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Federal Register, Volume 84 Issue 144 (Friday, July 26, 2019)
[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
[[Page 36434]]
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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 (http://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 (http://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.
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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 http://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).
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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).
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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.
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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).
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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
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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.
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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.
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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
—————————————————————————
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).
—————————————————————————
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
—————————————————————————
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
—————————————————————————
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
—————————————————————————
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-
index1 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 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.
—————————————————————————
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.
—————————————————————————
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).
—————————————————————————
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
—————————————————————————
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).
—————————————————————————
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.
—————————————————————————
83 See CFTC Rule 1.17, 17 CFR 1.17.
84 See SEC Rule 240.15c3-1, 17 CFR 240.15c3-1.
—————————————————————————
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.
—————————————————————————
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.
—————————————————————————
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
—————————————————————————
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.
—————————————————————————
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.
—————————————————————————
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.
—————————————————————————
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
—————————————————————————
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.
—————————————————————————
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.
—————————————————————————
90 See CFTC Rule 39.13, 17 CFR 39.13.
—————————————————————————
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
—————————————————————————
91 See supra note 88.
—————————————————————————
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
—————————————————————————
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.
—————————————————————————
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).
—————————————————————————
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
—————————————————————————
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.
—————————————————————————
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.
—————————————————————————
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
—————————————————————————
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
—————————————————————————
103 See infra section IV.B.3.iii.
—————————————————————————
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.
—————————————————————————
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.
—————————————————————————
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
—————————————————————————
110 Monetary authorities may also rely on regulatory margin
requirements as a policy tool. The SEC does not consider such
motives here.
—————————————————————————
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.
—————————————————————————
[[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 http://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
—————————————————————————
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.
—————————————————————————
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
—————————————————————————
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).
—————————————————————————
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.
—————————————————————————
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).
—————————————————————————
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.
—————————————————————————
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:
—————————————————————————
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).
—————————————————————————
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:
—————————————————————————
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
—————————————————————————
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
—————————————————————————
3 Proposal, section II.A.5.
4 See 15 U.S.C. 78g(c)(2)(B) (2018).
—————————————————————————
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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