     A major increase in costs or prices for consumers or 
individual industries; or
     Significant adverse effect on competition, investment or 
innovation.
    If a rule is ``major,'' its effectiveness will generally be delayed 
for 60 days pending Congressional review. The Commissions request 
comment on the potential impact of the proposed amendments for margin 
requirements for security futures on:
     The U.S. economy on an annual basis;
     Any potential increase in costs or prices for consumers or 
individual industries; and
     Any potential effect on competition, investment, or 
innovation.
    Commenters are requested to provide empirical data and other 
factual support for their view to the extent possible.

[[Page 36453]]

VII. Anti-Trust Considerations

    Section 15(b) of the CEA requires the CFTC to ``take into 
consideration the public interest to be protected by the antitrust laws 
and endeavor to take the least anticompetitive means of achieving the 
purposes of [the CEA], in issuing any order or adopting any [CFTC] rule 
or regulation (including any exemption under Section 4(c) or 4c(b)), or 
in requiring or approving any bylaw, rule, or regulation of a contract 
market or registered futures association established pursuant to 
Section 17 of [the CEA].'' \180\ The CFTC believes that the public 
interest to be protected by the antitrust laws is generally to protect 
competition. The CFTC requests comment on whether this proposal 
implicates any other specific public interest to be protected by the 
antitrust laws.
---------------------------------------------------------------------------

    \180\ 7 U.S.C. 19(b).
---------------------------------------------------------------------------

    The CFTC has considered the proposal to determine whether it is 
anticompetitive and has preliminarily identified no anticompetitive 
effects. The CFTC requests comment on whether the proposal is 
anticompetitive and, if it is, what the anticompetitive effects are.
    Because the CFTC has preliminarily determined that the proposal is 
not anticompetitive and has no anticompetitive effects, the CFTC has 
not identified any less anticompetitive means of achieving the purposes 
of the CEA. The CFTC requests comment on whether there are less 
anticompetitive means of achieving the relevant purposes of the CEA 
that would otherwise be served by adopting the proposal.

VIII. Statutory Basis

    The SEC is proposing the amendment to SEC Rule 403(b)(1) pursuant 
to the Exchange Act, particularly Sections 3(b), 6, 7(c), 15A and 
23(a). Further, these amendments are proposed pursuant to the authority 
delegated jointly to the SEC, together with the CFTC, by the Federal 
Reserve Board in accordance with Exchange Act Section 7(c)(2)(A).

Text of Rules

List of Subjects

17 CFR Part 41

    Brokers, Margin, Reporting and recordkeeping requirements, Security 
futures products.

17 CFR Part 242

    Brokers, Confidential business information, Reporting and 
recordkeeping requirements, Securities.

COMMODITY FUTURES TRADING COMMISSION

17 CFR Part 41

    For the reasons discussed in the preamble, the Commodity Futures 
Trading Commission proposes to amend 17 CFR part 41 as set forth below:

PART 41--SECURITY FUTURES PRODUCTS

0
1. The authority citation for part 41 continues to read as follows:

    Authority:  Sections 206, 251 and 252, Pub. L. 106-554, 114 
Stat. 2763; 7 U.S.C. 1a, 2, 6f, 6j, 7aa-2, 12a; 15 U.S.C. 78g(c)(2).

0
2. Amend Sec.  41.45 by revising paragraph (b)(1) to read as follows:


Sec.  41.45  Required margin.

* * * * *
    (b) Required margin. (1) General rule. The required margin for each 
long or short position in a security future shall be fifteen (15) 
percent of the current market value of such security future.
* * * * *

SECURITIES AND EXCHANGE COMMISSION

17 CFR Part 242

    In accordance with the foregoing Title 17, chapter II, part 242 of 
the Code of Federal Regulations is proposed to be amended as follows:

PART 242--REGULATIONS M, SHO, ATS, AC, NMS, AND SBSR AND CUSTOMER 
MARGIN REQUIREMENTS FOR SECURITY FUTURES

0
3. The authority citation for part 242 continues to read as follows:

    Authority:  15 U.S.C. 77g, 77q(a), 77s(a), 78b, 78c, 78g(c)(2), 
78i(a), 78j, 78ka-1(c), 78l, 78m, 78n, 78o(b), 78o(c), 78o(g), 
78q(a), 78q(b), 78q(h), 78w(a), 78dda-1, 78mm, 80aa-23, 80aa-29, and 
80aa-37.

0
4. Section 242.403 is amended by revising paragraph (b)(1) to read as 
follows:


Sec.  242.403  Required margin.

* * * * *
    (b) Required margin. (1) General rule. The required margin for each 
long or short position in a security future shall be fifteen (15) 
percent of the current market value of such security future.
* * * * *

    By the Securities and Exchange Commission.

    Dated: July 3, 2019.
Vanessa A. Countryman,
Secretary.
    Issued in Washington, DC, on July 9, 2019, by the Commodity 
Futures Trading Commission.
Christopher Kirkpatrick,
Secretary of the Commission.

    Note:  The following appendices will not appear in the Code of 
Federal Regulations.

Commodity Futures Trading Commission (CFTC) Appendices to Customer 
Margin Rules Relating to Security Futures--CFTC Voting Summary and CFTC 
Commissioner's Statement

Appendix 1--CFTC Voting Summary

    On this matter, Chairman Giancarlo and Commissioners Quintenz, 
Behnam, Stump, and Berkovitz voted in the affirmative. No 
Commissioner voted in the negative.

Appendix 2--Statement of CFTC Commissioner Dan M. Berkovitz

    I support issuing the joint notice of proposed rulemaking 
(``Proposal'') with the Securities Exchange Commission (``SEC'') 
(collectively with the CFTC, ``Commissions'') to amend the security 
futures margin requirements.
    In 2000, Congress passed the Commodity Futures Modernization Act 
(``CFMA'') which permitted security futures trading.\1\ The CFMA 
provides that customer margin requirements for security futures 
shall be set at levels that:
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    \1\ See App. E of Public Law 106-554, 114 Stat. 2,763 (2000).
---------------------------------------------------------------------------

    (1) Require (a) consistency with the margin requirements for 
comparable exchange-traded options and (b) margin levels not lower 
than the lowest level of margin, exclusive of premium, required for 
any comparable exchange-traded options,
    (2) preserve the financial integrity of markets trading security 
futures products,
    (3) prevent systemic risk, and
    (4) are and remain consistent with certain margin requirements 
established by the Federal Reserve Board under its Regulation T.\2\
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    \2\ See 15 U.S.C. 78g(c)(2)(B) (2018).
---------------------------------------------------------------------------

    The Proposal would decrease the required minimum margin from 20 
percent to 15 percent of the current market value. The Proposal 
reasons that amending the minimum required margin reflects the 
current stress level percentage of 15 percent set for unhedged 
exchange-traded options in self-regulated organization risk-based 
portfolio margining programs.\3\ This action would increase 
consistency in the markets by bringing the margin requirement for 
security futures held outside of a securities portfolio margin 
account into alignment with the margining for security futures under 
risk-based portfolio margining methodologies.\4\
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    \3\ Proposal, section II.A.5.
    \4\ See 15 U.S.C. 78g(c)(2)(B) (2018).
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    The 20 percent level was originally set by the Commissions in 
2002. Markets have

[[Page 36454]]

evolved since that time and it is appropriate to reconsider the 
margin level in light of the subsequent adoption of the risk-based 
portfolio margining programs. In doing so, the Proposal has followed 
the statutory mandate to set the security futures margin requirement 
at levels consistent with, and not lower than, levels for similar 
options.
    In conclusion, I commend the joint work by the Commissions' 
respective staffs in preparing the Proposal. The Proposal represents 
an opportunity for the Commissions to gain more knowledge about the 
security futures markets, reevaluate the status quo, and establish a 
more effective regulatory standard. I look forward to public 
comments in response to the Proposal, particularly comments that 
provide additional data and analysis regarding the appropriateness 
of the 15 percent level under each of the statutory factors the 
Commissions must consider.

[FR Doc. 2019-15400 Filed 7-25-19; 8:45 am]
 BILLING CODE 6351-01-P

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